For first time, state regulators pursue more cases against RIAs than against broker-dealers

Growth of independent sector translates into more enforcement actions

Oct 24, 2018 @ 1:00 pm

By Mark Schoeff Jr.

Strong growth in the number of registered investment advisory firms brings with it the greater likelihood that they'll be enforcement targets, recent state statistics show.

In its 2018 enforcement report, the North American Securities Administrators Association said that, for the first time, state regulators pursued more registered investment advisers in disciplinary cases than broker-dealers.

In 2017, there were 377 RIA firms and investment advisers named in enforcement actions, a 32% increase over 2016, and 270 brokerages and their registered representatives named, an 11% decline. The 2018 NASAA report reflects 2017 results.

The crackdown on RIAs makes sense, given that the total number of RIA firms has grown by 20% — from 25,073 in 2008 to 30,193 in 2017 — while the number of brokerage firms has declined by 24% — from 3,969 to 3,132 — over the same period, according to an analysis by the consulting firm RIA in a Box based on an industry snapshot by the Financial Industry Regulatory Authority Inc.

Growth of the RIA sector probably won't slow down, and neither will RIA enforcement actions.

"This is unlikely to be a one-year anomaly, but more likely a continuing trend," said G.J. King, president of RIA in a Box.

The migration of RIAs from registration with the Securities and Exchange Commission to the states has also contributed to the increase in enforcement cases, according to Christopher Gerold, chief of the New Jersey Bureau of Securities and chairman of the NASAA enforcement committee.

The number of state-registered advisers grew from 13,799 in 2008 to 17,534 in 2017. The biggest jump came from 2011 to 2012, when about 3,000 RIAs switched from SEC to state registration because of a Dodd-Frank law requirement that advisers with less than $100 million in assets under management move to state oversight. Previously, that threshold was $25 million.

"States are catching up with their examination programs and bringing more actions," Mr. Gerold said. "State regulators are taking their examinations very seriously."

In putting together its enforcement report, NASAA did not survey states on the types of actions filed against RIAs. But in his practice, one compliance lawyer said the primary compliance problem he sees with small RIAs is conflicts of interest.

"A good number of IAs tend to have the same conflicts they had as B-Ds, and they're not really mitigating those conflicts," said Brian Hamburger, president of MarketCounsel. "Just because you're smaller, it doesn't give you a pass on mitigating conflicts."

An emerging problem area for state-registered RIAs is senior financial abuse. The NASAA model rule to combat senior exploitation has been adopted by 18 states. Texas opened 24 such cases in 2017.

"You're going to see more enforcement actions on senior protection at the state and federal level," Mr. King said. "RIAs can be vulnerable, given the amount of retirement business a lot of them do."

As more RIAs are subject to enforcement actions and more brokers become RIAs, the debate over whether RIAs or brokers are more heavily regulated is likely to heat up.

"Another contributing factor is that broker-dealers tend to have more robust internal compliance departments with policies and procedures in place that prevent securities violations and subsequent enforcement actions," Eleonora Zlotnikova, a securities attorney at Sam P. Israel, wrote in an email.

Mr. Gerold said the increase in state RIA enforcement reflects the fact that states are the only regulator with responsibility for small RIAs.

"I'm not saying that IAs are better or worse than B-Ds or vice versa," he said. "It's a product of who is the primary regulator of the segment of the financial market."

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