Critical steps to fix the examination gap among advisers

With the Department of Labor’s final fiduciary rule nearing release, much of our industry’s attention has rightly been focused on the harmful impacts this sweeping regulation will have on retirement investors and the financial advisers who serve them on a commission basis. Elsewhere in our industry, though, serious and persistent challenges have seemingly been moved to the back burner in recent years.

One of the most intractable issues facing firms and advisers — and the Main Street investors we serve — has been the severe imbalance in examination frequency between broker-dealer affiliated financial advisers, who are overseen by the Financial Industry Regulatory Authority Inc., and registered investment advisers, who are regulated directly by the Securities and Exchange Commission or the states, depending on their size.

Now that the SEC has begun taking steps to expand its capabilities for examining RIAs, however, we are pleased to see that real progress is being made. We also applaud the work of state regulators who managed a relatively seamless transition of thousands of smaller RIAs from the SEC to state oversight as a result of Dodd-Frank.

The challenges of monitoring RIAs have been well documented. While broker-dealer affiliated advisers can expect to undergo Finra examinations every two years, RIAs have been examined by the SEC only once every 10+ years, on average. Ensuring proper investor protection is simply not feasible under such an infrequent examination schedule.

Fortunately, the SEC’s recent measures represent a serious effort to address this problem. The commission is using the expanded funding it received as part of the omnibus spending bill passed late last year to further bulk up its staff of examiners. The regulator says its current process of hiring new examiners and re-tasking others will result in 100 more professionals focused on RIA examinations — an increase of 20% versus its current headcount.

While some have objected to the commission’s approach of shifting resources from examinations of broker-dealer affiliated advisers to focus instead on the RIA sector, we believe that this shift makes a great deal of sense, given Finra’s extensive resources and track record of conducting regular examinations in the broker-dealer space.

The SEC is also considering allowing third-party firms to perform examinations of RIAs; these third-party examiners would then pass their findings on to the SEC. RIAs would be mandated to undergo such examinations at pre-determined intervals and would shoulder the cost of the service themselves, freeing up the SEC’s own personnel to fulfill valuable supervisory functions.

We are pleased to see the SEC engaging once again with the issue of examination disparity within our industry. With that said, there are additional steps and safeguards we hope the commission will consider as it moves forward in this effort.

One key consideration that could further improve efficiency and examination outcomes in both the RIA and broker-dealer sectors is closer coordination of exam activity between the SEC and FINRA. Both regulators work hard to share information and collaborate effectively, and have made significant progress on this point in recent years. Unfortunately, many of our broker-dealer member firms still report instances in which an examination by one regulator was followed soon after by a separate examination by the other. These firms have also noted that, in many cases, information provided to one regulator did not reach the other, resulting in duplicative requests for data or documents.

In addition, we hope that the SEC will work to guard against any dilution in training standards, even as it seeks to enlarge the pool of examiners. As our members can attest, an examination conducted by a team that does not have a strong grasp of the financial advice industry -– and of the independent channel specifically -– can be distracting and unproductive for firms, clients and, ultimately, the regulators themselves. Maintaining strong training standards will become increasingly important as the RIA sector continues to grow in the years ahead.

Further, if the effort to allow third-party examiners moves forward, we would encourage the commission to be as transparent as possible in communicating the standards by which these examiners will be chosen and the processes they will need to follow in evaluating RIAs. We hope the SEC will establish firm examination standards that will be fixed and consistent across examiners to prevent firms from “shopping around” for more lenient evaluations.

The SEC’s renewed focus on the critical issue of ensuring robust investor protections throughout the financial advice industry by increasing the frequency of RIA examinations is a positive sign for our industry. The Financial Services Institute (FSI) looks forward to leveraging our strong relationships with the SEC and other industry regulators to serve as a resource on this crucial topic.

By taking a balanced and informed approach to this persistent challenge, we are confident that the SEC and members of our industry can work together to develop solutions that work for all advisers and their clients -– no matter the adviser’s business model.