SEC budget woes may bolster case for creation of SRO

The impasse on Capitol Hill over the federal budget may give more ammunition to proponents of establishing a self-regulatory organization for investment advisers.

Just before its holiday recess, the Congress approved a short-term funding bill that would force the Securities and Exchange Commission to forge ahead with dozens of studies and regulations called for by the Dodd-Frank financial reform law without any extra funding.

The so-called continuing resolution will keep the government in business until March 4 at fiscal year 2010 funding levels. The SEC and other federal agencies will have to make do while a reconstituted Congress — featuring a Republican House majority and a stronger Senate GOP minority raring to reduce the size of government — sorts out whether and when it will pass a permanent budget.

Even before it had to cope with Dodd-Frank mandates, such as monitoring private equity and hedge funds, the SEC lacked the wherewithal to examine more than a small slice of advisers annually. The latest federal budget tension exacerbates SEC funding vicissitudes, potentially bolstering SRO advocates’ call for the SEC to outsource adviser oversight.

In December, Senate Republicans blocked a $1.108 trillion omnibus appropriations bill that would have given the SEC $1.3 billion more — an 18% increase over the 2010 budget of $1.118 billion and 3% more than the Obama administration’s budget request of $1.258 billion.

One of the primary arguments that backers of an adviser SRO make is that the SEC doesn’t have the resources to conduct regular adviser examinations — and that advisers receive much less oversight by the SEC than broker-dealers do from the Financial Industry Regulatory Authority Inc.

The SEC estimates that it will review only about 9% of the roughly 11,500 registered investment advisers over the next fiscal year.

“SEC funding is subject to the whims of the congressional appropriations process, whereas an SRO would be funded by the industry and thereby would have a more reliable base of resources to close the regulatory gap,” said Dale Brown, chief executive of the Financial Services Institute Inc.

Mr. Brown’s organization, which represents more than 200,000 independent broker-dealers and financial advisers, filed a comment letter with the SEC on Dec. 20 in which it advocated making Finra the SRO for advisers.

Under Dodd-Frank, the SEC must submit a study of adviser examination and enforcement to Congress by Jan. 17. In that report, the SEC may ask Congress to authorize an SRO for advisers.

“The SEC and states simply lack the resources to do the job,” Mr. Brown wrote in the FSI comment letter. “However, the existence of a well-funded, experienced self-regulatory authority dedicated to the supervision of investment advisers would allow for more-frequent examinations of these regulated entities.”

CONFLICTS OF INTEREST?

Opponents of an SRO contend that it would suffer from inherent conflicts of interest and mean higher costs and new regulatory burdens for advisers. They are especially wary of Finra because they claim it lacks accountability and transparency.

Marilyn Mohrman-Gillis, managing director of public policy and communications for the Certified Financial Planner Board of Standards Inc., said that the SEC has a history of upholding the fiduciary standard of care for investment advice and should be adequately funded to monitor advisers.

“If that is not politically possible or the SEC and Congress move toward an SRO model, any investment adviser SRO that is established should have to meet governance, experience and competency criteria suited to the oversight of fiduciary advisers,” she wrote in an e-mail. “We do not believe that Finra, with its inherent pro-broker-dealer membership bias and its long-standing opposition to the fiduciary standard of care, would meet the governance, expertise or experience qualifications that we believe should be required for effective and appropriate oversight of investment advisers.”

Broker-dealers operate under a less stringent standard of care called suitability, which requires that the financial products they recommend meet the investment needs, timelines and risk appetites of their customers.

Mr. Brown said that if Finra becomes the SRO for advisers, it will develop an oversight approach that respects their business practices.

“This is not an argument for taking Finra’s rules-based regulation of broker-dealers and simply superimposing it on investment advisers,” he said. “The goal here is to enhance investor protection.”

Even though the SEC will have to continue to operate at its current budget levels, it is unlikely that the adviser SRO study will be delayed. A study on the differences in regulation of advisers and broker-dealers, as well as on the efficacy of a universal standard of care, is due to Congress by Jan. 21.

While the SEC is likely to deliver that study on time, other dimensions of Dodd-Frank implementation already have slowed. For example, initiatives that would create investor advisory and investor advocacy offices are on hold.

LACK OF MANPOWER

In congressional testimony over the summer, SEC Chairman Mary Schapiro said that the commission would need to hire 800 new staff members to implement Dodd-Frank.

A lack of manpower could undermine regulations even after they are written, according to Barry Goldsmith, a partner at the law firm Gibson Dunn & Crutcher LLP and former chief litigation counsel in the SEC’s Division of Enforcement.

“You have rules, you have a process, but you may not have people,” he said.

Budget problems already are forcing the SEC to curtail enforcement while restricting travel, hiring and contracts.

“We believe a well-funded, effective SEC is essential for investors and the markets,” SEC spokesman John Nester wrote in an e-mail.

“Operating under the continuing resolution is already forcing the agency to delay or cut back enforcement and market oversight efforts,” he wrote.

“The longer we operate under significant budgetary restrictions, the greater the impact.”

Inability of Congress to reach an agreement on the budget is a frequent occurrence.

The SEC has had to deal with many continuing resolutions. But the Dodd-Frank mandates for more than 20 studies and nearly 100 regulations make this time different.

Beyond implementing Dodd-Frank, Ms. Schapiro has been restructuring the SEC, expanding and deepening staff skills through new hiring and upgrading technology since she took over in 2009.

“That takes money and planning,” Mr. Goldsmith said. “This [continuing resolution] could be disruptive — more so than other periods of time.”

E-mail Mark Schoeff Jr. at [email protected].