The Securities and Exchange Commission's move to expand its examinations of advisory firms to include going directly to clients for verification of their assets managed by advisers raises legitimate concerns.
The Securities and Exchange Commission's move to expand its examinations of advisory firms to include going directly to clients for verification of their assets managed by advisers raises legitimate concerns.
Financial advisers are worried that clients who receive such requests will suspect that something fishy is going on — even if the requests are posed as "routine."
Another concern is the prospect of defending one's integrity to a client — or even losing their business — because of a tactless or unthinking remark by an SEC examiner.
Who can blame advisers for worrying about regulatory overreach? Imagine an investigator from a state health department calling on patients to see whether they were accurately diagnosed by their doctor or an examiner from a state bar association randomly calling a law firm's clients to inquire about the ethics of a particular lawyer.
That is exactly what the SEC plans to do in the financial advice industry. And it is doing it at a time when significant financial losses have frayed the bond of trust between advisers and clients.
A more measured approach is needed.
Rather than randomly calling on clients to verify their holdings, the SEC should limit its requests for information to clients of advisers who are strongly suspected of fraud or other illegal activities. After all, for the vast majority of advisers, the SEC can verify assets by dealing directly with broker-dealers and third-party custodians — leaving the client completely out of the loop.
Another option is for the SEC to call only on clients of advisers who have custody of their own assets. If the SEC learned nothing else from the scandal involving Bernard Madoff, it is that firms that have self-custody of client assets need to be watched more carefully than those that don't.
Either way, the risk of raising unfounded concerns about the integrity of good advisers would be minimized dramatically.
Despite our concerns, we applaud the SEC's efforts to expand the scope and thoroughness of its examinations to include input from end users. Had Mr. Madoff's clients been asked by examiners to verify their holdings, the extent of his thievery might have been lessened.
And given the myriad ways in which wealthy investors, as well as those of modest means, have been victimized in recent years by Ponzi schemes, unscrupulous mortgage brokers and dishonest financial advisers, the SEC should be applauded for its creative efforts to ferret out criminals masquerading as advisers.
Despite some misgivings, honest advisers have little to fear about the move by the SEC. After all, the commission has promised to make it clear to clients that requests for information shouldn't be construed as a reflection on the adviser, or as an implication that any violation of the law has occurred.
Given that the SEC has already made clear its intention to begin calling on investors, now is the time for advisers to be proactive in informing clients of the new procedures. That way, advisers can help alleviate any anxiety that might result from an unanticipated telephone call or letter from an SEC examiner.
It is also a good opportunity for advisers to reassure clients about the soundness of their investment decisions and the benefits of due diligence.
