Maybe the shift from the SEC to state regulation won't be as bad as critics are making it out to be, but observers predict that some advisers will resort to “creative accounting” and “flat-out lying” to avoid having to change their registration.
Under the Dodd-Frank financial reform law, any firm with less than $100 million in assets under management will be regulated by state regulators. Previously, only firms with less than $25 million in assets fell under the states' purview. Everyone else was regulated by the SEC.
Observers said it will not be easy for the 4,000 or so firms expected to have to change their registration. The paperwork, for one thing, is going to be onerous, they said.
“There's a nasty surprise coming for a lot of people,” said Dave Campbell, president of Nye Co., a compliance consultant in Palo Alto, Calif.
He said that for each client coming under state regulation, California requires a financial statement, a financial-ratio worksheet, tests for net capital and a record of reconciling bank statements.
“The state regulators in Michigan want agreements with clients all referencing the state [laws] ... so every single contract has to be rewritten and resigned” with state registration, said Gerald VanderLugt, owner and chief compliance officer at JVL Associates LLC in Wyoming, Mich. With $102 million in assets under management, Mr. VanderLugt's firm is right at the threshold.
“I suspect there will be some creative accounting to get over the $100 million,” Mr. Campbell said.
Some will resort to “flat-out lying,” said Zachary Gronich, owner of RIA in a Box, a compliance consultant. “We don't recommend that, but I think you'll see it” because of the expense to re-register.
FINAL RULES
Last fall, the Securities and Exchange Commission proposed rules for “the switch,” as the re-registration process is called. The agency is evaluating comments on the proposal and is expected to approve final language before summer.
The SEC proposed that by Aug. 20, advisory firms will have to calculate assets under management and determine if they're still eligible for SEC registration. If not, they'll have to re-register with states by Oct. 19. The dates could change in the final rules.
Making life even tougher, the SEC has proposed a 90-day transition process for registering with states, which is shorter than the 180-day transition period that SEC rules now provide for advisers making a switch.
The time frame is shorter “in order to promptly implement this congressional mandate,” the SEC said in its rule proposal.
To expedite the process, advisers should file for registration in states in which they may need to be registered, said Melanie Lubin, Maryland securities commissioner and head of the committee of the North American Securities Administrators Association Inc. known as the “switch team.”
Advisers should be able to remain on pending status while states review them, and then be ready if they need to switch, she said.
“They'll avoid the rush that way,” Ms. Lubin added.
“States do a thorough review when someone gets registered,” starting with client agreements and advisers' disciplinary histories, she said,
Ms. Lubin downplayed any differences among state requirements, noting that all states use the Form ADV for registration and that advisers are already providing the SEC with some financial information states require.
Meanwhile, advisers whose assets fluctuate around the $100 million threshold are worried about flip-flopping between state and SEC registration.
That's because the SEC is proposing to do away with the current $5 million buffer that advisers have had with the old $25 million threshold. That buffer has helped advisers avoid registration changes caused by normal flows and market moves, observers said.
“I don't see any advantage in doing away with the buffer,” said Jean Fullerton, a partner at WJM Financial LLC of Bedford, N.H., which has just under $100 million under management.
In its rule filing, the SEC argued that a buffer is not needed since advisers calculate assets just once a year to determine their regulatory status, and have a grace period to change registrations.
Mr. Gronich thinks the SEC will incorporate a buffer in a final rule.
As the conversion time approaches, “I think the SEC will see a bunch of advisers that might have to reverse back,” he said.
Compliance consultants expect most advisers who are on the edge will want to be SEC-registered. There is a prestige factor in being a larger, SEC-registered firm, and dealing with one regulator instead of several states is seen as more efficient.
E-mail Dan Jamieson at [email protected].
