An idea worthy of serious consideration has emerged from the contentious battle over how investment advisers should be regulated. A report released this month by James J. Angel, a professor at Georgetown University,
suggested allowing advisory firms to pick an outside accountant to perform routine compliance exams, rather than relying on government auditors or a self-regulatory organization. Under such a system, outside auditors registered with the Public Company Accounting Oversight Board would be responsible for verifying information contained in ADV forms and make sure that firms are in compliance with U.S. securities law.
The frequency and thoroughness of the exam would depend on the firm's history of compliance and the level of risks associated with its size and business activities, according to the report, which was sponsored by TD Ameritrade Holding Corp. That means that large firms or those with spotty compliance records would be examined more rigorously.
No firm, however, would go more than five years without being audited, Mr. Angel told the
InvestmentNews editorial board last week. Now the SEC can examine a firm once every 11 years.
It is worth noting that his idea isn't entirely without precedent.
The PCAOB already oversees the audits of broker-dealers, including compliance reports filed pursuant to federal securities law. Furthermore, the Securities and Exchange Commission requires registered investment advisers that hold custody of customer assets to submit to annual surprise audits by outside audit firms.
The brokerage industry, which believes current investment adviser oversight is too lax and wants RIAs brought under the umbrella of the
Financial Industry Regulatory Authority Inc., claims the use of outside auditors is inadequate to the task.
The proposal is a “nonstarter,” Chris Paulitz, a spokesman for the Financial Services Institute Inc., wrote in an e-mail. “Bernie Madoff was subject to the supervision of an auditing firm he handpicked, and we all know how effective that turned out to be.”
Ira Hammerman, general counsel of the Securities Industry and Financial Markets Association, wrote in an e-mail: “Using accounting or auditing firms to do the job simply would not offer the level of protection and oversight that retail investors deserve under a [proposed] uniform [fiduciary] standard.”
Although rough, Mr. Angel's vision for the way advisers are overseen is infinitely better than what exists.
At this point, it still would be preferable for investment advisers to be regulated by a well-structured SRO, or even two. But the idea of allowing seasoned accounting, auditing and compliance firms to monitor the industry shouldn't be dismissed.
The main benefit of such a plan is that it could be implemented quickly and at relatively low cost, provided that the auditing firms adhered to strict guidelines governing the scope of their exams. It also would bypass much of the political obstructionism that would likely be involved in setting up an SRO or giving the job to Finra.
That said, there are a few modifications that could be made.
Rather than allow firms to handpick their own auditors, a better system might be a pool of “qualified auditors,” randomly assigned to oversee particular investment advisers. Those auditors would fall under the jurisdiction of the PCAOB, which itself is monitored by the SEC. Of course, the auditors would be required to adhere to a predetermined fee schedule based on the size and complexity of the firm being audited.
All firms would be audited at least once every three years, regardless of how clean their businesses were.
If nothing else, Mr. Angel's ideas deserve serious consideration and may represent some sort of middle ground between the status quo and the creation of a new SRO or SROs.
