Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, January 20, 2011

SEC Staff Releases Study on Investment Adviser Exams; Walter Expresses Support for SRO Option

Section 914 of the Dodd-Frank Act mandates that the SEC conduct a study to review and analyze the need for enhanced examination and enforcement resources for investment advisers.  The statute requires the examination of: (1) the number and frequency of examinations of investment advisers by the Commission over the five years preceding the date of the enactment (2) the extent to which having Congress authorize the Commission to designate one or more self-regulatory organizations (each, an “SRO”) to augment the Commission’s efforts in overseeing investment advisers would improve the frequency of examinations of investment advisers; and (3) current and potential approaches to examining the investment advisory activities of dually-registered broker-dealers and investment advisers (“dual registrants”) and registered investment advisers that are affiliated with a broker-dealer. The Study must also include a discussion of the regulatory or legislative steps that are recommended or that may be necessary to address the concerns identified in the Study. 

On Jan. 19 the SEC released the Study (Download 914studyfinal), which is a product of the Staff of the Division of Investment Management.  The Commission has officially expressed no view regarding the Study's analysis, findings or conclusions, although as discussed below Commissioner Walter has expressed her view independently.

The SEC reports that while the number of registered investment advisers (RIAs) and the assets managed by them have grown significantly over the past six years, the number of OCIE staff has declined over the same period.  As a result, the number and frequency of examinations have also declined during this period.

 While the anticipated decline in the number of RIAs (resulting from the increased numbers of investment advisers that will be regulated by the states) could result in a greater percentage of RIAs being examined, because of new examination obligations created by Dodd-Frank, the staff believes that the SEC will not likely have sufficient capacity to conduct effective examinations of RIAs with adequate frequency without an adequate source of stable funding.

The Study sets forth three options that Congress should consider in order to strengthen the examination program.  Specifically, it discusses:

  1. imposing user fees on RIAs to fund their examinations by OCIE;
  2. authorizing one or more SROs to examine, subject to SEC oversight, all RIAs; and
  3. authorizing FINRA to examine dual registrants for compliance with the Advisers Act.

The Study goes on to analyze the ability of user fees and one or more SROs to augment the SEC's regulation of RIAs.  It also analyzes alternatives to the current approach of examining dual registrants and RIAs that are affiliated with a broker-dealer.

The Study concludes by recommending that Congress consider the three options outlined above.

SEC Commissioner Elisse Walter released a statement (Download Walterletteron914Study) in which she expressed her disappointment with the result:

Although I voted to release the study, for the first time in my tenure as a Commissioner, I feel that it is necessary for me to write separately in order to clarify and emphasize certain facts, and ensure that Congress knows that the current resource problem is severe, that the problem will only be worse in the future, and that a solution is needed now. I have spent many years considering these issues, and have definite and clear views on them.

She goes on to state that "unfortunately, the study's description and weighing of the alternatives is far from balanced or objective."  In her view, the Study states the benefits of a user fee option without making clear that many of these benefits would be achieved under the SRO option.  The Study also attributes virtually no disadvantages to the user fee option, but many disadvantages to the SRO and FINRA dual registrant options.  She goes on to advocate for the SRO model and concludes:

Through NSMIA we have precedent, albeit limited, indicating that periodic reallocation of responsibilities for the regulation of investment advisers from the Commission to the states is not a long-term solution to enhancing the Commission’s examination and enforcement resources. We also have precedent, spanning more than seven decades, that SROs can significantly enhance the Commission’s examination and enforcement resources relating to its regulated entities. And this can and has been done through a structure in which the Commission retains and exercises comprehensive oversight and supervision of SROs. The SRO model can also be used to buttress scarce resources at the state level.
We need to address this issue now. It must not be relegated to another day—as has happened in the past. For far too long, in the investment advisory area, the Commission has been unable to perform its responsibilities adequately to fulfill its mission as the investor’s advocate, and investment advisory clients have not been adequately protected. This must change.

FINRA released the following response to the Study:

The SEC has thoughtfully evaluated the need for additional oversight of investment advisers and has rightly concluded that having the ability to leverage SRO resources could be advantageous to assisting the Commission. We agree with the SEC that an SRO can augment government oversight programs through more frequent examinations. As we have consistently stated, customers of investment advisers would benefit from the additional protection afforded by SRO oversight. Investors deserve the same level of protection regardless of whether they are dealing with a broker or investment adviser.  We also appreciate the SEC's recognition that SROs have played an important role in protecting investors in the regulation of broker-dealers

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