Securities Law Prof Blog

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

Saturday, September 10, 2011

Who Should Regulate Investment Advisers?

In previous posts I described the debate over a uniform fiduciary duty standard for investment advisers and broker-dealers.  Another significant difference between investment advisers and broker-dealers is their regulatory framework.  The SEC or the states, in the case of small and mid-sized firms, regulate investment advisers, while FINRA is the primary regulator of broker-dealers, with the SEC providing oversight of the SRO.   A longstanding controversy is whether the principal regulator for investment advisers should continue to be the SEC or whether a self-regulatory organization should be established for the industry along the line of the FINRA model.   The Investment advisory industry has long opposed creation of an SRO, but interest in this issue was renewed, in part because of the SEC’s failure to uncover Bernard Madoff’s  Ponzi scheme. 

This post describes recent developments, in particular the SEC staff’s study mandated by  Section  914 of the Dodd-Frank Act.   On Sept. 13, 2011 the Capital Markets Subcommittee of the House Financial Services Committee will hold a hearing on “Ensuring Appropriate Regulatory Oversight of Broker-Dealers and Legislative Proposals to Improve Investment Adviser Oversight.”  It has released a discussion draft of a bill that would provide for the registration and oversight of national investment adviser associations.

The SEC Staff’s Section 914 Study.  Section 914 mandated an SEC study to review and analyze the need for enhanced examination and enforcement resources for investment advisers.  The statute required the examination of: (1) the number and frequency of examinations of investment advisers by the Commission over the past five years;  (2) the extent to which having Congress authorize the Commission to designate one or more self-regulatory organizations 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 statute also directed the study to include recommendations to address the concerns identified in the Study.

On Jan. 19, 2011 the SEC released the Study, which is a product of the Staff of the Division of Investment Management.  The Commission officially expressed no view regarding the Study's analysis, findings or conclusions, although, as discussed below,  Commissioner  Elisse Walter expressed her views independently.

The SEC staff 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 OCIE examined eighteen percent of RIAs in 2004, only nine percent were examined in 2010.   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, in fact the staff believes that, because of new examination obligations created by Dodd-Frank, 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’s bottom line:

the Staff believes that the Commission likely will not have sufficient capacity in the near or long term to conduct effective examinations of registered investment advisers with adequate frequency. The Commission’s examination program requires a source of funding that is adequate to permit the Commission to meet the new challenges it faces and sufficiently stable to prevent adviser examination resources from periodically being outstripped by growth in the number of registered investment advisers (i.e., it requires resources that are scalable to any future increase ― or, for that matter, decrease ― in the number of registered investment advisers).

The study went on to discuss three options for Congress to consider:

(1) imposing user fees on SEC-registered investment advisers to fund their examinations by OCIE;
(2) authorizing one or more SROs to examine, subject to SEC oversight, all SEC-registered investment advisers; and
(3) authorizing the Financial Industry Regulatory Authority (“FINRA”) to examine dual registrants for compliance with the Advisers Act.

With respect to the user fee option, the study noted that many other federal agencies impose user fees as an important source of revenue and suggested that this option may be less expensive than establishing one or more SROs.  It also observed that OCIE has already invested resources into improving the examination program that presumably would be lost if the responsibility was delegated to an SRO.

With respect to establishing one or more SROs, the staff noted that the SEC would still have costs associated with SRO oversight and that the costs of designing and implementing one or more SROs would be considerable.  It also noted the opposition of industry leaders.

Finally, with respect to the option of FINRA regulating dual registrants, the study recognized that authorizing FINRA to conduct examinations of dual registrants would free up SEC resources.  The study, however, saw disadvantages because the SEC staff would lose experience examining the large retail firms that are dual registrants as well as insights gained in the field.

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

Commissioner Walters's Statement.  SEC Commissioner Elisse Walter released a separate statement at the time the study was publicly released, in which she expressed her disappointment with it:

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.

In her view, "unfortunately, the study's description and weighing of the alternatives is far from balanced or objective," because it attributed virtually no disadvantages to the user fee option, but many disadvantages to the SRO and FINRA dual registrant options.  She went on to advocate for the SRO model and concluded:

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’s Advocacy.  Richard Ketchum, FINRA’s CEO, has made clear that the SRO is willing and able to take on the regulation of investment advisers.  In a March 22, 2011 speech, Mr. Ketchum addressed the opposition of investment advisory industry based on its concern that FINRA was not sensitive to the different regulatory risks of investment advisers:

If FINRA became the SRO for some or all investment advisers, we would have no intention to force the full suite of specific broker-dealer requirements on investment advisers.  That would not be appropriate or in the public interest.  The regulatory concerns regarding investment advisers primarily relate to the lack of examination resources, which places advisory clients at unacceptable risk….That’s a service FINRA is well-positioned to provide.

CFA’s Testimony.  The investment advisory industry and investor advocates have long opposed creation of an SRO to regulate investment advisers and, in particular, have opposed FINRA’s taking on this responsibility.  However, the tide may have turned this summer when Barbara Roper, Director of Investor Protection,  Consumer Federation of America, testified before  the Senate Banking Committee.   Ms. Roper stated

In the past, CFA has categorically opposed delegating investment adviser oversight to an SRO, particularly one dominated by broker-dealer interests and particularly if that SRO were given rule-making authority. We continue to believe the user-fee approach outlined in the SEC report offers the best option for funding enhanced inspections in a way that promotes investor protection while minimizing added costs to industry.
However, having spent the better part of two decades arguing for various approaches to
increase SEC resources for investment adviser oversight with nothing to show for our efforts, we have been forced to reassess our opposition to the SRO approach. Specifically, we have concluded that a properly structured SRO proposal would be a significant improvement over the status quo.

Discussion Draft: “Investment Adviser Oversight Bill of 2011.”  As noted earlier, in connection with its Sept. 13, 2011 hearing on “Ensuring Appropriate Regulatory Oversight of Broker-Dealers and Legislative Proposals to Improve Investment Adviser Oversight,”   the House Financial Services Committee released a discussion draft of a bill that would provide for the registration and oversight of national investment adviser associations.  The bill would amend the Investment Advisers Act of 1940 to require any investment adviser (either registered with the SEC or with state authorities) to be a member of a registered national investment adviser association.  In turn, the act provides a procedure for an association of investment advisers to register with the SEC as a national investment adviser association and sets forth requirements for registration.  The SEC would provide oversight of the SRO, similar to existing SROs, including approval of SRO rules.  In a press conference accompanying release of the draft bill, Senator Bachus spoke highly of FINRA.

Stay tuned for later developments!

September 10, 2011 in Other Regulatory Action, SEC Action | Permalink | Comments (0) | TrackBack (0)

Thursday, September 8, 2011

House Committee Posts Witness List for Hearing on Regulation of Securities Professionals

The Capital Markets Subcommittee of the House Financial Services Committee has posted the list of witnesses for the Sept. 13, hearing entitled “Ensuring Appropriate Regulatory Oversight of Broker-Dealers and Legislative Proposals to Improve Investment Adviser Oversight.”   It has also posted a discussion draft of a bill for the registration and oversight of national investment adviser associations.


  • Mr. William E. Dwyer III, Chairman, Financial Services Institute
  • Mr. Ken Ehinger, President and Chief Executive Officer, M Holdings Securities, Inc., on behalf of the Association for Advanced Life Underwriting
  • Mr. Terry Headley, President, National Association of Insurance and Financial Advisors
  • Mr. Steven D. Irwin, Commissioner, Pennsylvania Securities Commission, on behalf of the North American Securities Administrators Association
  • Mr. Richard G. Ketchum, Chairman and Chief Executive Officer, Financial Industry Regulatory Authority
  • Ms. Barbara Roper, Director of Investor Protection, Consumer Federation of America
  • Mr. John G. Taft, Chief Executive Officer, RBC Wealth Management, on behalf of the Securities Industry and Financial Markets Association
  • Mr. David Tittsworth, Executive Director/Executive Vice President, Investment Adviser Association



September 8, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Massachusetts Adviser Charged with Forex Fraud

The SEC filed a civil injunctive action in federal district court in Massachusetts against registered investment adviser EagleEye Asset Management, LLC, and its sole principal, Jeffrey A. Liskov, in connection their fraudulent conduct toward advisory clients.  According to the SEC, between at least April 2008 and August 2010, Liskov made material misrepresentations to nearly a dozen advisory clients to induce them to liquidate investments in securities and invest the proceeds in foreign currency exchange (“forex”) trading. These investments, which were not suitable for older clients with conservative investment goals, resulted in steep losses for clients, totaling nearly $4 million, but EagleEye and Liskov came away with over $300,000 in performance fees on these investments alone, in addition to other management fees they collected from clients.

According to the Commission’s complaint, Liskov’s material misrepresentations to clients concerned the nature of forex investments, the risks involved, and his expertise and track record in forex trading. As to some clients, Liskov did not explain what forex trading was at all. As to other clients, Liskov downplayed the risks of forex investments. Liskov also falsely told several clients that he had had prior success in forex trading, when in fact he had lost substantial sums of his own or other clients’ money in forex trading when he made such statements.

The Commission seeks a permanent injunction, disgorgement of ill-gotten gains plus prejudgment interest thereon, and the imposition of a monetary penalty against both EagleEye and Liskov.

The Commodity Futures Trading Commission and Secretary of the Commonwealth of Massachusetts William F. Galvin also filed related cases.

September 8, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, September 7, 2011

CFPB Seeks Input on Financial Products Tailored to Military

The Consumer Financial Protection Bureau (CFPB) today announced that it is seeking public input on consumer financial products and services tailored to servicemembers and their families. The information provided will help the CFPB’s Office of Servicemember Affairs to develop financial education and outreach initiatives for military families.  The OSA is seeking information on:

Products and Services: The consumer financial products and services that are currently offered to or used by servicemembers and their families, including those that are specifically tailored to their unique financial needs.

Education: The financial education opportunities that are offered to servicemembers and their families, both in person and online.

Programs: The types of programs, policies, accommodations, and benefits that financial service providers currently provide to servicemembers and their families that may exceed those required by statute.

Homeowner Assistance: The types of unique assistance offered by financial service providers to servicemembers and their families who are distressed homeowners, such as: mortgage modifications; accommodations for servicemembers with Permanent Change of Station Orders; and assistance for wounded, ill or injured servicemembers or surviving spouses of deceased servicemembers.

Marketing and Communication: The marketing and communication strategies that are currently used to inform servicemembers and their families of consumer financial products and services, and those that are most and least effective.

Public comments are due 14 days after the notice is published in the Federal Register.

September 7, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

FINRA Fines 5 Firms for Improper Handling Fees

The FINRA fined five broker-dealers for understating the amount of total commissions charged to customers in trade confirmations and on fee schedules by mischaracterizing a portion of the commission charges as fees for handling services. With respect to each of these firms, the handling fees were designed to serve as a source of additional transaction based remuneration for the firm and were far in excess of the cost of the handling-related services the firms provided.

The cases resulted from a targeted review of improper fees charged by broker-dealers in which FINRA found that the firms were routinely charging customers for handling fees that far exceeded the actual cost of the direct handling-related services the firms incurred in processing securities transactions. In some cases, firms charged a handling fee of almost $100 per transaction and earned a substantial percentage of their revenue from these fees.

FINRA sanctioned the following firms:

  • Pointe Capital, Inc. (nka JHS Capital Advisors, Inc.), of Boca Raton, Florida, was fined $300,000. The firm charged customers a handling fee as high as $95 per trade in addition to a commission. (Additional violations included inadequate supervisory procedures.)
  • John Thomas Financial, of New York, NY, was fined $275,000. The firm charged its customers a handling fee as high as $75 per trade in addition to a commission. (Additional violations included effecting material changes in its business operations without prior approval from FINRA, and deficiencies in complaint reporting, supervisory controls and certifications, branch office supervision and recordkeeping.)
  • First Midwest Securities, Inc., of Bloomington, IL, was fined $150,000. The firm charged customers a handling fee as high as $99 per trade in addition to a commission. (Additional violations included unfair and unreasonable markups/markdowns and inadequate written supervisory procedures.)
  • A&F Financial Securities, Inc., of Syosset, NY, was fined $125,000. The firm charged its customers a handling fee of $65 per trade in addition to a commission. (Additional violations included inadequate supervisory system and procedures, and failure to comply with continuing education requirement.)
  • Salomon Whitney LLC, of Babylon Village, NY, was fined $60,000. The firm charged its customers a handling fee as high as $69 per trade in addition to a commission.

In settling FINRA's actions, the firms agreed to implement corrective action to remedy the handling fee-related violations. In concluding these settlements, the firms neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

September 7, 2011 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Schapiro Says Business Roundtable v. SEC is Over

The SEC confirmed that it is not seeking further review of Business Roundtable v. SEC, the D.C. Circuit opinion that vacated Rule 14a-11 that would have required companies to include shareholders' director nominees in company proxy materials in certain circumstances. Chairman Mary L. Schapiro issued the following statement:

"I firmly believe that providing a meaningful opportunity for shareholders to exercise their right to nominate directors at their companies is in the best interest of investors and our markets. It is a process that helps make boards more accountable for the risks undertaken by the companies they manage. I remain committed to finding a way to make it easier for shareholders to nominate candidates to corporate boards.

"At the same time, I want to be sure that we carefully consider and learn from the Court's objections as we determine the best path forward. I have asked the staff to continue reviewing the decision as well as the comments that we previously received from interested parties."

The SEC's decision is consistent with its past practice.  The D.C. Circuit has in recent years vacated several SEC rules, and the agency did not seek further review in those instances.

September 7, 2011 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, September 6, 2011

SEC Still Destroying Records, According to Whistleblower

The lawyer for SEC staff attorney and whistleblower Darcy Flynn says in a letter to SEC Chair Schapiro and the SEC Inspector General that the agency is still destroying agency records contrary to law.  WPost, SEC still destroying records illegally, whistleblower’s lawyer says

September 6, 2011 in News Stories | Permalink | Comments (0) | TrackBack (0)

SEC Seeks Comments on Retrospective Reviews of Regulations

The SEC announced that it seeks public comment on a plan to conduct retrospective reviews of its existing regulations and on the process it should use to conduct retrospective reviews, such as how often rules should be reviewed, the factors that should be considered, and ways to improve public participation in the rulemaking process.  Public comments should be received by Oct. 6, 2011.

President Barack Obama issued an order on July 11 that recommended that independent regulatory agencies consider how they might best analyze rules that may be outmoded, ineffective or excessively burdensome, and modify, streamline or repeal them. The order also recommends analysis of regulations that might need to be strengthened or modernized, which may entail new rulemaking.


September 6, 2011 in SEC Action | Permalink | Comments (1) | TrackBack (0)

Monday, September 5, 2011

The Uniform Fiduciary Duty Standard for Securities Professionals -- Part III

This is the third part of a series of blogs addressing the issue of a uniform fiduciary duty standard for securities professionals that provide personalized investment advice to retail investors.  SEC Chair Schapiro recently stated that the SEC expects to take up this issue later this year.  In addition, the House Financial Services Committee announced a hearing on the standards of care for broker-dealers and investment advisers on Sept.  13. 

 I previously described the January 21, 2011 SEC Staff Study on Investment Advisers and Broker-Dealers required by Dodd-Frank § 913 that recommends adoption of a uniform fiduciary duty standard.  I also described comments on the staff study filed with the SEC on July 14, 2011 by the Securities Industry and Financial Markets Association (SIFMA).   In this post I look at some other reactions to the staff study.

“The SEC Should Slow Down”

1. Opposing Commissioners.   Two SEC Commissioners, Kathleen Casey  (whose term expired August 5, 2011) and Troy Paredes, issued a statement on January 21, 2011 stating that they opposed the study’s release to Congress as drafted and called for additional economic and empirical research.   In essence, they feel that the staff did not do what Dodd-Frank § 913 mandated.  In their view, “the Study’s pervasive shortcoming is that it fails to adequately justify its recommendation that the Commission embark on fundamentally changing the regulatory regime …. A stronger analytical and empirical foundation … is required before regulatory steps are taken that would revamp how broker-dealers and investment advisers are regulated.”   Accordingly, the study did not fulfill the statutory mandate to evaluate “the effectiveness of existing legal or regulatory standards of care” applicable to broker-dealers and investment advisers.

In particular, the Commissioners fault the study for premising its recommendations on investor confusion without sufficient study of the practical consequences of such confusion and without addressing the possibility that its own recommendations may  not resolve the confusion.  In addition, they criticize the study for failing to account for the potential overall cost of the recommendations.  “The Study unduly discounts the risk that, as a result of the regulatory burdens imposed by the recommendations on securities professionals, investors may have fewer broker-dealers and investment advisers to choose from, may have access to fewer products and services, and may have to pay more for services and advice they do receive.”

2. National Association of Insurance and Financial Advisors (NAIFA).  NAIFA describes its membership as “Main Street financial services professionals who serve middle-market consumers.”  In an April 2011 statement NAIFA expressed the criticisms made by Commissioners Casey and Parades and also introduced an element of class distinction.  According to NAIFA, “data about how the two standards are applied and enforced on Main Street demonstrates that the suitability standard governing broker-dealers is a rigorous consumer protection standard that is arguably a more robust standard than a fiduciary duty.”  In addition, “NAIFA is concerned that the costs associated with increased regulation and liability associated with a fiduciary standard could either drive our members out of the market or to an investment adviser model that primarily serves wealthier consumers.”  Accordingly, NAIFA called upon Congress “to ensure the SEC conducts all of the analysis necessary to ensure any changes to the regulations of broker-dealers achieves three important objectives:

1. It should be supported by facts from the study.
2. It should provide for greater consumer protection.
3. It should not diminish the middle-market consumers’ ability to afford financial services.”

3.     Representative Bachus.  Representative Spencer Bachus, the Chairman of the House Financial Services Committee, expressed his support for the comments of Commissioners Casey and  Paredes in an August 2, 2011 letter to Chair Schapiro and expressed his concern that moving forward with rulemaking was “premature.”   The Financial Services Committee has scheduled a hearing on the issue for Sept. 13.

“The SEC Should Act Now”

In contrast, the SEC staff study’s recommendations have strong support from members of the investment advisory industry, state securities regulators, and consumer advocates.

1.     Financial Planning Coalition (FPC).  The FPC represents nearly 75,000 financial planners and is a collaboration of Certified Financial Planner Board of Standards, Inc., the Financial Planning Association and the National Association of Personal Financial Advisors.  On January 22, 2011 the FPC commended the SEC staff study and called on the SEC to act quickly and promulgate a rule extending the fiduciary standard of care to broker-dealers.  The FPA followed up on its show of support by submitting to the SEC on June 23, 2011 a petition signed by more than 5,200 financial planners urging adoption of the uniform fiduciary standard.  In its cover letter, the FPC cited a recent study showing that “investors remain confused about the advice they receive” and “overwhelmingly believe that all financial professionals who give personalized investment advice should be required to act in the best interest of their clients and disclose conflicts of interest.”

2.     North American Securities Administrators Association (NASAA).  NASAA applauded the SEC staff study’s recommendation and called upon the SEC to move forward quickly to implement the recommendation:

“Applying the fiduciary standard to broker-dealers is necessary to protect investors from abuses fostered by current fragmented industry standards.  The time has come to end this confusion and close the longstanding gaps in industry standards.  The SEC must act without delay.”

3.     Consumer Federation of America (CFA).  The CFA, an association of nearly 300 nonprofit consumer organizations, has strongly supported the adoption of a uniform fiduciary standard.  The CFA reaffirmed its support for the SEC staff study in a May 9, 2011 letter to Chairman Bachus and other members of the House Financial Services Committee, calling it “a way to move forward on fiduciary duty that maximizes investor protections while minimizing industry disruption.”  It argued that proponents of the view that regulation would harm middle income and rural investors “ignore serious short-comings in existing investor protections as well as the significant steps the SEC proposes to take to ensure that the fiduciary duty would be applied in a way that is consistent with the broker-dealer business model.”  In addition, “we believe the best way for the SEC to satisfy the demands to provide a stronger economic basis for rulemaking is to document the significant costs that investors bear and the benefits they lose as a result of conduct that is permissible under a suitability standard but unacceptable under a fiduciary duty.”

Future posts will describe the House Financial Services Sept. 13 hearing as well as other issues involving regulation of securities professionals.

September 5, 2011 | Permalink | Comments (0) | TrackBack (0)