Earlier today, Mark Schoeff from Investment News provided a great summary on the growing momentum behind the idea of registered investment adviser (RIA) regulatory examinations being conducted by third parties. As Schoeff notes, SEC Commissioner Daniel Gallagher first introduced this 3rd-party compliance exam concept last month. David Tittsworth, President & CEO of the Investment Adviser Association (IAA), spoke out earlier this week in oppostion to third-party audits with a letter to Commissioner Gallagher. However, other industry executives including Bernie Clark of Schwab and Skip Schweiss of TD Ameritrade have now publicly stated that they would like the SEC to at least consider the third-party exam option.
When David Tittsworth speaks, the RIA industry tends to listen as he helped lead the industry opposition to introducing FINRA as a self regulatory organization (SRO) for investment advisers. For now, his efforts appear to have been successful. However, in his letter, Tittsworth does raise alarm that third-party examinations could be a more subtle way for FINRA to involve itself in the regulation of investment advisers. If Tittsworth’s fears do begin to materialize and it becomes evident that this may lead to FINRA regulating RIA firms, expect many more industry leaders to also raise strong opposition. At this moment, it’s probably a bit premature to speculate how this may all play out.
In lieu of third-party RIA exams, Tittsworth continues to support imposing user fees on investment advisory firms. This approach has also been championed US Representative Maxine Walters who previously introduced a bill In April 2013 supporting user fees in the House. So far, it would appear that the bill has not gained much traction. What’s particularly interesting is that the implementation of third-party RIA regulatory audits would not require the passing of a bill, as the SEC has the direct authority to write such a rule.
In 2013, the SEC examined around 9% of investment advisory firms. Of the audits performed by the SEC, around 80% resulted in a deficiency letter being issued. However the story is told, the fact that only 9% of SEC-registered RIA firms were audited this past year is not a good headline for the investment adviser industry. The SEC continues to push to hire more examiners but has yet to receive the neccessary funding from Congress. With the user fee bill seemingly unlikely to be put into law anytime soon, it does seem logical for the indutry to explore the concept of third-party investment adviser examinations. If deployed thoughtfully, it has the potential to be an attractive option for individual consumers and the RIA industry compared to the introduction of FINRA as a SRO.
There is also precedent for the SEC to mandate third party examinations of RIA firms as it did with custody rule 206(4)-2 requiring independent third party audits by CPA firms in certain circumstances. While met by some initial opposition, the custody rule seems to have been relatively successful in helping the SEC better monitor and track situations in which an investment advisory firm may be deemed to have custody.
Of course, top of mind for all investment advisory firms is what the potential financial impact of an independent regulatory examination program may be. Right now, it’s unfortunately hard to speculate given the lack of details on the potential scope, frequency, and auditor qualifications, but it’s fair to say that the cost will likely be highly correlated to the size and complexity of the firm. How such a cost would compare to potential user fees is also somewhat impossible to predict right now. In regards to user fees, the general consenus has been that the fee would be tied to a firm’s total assets under management. However, in either scenario, as RIA compliance consultants, we believe that the financial impact to the advisory firm is more likely to be a managable nuisance than a significant hit to firm profitability. It should also be noted that either proposal would presently only be applicable to SEC-registered RIA firms as state-registered RIA firms would continue to be examined by the relevant states.