Many people believe the economic collapse of the late 2000s and subsequent recession was caused, at least in part, by a lack of regulatory oversight. In response, Congress currently is considering a bill—the Investment Advisers Oversight Act of 2012 (H.R. 4624)—that would subject small and mid-level financial advisers to increased oversight at the hands of a self-regulatory organization.
This proposed legislation would significantly increase the oversight and testing to which smaller and mid-level advisers are subject, resulting in increased oversight fees for these same advisers. Consequently, it is important that the potentially affected advisers understand the proposed legislation, how it will impact their examination requirements and their bottom line.
Current Oversight Scheme Inadequate
The Securities and Exchange Commission is currently responsible for oversight of registered investment advisers. During the past six years, the number of registered investment advisers has increased, while resources dedicated by the SEC to adviser examination have decreased.
Based on numbers published by the SEC, it examined approximately 8 percent of registered advisers in FY 2011. This was down from 9 percent in FY 2010. Because the majority of SEC examinations are either “cause” exams (targeted examinations based on customer complaints) or “sweep” exams (industry-wide single issue examinations), some advisers can go more than 15 years between regular examinations. Indeed, one-third of registered advisers have never been subject to an SEC compliance examination.
Even groups opposing H.R. 4624 concede that enhanced examinations would protect investors, elevate investor confidence, and generally improve the investment adviser profession.
H.R. 4624 would require most SEC and state-registered advisers to join a Self-Regulatory Organization (SRO). Advisory firms with a single mutual fund as a client, firms with at least 90 percent of assets under management attributable to “qualified purchasers” (individuals with $5 million or institutions with $25 million in investments), hedge funds, private equity funds, and venture capital funds would be exempt from the membership requirements.
The SRO would have rules designed to protect investors, authority to enforce those rules and establish disciplinary procedures, and the ability to provide for “periodic” examination of its members. The bill also grants the SEC oversight of the SRO, and imposes certain annual reporting obligations on the SRO.
H.R. 4624 does not specifically name a “national investment adviser association,” and any such organization can apply to become an adviser SRO. However, because of its existing oversight infrastructure and dominance as the largest independent regulator for all advisory firms doing business in the United States, the Financial Industry Regulatory Authority (FINRA) is best positioned to fill that role, and is the likely candidate.
Impact on Advisers
FINRA examines a significantly higher percentage of its members than the SEC. On average, FINRA members are examined every two years while the SEC examines its members approximately once every 10 years. Consequently, FINRA oversight would guarantee more frequent adviser examinations. For those advisers already subject to FINRA oversight, this would bring oversight and examination under one roof.
H.R. 4624 also would ensure that all advisers are subject to some form of routine examination. Under the current regulatory scheme, mid-sized investment advisers (those with between $25 million and $100 million in assets under management) are subject to state rather than SEC oversight. By bringing these mid-level advisers under the SRO umbrella, H.R. 4624 would guarantee that all advisers, regardless of asset management size, are periodically examined.
Though, this increased oversight would come at a price. Advisory firms would be required to pay membership fees to support the SRO. If the costs of establishing and operating the SRO were spread across all advisory firms subject to SRO oversight, some estimates place the annual fee at more than $50,000 per firm. Because of the exemptions, this burden would be borne mostly by small and mid-level advisory firms.
Those opposing the proposed legislation argue that the expense associated with SRO oversight, in addition to pre-existing regulations (i.e. SEC and Department of Labor), would further encumber small businesses already weighed down by significant compliance requirements. Advisers associated with smaller businesses would therefore be priced out of the market or forced to pass those costs on to investors. That, some argue, would negatively affect retirement savings and investment opportunities. Suggested alternatives to SRO regulation include payment of user fees directly to the SEC to enable increased examinations. Using the SEC’s existing infrastructure, some argue, would be a less costly way to increase adviser examination and oversight.