Simons Says: Déjà vu All Over Again

5x_Simons-Tim-168 for Simons SaysI read something the other day that I want to share, “It will take over 24 million man hours to comply with Dodd-Frank rules per year. It took only 20 million to build the Panama Canal,” according to Rep. Neugebauer, Oversight and Investigations Subcommittee Chairman.

Meanwhile, SEC Commissioner Dan Gallagher, in comments earlier this month, addressed the concern about the small percentage of RIAs that are examined by the SEC annually, eight to nine percent, and the need for more to be examined. Of course, this is not a new issue; it has been under discussion for several years, and as far back as 1992. You may remember that as part of Dodd-Frank, the SEC did a study on the issue and essentially identified three main options on addressing the problem:

1) user fees charged by the SEC to RIAs, probably based on either AUM ranges, or the number of SEC hours required for the examination;
2) the authorization of one or more self-regulatory organizations (“SROs”) for RIAs; and
3) allowing FINRA, the SRO for broker-dealers, to become the SRO for RIAs that are also registered as broker-dealers and perhaps eventually for all RIAs.

The SEC suggested the three options to Congress, and although much discussion ensued with input from the industry, no decision was made. Commissioner Gallagher suggested that the solution may be to provide for third-party examiners of RIAs, perhaps including FINRA to examine dual registrants. I thought it might be worthwhile to identify some of the problems with each potential solution.

User Fees

Using fees generated through some tiered structure based on AUM would probably be the easiest to implement because the fees would be going directly to the SEC, but earmarked to be used solely for the examination program. This would probably also be the cheapest to implement, since the SEC already has the infrastructure in place. The SEC has requested additional funding from Congress to hire more examiners, but that has not gone well. This is also the option that received the greatest support from RIAs. This RIA support may turn off the SEC and the Congress.


Authorizing one or more SROs received some support from the industry, but the question of funding those SROs caused concern. There was talk that some existing organizations would assume that task for their membership, such as the Investment Adviser Association, the Financial Planning Association, and others. None of those organizations stepped forward, but FINRA did, and the other organizations expressed their concerns with that possibility. Already the SRO for most brokerdealers, FINRA volunteered to be the SRO for RIAs. This met with opposition from many RIAs as well as their Associations, most of which seem to be behind the idea of user fees. Concerns expressed by those advisers and associations include: the perceived large firm bias at FINRA; the salaries paid to the hierarchy at FINRA (which appear to be far above that received by those in similar positions at the SEC); and that any SROs would have to be overseen by the SEC, as would the training of any examination staff employed by the SRO, which would also trigger additional costs to the SEC.


Although most RIAs have no problem with FINRA as the SRO for broker-dealers, the concern is that FINRA does not have staff trained to conduct investment-adviser examinations, and that any additional examination staff hired would have to be trained by the SEC. There is also the perception that the change from a suitability standard to a fiduciary standard may be difficult for FINRA examiners, along with concerns from some that since FINRA was the examination authority for Madoff, the whole culture of the investment adviser industry may be difficult for a FINRA examiner to understand.

Third-Party Examiners

Not discussed in the SEC’s Study on Enhancing Investment Adviser Examinations, but mentioned by Commissioner Gallagher, was the idea of passing a rule authorizing third parties other than FINRA to conduct examinations of RIAs. There are a number of firms including the Big 4 accounting firms and Focus 1 that conduct “mock SEC exams,” in many cases using the SEC’s own request list. In fact, many of the individuals conducting those examinations are former SEC examiners who are certainly qualified to perform those examinations. I hear arguments on both sides of the issue from those individuals, many of whom would benefit from the SEC passing such a rule.

One concern is how the SEC would manage the entire process. Would individuals or firms apply to the SEC for the right to conduct SEC exams? Would applicants have to pass a test, or just document their experience? Would advisers have to select examiners from an approved list? Would third-party examiners submit examination reports to the SEC, submit the report to the adviser paying for the examination, or both? Would the SEC develop a structure for reporting so that all exam reports are comparable? Would the third-party examiner be working for the adviser or the SEC, which could impact on the information provided to the examiner by the adviser? What about the conflicts of interest for the third-party examiner if they are paid by the adviser? Would the third-party examiner then be able to contract with the adviser to fix the problems or would that be part of the engagements mandated by the SEC?


I think Congress and the SEC need to determine which path they think is best, but I also think they need to get input from the industry before making that decision. It certainly seems as though user fees would be the easiest route, but whether that would be more effective if paid to the SEC or to third-party examiners, or some combination of the two, sounds like the question to be answered.

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