Advisory firms now come under SEC examination about once every seven years on average.
Members of the Securities and Exchange Commission's Investor Advisory Committee said at a virtual meeting on June 22 that they would instead like to see the reviews conducted once every four or five years and even more frequently for firms that have been flagged as risky. To bolster regulators' ability to review internal books and policies, they're calling for advisors to pay new user fees to provide additional funding to the SEC's division of examinations.
The money is needed, according to members of the investor committee, because SEC budgets and headcounts have not kept up with growth in the advisory industry in recent years.
Paul Roye, a member of the committee and a former senior vice president and senior counsel at the asset manager Capital Research and Management Company, said the proposal stems from concerns that the SEC is inadequately equipped "to detect or credibly deter fraud in the investment advisor industry."
Besides recommending firms pay user fees to help fund more examinations, the Investor Advisory Committee called on the SEC to accept comments on a proposal to outsource at least some of its examination duties to third-party companies.
As one possibility, Roye said, the SEC might consider turning to outside companies for routine matters, such as verifying the accuracy of data submitted in annual regulatory filings and information displayed on websites, reviewing internal policies and procedures and taking account of the assets firms have under management. That would free the SEC to concentrate on more complex matters or advisors in need of heightened scrutiny, Roye said.
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The committee's recommendation recognizes many questions need answering before the SEC could start outsourcing exams. What qualifications, for instance, would a firm need to do this sort of work? How would the SEC monitor these firms to make sure they're doing the work properly? And should only certain types of advisors be subject to review by third parties?
Roye acknowledged that much remains uncertain about the proposal. But he said he thinks the idea is at least worth considering, especially since "congressional appropriations to the SEC are always uncertain and never seem to keep pace with industry growth."
The committee voted in favor of the proposal with 14 yes votes, one no and four abstentions. Since it's merely a recommendation, the SEC still has to accept it before a formal comment period would open on the outsourcing proposal. Congressional action would most likely also be needed for the proposal to collect user fees from firms.
This isn't the first time the idea has come up. The SEC's division of investment management recommended in 2013, following a study called for in the Dodd-Frank overhaul of Wall Street oversight, that regulators begin collecting user fees to help pay for examinations of advisory firms. The latest proposal doesn't state how the fees should be calculated.
They could be set, according to the recommendation, by looking at the "complexity of the firms, number of representatives, number of offices, complexity of products and assets under management. Larger and more complex firms could be charged higher user fees."
"Given the battering the industry is taking courtesy of an unprecedented wave of costly regulations, would the imposition of a user fee or the forced hiring of third-party examiners serve as that one last straw on the back of small advisers?" Peirce said in the statement.
Cien Asoera, a member of the Investor Advisory Committee and a financial advisor at Edward Jones in Elkhart, Indiana, said he thinks it would be best if the SEC kept its examination duties in house rather than outsource them.
"But we do need to be thinking of this now before it gets out of control, which some would probably argue the numbers have gotten that large already," said Asoera, who abstained from voting on the recommendation because of his ties to the advisory industry.
Leslie Van Buskirk, another committee member and an administrator in the Wisconsin Department of Financial Institutions' Division of Securities, also expressed concerns about third-party examinations.
"The inherent conflicts of interest and the risks of a check-the-box mentality are likely to result in less trustworthy exams delegated to third parties," Van Buskirk said, adding that money raised by user fees should be used to bolster the SEC's own examination and enforcement divisions.
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The Investment Adviser Association, which represents more than 600 advisory firms, said it can support the user fee proposal as long as the SEC offers assurances the money will be used for more reviews rather than as a substitute for existing examination funding. Gail Bernstein, the general counsel for the IAA, said she and her colleagues' preference would be for Congress simply to provide more funding to the SEC.
But in the absence of that, user fees are probably the best alternative, she said. Still lower down on the preference list, Bernstein said, is the proposal to rely on third parties to help supplement the SEC's examination activities.
Bernstein said many more questions will need answering before IAA can lend its support to such a plan.
"Who is going to be responsible for ensuring the quality of these examinations?" Bernstein said. "And who is going to oversee these third parties? Is it the SEC? And then, where are those resources going to come from?"
The Investor Advisory Committee's recommendation also called on the SEC to join the North American Securities Administrators Association, which represents state and provincial regulators in the U.S., Canada and Mexico, to encourage more states to adopt model rules on continuing education for advisors. These rules, first put forward by NASAA, require advisors to obtain 12 continuing education credits a year — six on ethics and professional responsibility and six on investment products and practice requirements.
