Outsourcing RIA oversight a ‘non-starter’

A proposal to allow advisory firms to outsource routine compliance exams, rather than rely on government auditors or a self-regulatory organization, is already facing head winds from the brokerage industry.

The idea was floated last week in a TD Ameritrade-sponsored study by Georgetown University professor James Angel.

Mr. Angel’s idea is a “non-starter,” Financial Services Institute Inc. spokesman Chris Paulitz wrote in an e-mail. “Bernie Madoff was subject to the supervision of an auditing firm he hand-picked, and we all know how effective that turned out to be.”

“Using accounting or auditing firms to do the job simply would not offer the level of protection and oversight that retail investors deserve under a new uniform [fiduciary] standard,” Ira Hammerman, general counsel of the Securities Industry and Financial Markets Association, wrote in an e-mail.

Mr. Angel’s paper essentially offers another option for performing adviser exams beyond creation of an adviser SRO, or Securities and Exchange Commission supervision funded through user fees.

“We think it’s an option that should be thrown into the mix,” said Skip Schweiss, managing director of advisor advocacy for TD Ameritrade Institutional, which in the past has supported SEC user fees to fund enhanced exams.

The idea isn’t new. Last year, the SEC, in response to the Madoff debacle, implemented a tightened custody rule that requires surprise audits by third-party examiners in some cases, said Dan Barry, managing director of government relations at the Financial Planning Association.

“So I don’t think [the FSI’s comment about Madoff’s auditor is] a strong criticism” of Mr. Angel’s idea, he said.

Mr. Barry said that using third-party auditors is worth discussing.

In proposing annual internal compliance reviews for advisers in 2003, the SEC floated the idea of outsourcing them to third parties. The SEC mandated the internal reviews in December 2003 without requiring outside auditors but reiterated its support for the idea.

Not surprisingly, compliance consultants contend that it could work.

“I think it’s a very viable solution,” said Lisa Roth, a compliance consultant and chief executive of Keystone Capital Corp.

PROCESS IS IN PLACE

“There are a good number of qualified professionals” who could examine advisory firms, she said.

Because RIAs already must perform annual internal compliance reviews, “it’s a process that’s already in place,” Ms. Roth said.

But third-party exams weren’t mentioned as an option in the SEC’s most recent adviser oversight study, mandated by the Dodd-Frank reform law, indicating that the idea has lost support within the agency, observers said.

“In reading the tea leaves in [Washington], there’s no appetite for mandatory third-party audits,” said David Tittsworth, executive director of the Investment Adviser Association.

A big challenge would be how to qualify and oversee the firms and personnel who conduct the compliance reviews for advisers.

“The idea of having private accounting firms hired by [advisers] evaluate sales practices raises a number of questions, including such firms’ lack of experience and expertise in conducting sales practice evaluations,” Howard Schloss, a spokesman for the Financial Industry Regulatory Authority Inc., said in a statement.

Finra supports appointing one or more SROs to take on adviser exams.

“You should have some initial vetting and approval, then some ongoing sampling” as a check on audit quality, Ms. Roth said, adding that Indiana already has a licensing and experience requirement for compliance consultants.

Despite the hurdles that Mr. Angel’s idea would encounter, TD Ameritrade isn’t done talking about the issue.

“One missing element has been what [enhanced adviser oversight] might cost,” Mr. Schweiss said. “We’re doing a deeper dive on that” with an upcoming analysis.

Email Dan Jamieson at [email protected]

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