Increase SEC exams of RIAs

Are brokers breaking away from their industry and joining the registered investment adviser channel to take advantage of a lax regulatory environment? And if so, is the investing public at risk?

It is hard to answer either question definitively, but Susan Axelrod, executive vice president of regulatory operations for the Financial Industry Regulatory Authority Inc., said she believes at least some of the brokers going RIA are practicing regulatory arbitrage.

At an industry conference earlier this year, as reported in a story this week by IN’s Mason Braswell, she asked her audience this question: “Why would you want to be examined frequently and have personal activity questionnaires [from Finra] when you can sit back for 10 years [without being examined]?”

Ms. Axelrod makes a valid point when it comes to examinations. Finra examines brokers, on average, once every two years, although it doesn’t get out to branch offices as often. The Securities and Exchange Commission examines RIAs under its jurisdiction, on average, only once every 10 years. Firms generally find exams time-consuming and stressful, so it stands to reason that given their druthers, some in the advice industry would opt for the latter over the former.

But even if some breakaway brokers are changing channels for regulatory reasons, the more important question to ask is whether investors are potentially at a higher risk because of it. Certainly, investors can be well-served in either channel.

The fact of the matter is, we don’t know. We don’t even know how many breakaway brokers there are, let alone what percentage of them have engaged in egregious conduct toward their clients. There is, however, anecdotal evidence that some breakaway brokers have run afoul of the law once they joined the RIA channel.

RIA LAWBREAKERS

While not addressing the issue of breakaway brokers per se, SEC Commissioner Daniel Gallagher believes there are more advisers in the RIA space overall violating the law than are being apprehended. “In reality, there are plenty of repeat offenders at investment advisory firms who are engaging in misconduct,” he said in a speech earlier this year. “We’re just not finding them as quickly.”

The solution to all of this seems apparent. Why not — once and for all — come up with an efficient way to increase the number of RIA exams? If exams were just as frequent for advisers as for brokers, we wouldn’t even be having this discussion. No one, it seems, disagrees with the solution. The problem is how to achieve this goal.

Until recently, the SEC sounded like a broken record on RIA exams. It conceded that it needed to increase the number of exams, but complained year after year that Congress wasn’t giving it enough funds to do the job. But when you are talking about authorizing hundreds of millions of additional dollars and the SEC itself acknowledges that each SEC examiner is doing only three or four exams a year, who can blame Congress?

OTHER SOLUTIONS

At least two other possible solutions have been floated in the past and both deserve serious consideration. One, advanced in March by SEC Chairwoman Mary Jo White, would allow for third-party exams of RIAs. The second, proposed by Rep. Maxine Waters, D-Calif., calls for a user fee to pay for the exams.

To our knowledge, beyond mentioning it at an industry conference, Ms. White has done little to advance her idea. It is incumbent on her to flesh out her proposal and start moving it through the process toward approval by the full commission.

Ms. Waters introduced legislation in two previous sessions of Congress that would allow the SEC to assess a fee on RIAs for their exams, but it didn’t receive enough support in the House and wasn’t even introduced in the Senate. Perhaps a new effort can be made to revive her idea in this Congress.

The American investing public has already waited too long for its government to rectify this problem. It’s time now for those in a position to fix it to roll up their sleeves and start working on a solution.