RIAs angry over SEC move to contact clients directly

Advisers are agitated by the SEC’s decision to expand its examinations of advisory firms to include contact with clients.
The Securities and Exchange Commission sent a letter this week to several trade associations, saying that its examiners would increase the number of sources used to verify account assets, including contacting clients, hedge fund investors and managers, bank and broker-dealer custodians, account administrators and others.
“The clients are going to be nervous that something is wrong, and then I have to spend time convincing people that I’m not stealing from them,” said Ivory Johnson, a dually registered adviser and director of financial planning at Scarborough Capital Management Inc. of Annapolis, Md., which has $600 million in assets under management. “I’m against it. It won’t solve anything.”
The agency’s decision to go directly to clients is a legitimate way to track their account positions and balances against what advisers are showing on their books, said Gene Gohlke, associate director of the SEC’s Office of Compliance, Inspections and Examinations.
“In addition to doing regular exams, we are taking a closer look at certain firms that, from our perspective, have a higher risk profile,” particularly those with dual registration as a broker-dealer and adviser that may provide custody for some assets, he said.
The custody-focused inspections with calls to third parties began about a month ago as part of the agency’s regular exam process. The SEC tries to examine advisers with a high risk profile on a three-year cycle and has no set cycles for others. Mr. Gohlke said the new procedures may lengthen the time it takes to complete an exam.
There are about 1,130 registered investment advisers that also are broker-dealers, and more than 4,000 that have affiliations with a broker-dealer, according to RIA Database of Charlotte, N.C.
Many advisers objected to the policy, saying it would only scare clients unnecessarily.
“As a client, if I get a letter from the SEC asking questions about any investments, I am going to think something is wrong. I’m going to go over the edge,” said Malcolm Makin, president of Professional Planning Group of Westerly, R.I. The firm has $550 million in assets under management and is associated with Raymond James Financial Services Inc. of St. Petersburg, Fla.
The SEC should do the verification the old-fashioned way, by looking at the books, he said.
The agency also needs to differentiate between advisers, Mr. Makin said. “The one-stop shop that produces all the documentation and holds the money is one type,” he said. “That’s different than the investment adviser who is working with a third-party broker-dealer. I think there is a higher level of protection with the firm working with the broker-dealer.”
The SEC can verify assets with the broker-dealers and custodians without contacting clients, said Mr. Johnson. “What are the clients going to say? They’re not going to know,” he said. Mr. Johnson, a fee-based adviser, is affiliated with SII Investments Inc., an Appleton, Wis.-based broker-dealer. His assets are held in custody with Charles Schwab & Co. of San Francisco.
There are positive and negative aspects of the idea, said Tom Orecchio, principal at Modera Wealth Management of Old Tappan, N.J., which has $325 million in assets under management.
“I think the extra scrutiny is a perception issue,” he said, noting that it could get clients to pay closer attention to their investments.
“Some investors aren’t going to know exactly how much they invested. They rely on the advisers for that information.”
Tim Kochis, founder of Aspiriant LLC, a San Francisco-based RIA with about $3.5 billion of discretionary assets under management, has no problem with the adjusted exam procedures, or its focus on custody.
“The SEC and other regulators are doing well to look at issues like this, rather than on the fill-in-the-blank, check-the box inspection regime,” he said. “If this changes to more in-depth exams, I think that would be great.”
Mr. Kochis said he would not be concerned if an examiner calls a client, noting that accounting firms that audit his company check at times with clients selected at random to verify certain records.
“Anybody that’s nervous about this probably should be nervous,” said Steven Greenwald, chief executive of Telemus Wealth Advisors LLC, an RIA in Southfield, Mich., which also owns a broker-dealer. Both of his businesses have their assets held in custody with units of Boston-based Fidelity Investments.
Still, advisers worry that the SEC’s decision to contact clients directly could also lead to a greater level of distrust.
“The clients will wonder why they are getting a call from the SEC about their investment and adviser,” Mr. Orecchio said. “The last thing we need is a further confidence problem.”
Art Grant, president of Cadaret Grant & Co. Inc. of Syracuse, N.Y. thinks clients will understand that the SEC is trying to protect them, but he argues that the agency doesn’t need to involve investors in order to uncover fraud.
“In order to catch what’s going on there, you simply have to reconcile client statements with custodian statements,” he said. Cadaret Grant is an investment advisory firm and broker-dealer with more than 900 financial adviser affiliates, representing $20 billion in assets. The firm has $1.5 billion under management.
“I think it’s great,” said William Stockwell, branch manager at Stockwell Wealth Management of Boston, an affiliate of LPL Financial of Boston. “Absolutely anything that can be done to verify and reassure clients is a good thing. I’m all for more regulation, more oversight and more scrutiny.”
If this policy was instituted five years ago, would it have uncovered the Madoff scheme? Mr. Stockwell said.

Related Topics: Securities and Exchange Commission