On the Regulation of Investment Advisory Services: Where Do We Go from Here?
Georgetown University - Department of Finance
October 31, 2011
A controversy has arisen over the regulation of investment advisers in the United States. Traditionally, larger registered investment advisers (RIAs) have been regulated by the SEC and smaller ones by the states. The Investment Advisers Act of 1940 severely restricts the ability of RIAs to engage in principal trades with their customers. Brokers, on the other hand, are regulated by a self-regulatory organization, FINRA, as well as by the SEC. Brokers may engage in principal trades with their customers as long as the advice is merely “incidental” to their other activities. In recent years, the boundaries between RIAs and brokers have become blurred as brokers offer more advisory services, and there is substantial confusion among consumers as to the differences between brokers and RIAs.
In a study mandated under §914 of Dodd-Frank, the SEC documented that it is examining RIAs at a rate of approximately once every eleven years, and recommended the study of additional means to increase the frequency of examinations including user fees to fund more examinations by the SEC, or requiring RIAs to become part of an SRO. It should be noted that the SEC has assigned fewer employees to its Office of Compliance, Inspections, and Enforcement (OCIE) in 2010 than in 2004, despite an increase in overall FTE over this period. This SEC diversion of resources presumably reflects its belief that RIA examinations are less important than other SEC activities.
This study examines several alternatives for increasing the frequency of examinations. It is unlikely in the current political environment that the SEC will be able to charge users fees to RIAs or to get the budgetary resources it needs. Moving more RIAs from federal to underfunded state regulatory agencies is likewise unsatisfactory.
SROs do much more than just examine their members; they also create and enforce rules and other activities. As RIAs who are not also brokers lack the same degree of conflict of interest as brokers trading opposite their own customers, they do not need the same regulation. However, institutional dynamics at the SEC would result in a new adviser SRO acting just like FINRA.
The problem is that RIAs are not being examined frequently enough. No other serious deficiencies in RIA regulation have been documented. Exam frequency can be increased by requiring RIAs to engage independent auditors such as accounting or consulting firms or an SRO to examine their regulatory compliance on a more frequent basis. Precedents for this include the SEC’s requiring corporate issuers to provide audited financial statements, and the SEC’s proposal to require broker-dealers to submit independently audited compliance reviews. This would free up scarce SEC resources for more important activities, and provide the benefits of competition in the provision of examination services.
Number of Pages in PDF File: 37
Keywords: Financial markets, regulation, investment adviders, broker dealers, SEC, FINRA
JEL Classification: G28, K22, K23working papers series
Date posted: October 31, 2011
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