HFSC Examines Bachus SRO Bill
At today’s House Financial Services Committee hearing, lawmakers examined H.R. 4624, the “Investment Adviser Oversight Act of 2012,” sponsored by Reps. Spencer Bachus (R-Ala.) and Carolyn McCarthy (D-N.Y.).
The legislation would amend the Investment Advisers Act of 1940 to provide for the creation of a National Investment Adviser Association (NIAA), registered with, and overseen by, the Securities and Exchange Commission (SEC). Investment advisers conducting business with retail customers would be required to become members of a registered NIAA and the SEC would have the authority to approve the registration of any NIAA.
In particular, the proposed legislation requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act, the SEC’s rules, and the NIAA’s rules before the association can register as an NIAA.
Under the legislation, the SEC is permitted to suspend or revoke an NIAA’s registration, censure or impose limits on an NIAA’s activities and operations if the NIAA is in violation of the Advisers Act, SEC rules, and the NIAA’s rules, and is able to suspend or revoke an NIAA’s registration if the association fails to enforce compliance with any provision by an NIAA member firm or associated person.
All costs associated with the authorization and functioning of an NIAA will be borne by the regulated, through an “equitable allocation of dues and fees.”
The proposed bill is a response to an SEC study required by the Dodd-Frank Act, which found that the SEC lacks the resources to adequately examine the nation’s nearly 12,000 registered advisors.
For additional information on the bill, please click here.
Opening Statements
In his opening statement, Bachus said of the three options the SEC study presented Congress with, the option authorizing one or more self-regulatory organizations (SROs) to examine investment advisers “is, in my opinion, the most practical, comprehensive and streamlined approach to address this weakness.” Bachus reiterated his readiness to work with anyone who has ideas to improve the bill, specifically mentioning concerns about the exemptions in the bill adding, “I am more than willing to work with any Member or interested stakeholder to address those concerns….”
In his opening statement, Ranking Member Barney Frank (D-Mass.) said “too often… we act as if states are not a factor here. State regulation is very important.” He added, “we have a federal statutory authority here that we have given to the SEC, and when we talk about how to share that, we should not subject the states to this role without their full participation.”
Turning to the SEC’s budget, Frank said the President “did not ask for enough.” He added, “the very fact that we’re considering an SRO argues strongly against the inadequate funding that this Congress has given the SEC. We need to, and can very well afford, the relatively small amounts of money to increase their funding.”
Rep. David Scott (D-Ga.) said he thinks investment advisers and broker-dealers are in fact, “inherently different. If that is the case, why subject investment advisers to the same type of SRO that broker-dealers are currently subjected to?” He added “if this bill preempts the states from regulating registered investment advisors, then the question becomes, aren’t the states preempted from regulating brokers?”
Rep. Carolyn McCarthy (D-N.Y.) said the bill is a “great start.” However, McCarthy said she would have preferred to go through the SEC, but since the SEC is not going to get the required funding, “it’s just not going to happen.”
Testimony
In his testimony, Dale Brown, President and CEO of the Financial Services Institute (FSI), applauded the proposed legislation “as an essential step in creating and enhancing the trust essential for financial stability, and in making sure that all American investors receive equal protections, regardless of where they do business with a broker-dealer or an investment adviser.” Investment advisers subject to routine examination would improve public confidence in the U.S. marketplace, Brown said. An independent regulator under SEC oversight “will help close this unacceptable regulatory gap, by assuring regular examinations for a sector of the industry that currently has almost no meaningful oversight,” he said.
Brown added that passing the legislation would establish a balanced playing field for all financial advisers, streamline the examination process for dual registrant firms operating as both broker-dealers and investment advisers, and remove the uncertainty surrounding how the investor protection problem will be resolved.
In his testimony, Thomas Currey, speaking on behalf of the National Association of Insurance and Financial Advisors (NAIFA), said the bill “is an important step in the right direction for protecting consumers and enhancing public faith in all financial professionals.” Currey added that the Financial Industry Regulatory Authority (FINRA) is “best equipped” to serve as the self-regulatory organization (SRO) for investment advisers as it “would be the least disruptive and most cost-efficient way” to instill confidence in consumers that their investment advisers are subject to regular supervision and testing.
Currey also said the bill “appropriately establishes a benchmark that all states must examine registered investment advisers at least once every four years.” In addition, Currey said if FINRA or any other SRO is given the examination authority over investment adviser representatives, there must be an independent investment adviser representative on that entity’s governing board as they “have a unique perspective on their business model – one that is not shared by investment advisers or their affiliated representatives.”
In his testimony, Chet Helck, Chairman-Elect of the Securities Industry and Financial Markets Association (SIFMA) and the CEO of the Global Private Client Group at Raymond James Financial, spoke on behalf of SIFMA and in support of H.R. 4624. Helck said SIFMA’s support of an SRO for retail advisers “is premised on the recognition that broker-dealers provide some of the same services as investment advisers – including providing personalized investment advice to individual clients.” Since both provide the same service, “they should be held to the same standard,” Helck said, adding that this is why SIFMA “supports the establishment of a uniform fiduciary standard for broker-dealers and investment advisers when they provide personalized investment advice about securities to retail customers.”
Helck added that H.R. 4624 will help ensure uniform examination and oversight of investment advisors and broker-dealers, while alleviating the SEC from using its constrained budgetary and financial resources to examine registered investment advisers. Since the SEC is currently not fulfilling its examination mandate with respect to investment advisers, “we do not believe that the SEC is a viable or practical candidate to fill the “examination enhancer” role contemplated by Dodd-Frank Section 914.”
Helck went on to say that the FINRA examination of dual-registrants alternative “would not provide any enhanced oversight or examination…. This option is not only grossly under-inclusive, but also inconsistent with taking a uniform approach to the examination and oversight of advisers who provide the identical services to retail customers” and would encourage brokers to flee from the highly-regulated broker-dealer environment.
Instead, Helck said SIFMA believes that the retail adviser regulatory organization alternative… “is the most practical and prudent approach and “would be an effective supplement to the SEC’s resources” as such an alternative would be able to devote “sufficient” examination resources, and be able to focus on specific activities and challenges unique to registered investment advisers (RIAs).
Concluding, Helck said the regulatory enhancements in the bill should be “equally extended” to broker-dealers under FINRA, and other SROs that oversee broker-dealers, and that both the rulemaking procedures and cost-benefit requirements applicable to the retail adviser’s independent, self funded, retail organization (IRO) should be “equally extended and applied” to regulatory organizations under the Securities Exchange Act of 1934. Helck added that SIFMA would be supportive of the Committee’s efforts “to ensure that retail advisers are subject to IRO oversight and institutional advisers remain under the jurisdiction of the SEC.”
In his testimony, Richard Ketchum, Chairman and CEO of FINRA, said H.R. 4624 “represents a direct, bipartisan response to the SEC’s study and recommendations” that will help “fill the gap” in the protection of investment advisory clients. The U.S. “has had a long and successful experience with the SRO model, and H.R. 4624 would represent a tailored extension of the SRO model to the investment adviser industry,” Ketchum said.
Ketchum called the Boston Consulting Group’s cost projections of FINRA becoming an SRO for investment advisers “inaccurate and based on flawed methodology,” and went on to describe FINRA’s own analysis which offers “a realistic estimate for extending FINRA’s examination program to covered investment advisers.”
In his testimony, John Morgan, Securities Commissioner of Texas and speaking on behalf of the North American Securities Administrators Association (NASAA), said Congress “should focus its attention on improving deficiencies in the oversight of federally registered investment advisers, while allowing the states to continue to focus on our distinct responsibility for the oversight of state registered investment advisers.”
Morgan said the proposed legislation “embraces a ‘one size fits all approach’ to regulation,” and for the “overwhelming majority of states,” H.R. 4624 is unnecessary as registered investment adviser firms are already subject to strong state oversight and inspection.
Morgan went on to explain the job-killing impact this bill would have on small and mid-sized investment adviser businesses if enacted and offered the following proposals to address critical flaws in the bill including: 1) State registered investment advisers should not be required to become members of an SRO; 2) States should be able to adopt examination practices that are best suited to their pool of investment advisers; 3) State securities regulators should not be required to report to an SRO; 4) The exemptions in H.R. 4624 undermine the legislation’s goal and purpose.
Morgan added that the “most appropriate way” to improve the oversight of federally registered investment advisers is to provide the SEC with the resources needed to do the job, “either through increased appropriations or by authorizing the SEC’s Office of Compliance Inspections and Examinations to collect user fees from the investment advisers it examines.”
In his testimony, David Tittsworth, Executive Director and Executive Vice President at the Investment Adviser Association (IAA), said the IAA “strongly opposes” the bill and cited the following drawbacks: minimal transparency and accountability, insufficient oversight by the SEC and Congress, conflicts of interest, excessive costs, and the lack of meaningful due process protections and cost-benefit analysis restraints, outweigh the potential benefits.
Like Morgan, Tittsworth explained the bill’s impact on smaller advisers and the bill’s attempt “to impose on investment advisers the same regulatory framework that currently exists for brokers.” Tittsworth pointed out that if enhancing investment adviser examinations is the objective, H.R. 4624 “represents both the least effective and most costly option.”
Tittsworth also said the IAA is particularly opposed to extending FINRA’s jurisdiction to investment advisers “due to its lack of transparency and accountability, questionable track record, the costs involved and its experience and bias favoring the broker-dealer regulatory model.” He went on to explain how the SEC is “best-positioned” to provide effective oversight and to ensure it has the resources, Tittsworth said the IAA supports a user fee on SEC-registered investment advisers “to be used solely to fund additional examinations by the SEC.”
Question & Answer
Questions voiced by lawmakers touched on user fee issues, the bill’s potential affect on small and medium sized investment practices and the diminishing roles of existing state and federal authorities.
Bachus opened up the question and answer session by questioning Tittsworth’s comments that the SEC, in their SRO report, said they favored the use of user fees. Tittsworth said the report suggests that there’s “the greatest number of advantages to user fees.” When pressed further on whether the report actually suggests this, Tittsworth said that was his interpretation, to which Bachus said “I’ve read it, and I don’t see that.”
In a follow up question, Bachus said Rep. Steve Stivers (R-Ohio) has an amendment to make a de minimis fee for small investment advisers to the SRO, and asked Tittsworth whether he supported this idea. Tittsworth said “it’s always hard to support any new fees,” adding “the bottom line is, whatever approach you’re going to take, there are going to be additional costs” and someone will end up having to bear those costs. He said, “spreading the pain is something that, I think, has to happen.”
Bachus also said he would like to follow up with Morgan and others to possibly find a de minimis fee “that the states could be satisfied with, or maybe some credit for states that have a vigorous program.”
Rep. Maxine Waters (D-Calif.) asked Tittsworth why his organization supports a user fee model instead of an SRO model.
Tittsworth said his organization supports “appropriate” user fee legislation as it would be “the most direct, the most efficient, and the most effective way to enhance investment adviser oversight.” Tittsworth said an appropriate user fee provision would be made up of several elements including: 1) in lieu of an SRO, an investment adviser should not have to pay the SEC user fees and an SRO; 2) a dedicated to an enhanced level of oversight, beyond the SEC’s current level; and 3) a review mechanism to ensure that the SEC is using this money for the intended purposes.
Waters said she is drafting legislation that would allow the SEC to collect user fees to enable the examination of investment advisers. Tittsworth said he would be happy to continue discussions with Waters on her legislation.
Rep. Judy Biggert (R-Ill.) discussed the concerns of small advisory firms with SRO regulation. She said it was her understanding that the SROs, like FINRA, are not required to go through a formal rulemaking process and do not conduct “any meaningful economic analysis of the rules.” She added that SROs are not subject to appropriations or directly accountable to Congress. She asked Tittsworth whether it made sense to require SROs to conduct a more robust cost-benefit analysis on their rulemaking.
Tittsworth said, “absolutely.” He added that the current bill takes a “very meager swipe at this issue,” yet the bill does not require FINRA or another SRO to conduct cost-benefit analysis. “You can sue the SEC… but I don’t think under the legislation that you would have that option with an SRO,” he said.
In a follow-up question, Biggert asked whether “it would be possible to achieve the goals of H.R. 4624 by allowing an SRO like FINRA to have a targeted set of authorities to examine investment advisers and enforce SEC promulgated rules.”
Tittsworth said deleting the rulemaking authority for an SRO in the bill “would be an improvement” as that would mitigate the opportunity for it to have a different set of regulations than the SEC. He added that the SEC is going to bear “significant costs in overseeing FINRA. And I think that’s the point that’s lost in this debate that the SEC is being criticized for not doing enough to oversee FINRA and this bill would require greater expenditure to achieve that.” Tittsworth also said having one set of rules “is always most desirable” for regulatory certainty.
Turning to Morgan, Biggert asked whether the bill makes clear which entity, the SEC or an SRO, would conduct audits of state regulators’ exams of investment advisors.
Morgan said its NAIFA’s position “that we should be excluded from this altogether.” In addition, Morgan said states should not be required to report to an SRO.
Rep. Carolyn Maloney (D-N.Y.) said “it would seem to me that we would want to share the burden” and not inappropriately target small businesses with additional costs and regulations, yet the bill “apparently” exempts large investment advisers and those with sizeable institutional assets, and allows them to choose one regulator over another. She asked the panel what the policy reasons were behind the exemptions.
Ketchum said, from the standpoint of small advisers and in response to Morgan’s concern, “we would entirely support an amendment that any SRO fee be de minimis, certainly with respect to any entity that does not have compliance problems.”
Ketchum added that from FINRA’s reading, “the bill does not exempt large investment advisers. The bill only exempts those advisers who provide advice to mutual funds or unregistered funds, and to those entities predominately providing advice to institutional investors.” Ketchum agreed that “there’s the potential that the exemptions are too broad,” and further stated that FINRA would work with the Committee to ensure the exemptions “don’t result in customers facing large investment advisors being outside.”
Rep. Scott Garrett (R-N.J.) also touched on cost-benefit analysis issue and whether it was necessary to include it in statute form to the bill.
Tittsworth said from the IAA’s reading, the bill “does not require FINRA to conduct cost benefit analysis, and there’s certainly no remedy other than the SEC taking FINRA to task if they do not do that.”
In a follow-up question, Garrett said the bill goes into some “prescriptive language as to what the SEC can look at as far as what an SRO would be going forward.” He asked the panel whether the legislation should be more prescriptive or less prescriptive with regard to a potential new SRO.
Helck said the rules should be extended to amend provisions in the Securities Exchange Act of 1934 that apply to FINRA “so that there would be a requirement for transparency and cost-benefit that would be consistent among all providers and therefore broker-dealers would be affected by that as well as investment advisers.”
Rep. Randy Neugebauer (R-Texas) asked the panel how creating another regulator fixes the problem, “if we’re not holding regulators accountable already.”
Brown said the bill creates an opportunity to hold FINRA more accountable. He said he did not believe that the bill creates a new regulator, “rather it is leveraging the benefits of an existing regulatory body to expand to address an important investor protection concern that’s inadequate frequency of investment advisor exams.”
Helck said “we’re not looking for more regulators; we’re looking for consistency among all providers of the same services. If one of the choices is to create a new regulator, that would be problematic. If we have one regulator that consistently applies the same high standards, than I think we’ve accomplished what we came here to do.”
Scott turned to concerns about the bill’s impact on smaller operators. He said the bill “clearly states” that such operators with under $100 million in assets would not be affected “if they are not already covered by state regulation.” He asked the panel whether this refutes the argument that this bill would be damaging to the operation of smaller investment adviser firms.
Morgan said smaller firms would be affected as they would be required to join the SRO and be subject to increased compliance costs and fees. If adequate regulation is already in place, “it’s absolutely an unnecessary layer of cost…. It makes no sense.”
Rep. Francisco Canseco (R-Texas) asked how the bill would make dual-registered representatives (broker-dealer and investment advisers) more effective.
Brown said it would create a lot more consistency as there’s one regulator looking at both sides. The bill would also close the regulatory gap as independent registered investment advisers, “who are subject to virtually no oversight would finally have someone verifying that they are complying by the rules.”
Rep. Patrick McHenry (R-N.C.) asked Helck whether “most investors” understand the difference between broker-dealers and investment advisers. He also asked whether the public understands the difference between the two regulatory structures.
Helck said the public “can’t be expected, nor should they have to understand this distinction to receive the same and consistent investor protections.” He added that the public does not understand the distinction between these regulatory structures.
In response to comments from Tittsworth that the bill would create opportunities for regulatory arbitrage, Helck argued that “we have regulatory arbitrage today, and that’s part of the problem we’re trying to address here. To have consistent policy and oversight across all providers of individual services would clarify for the public and remove the need to understand the differences between various structures and provide consistent protection.” He added that in today’s world, firms like Raymond James are governed by “all of the above.” In other words, “we are a broker-dealer, we are an investment adviser, we have all 50 states and have the SEC and FINRA.” Those firms that are “escaping portions of that” are where the inconsistencies lie, “and that’s where we need to make the level playing field.”
For additional information on the hearing, please click here.
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At today’s House Financial Services Committee hearing, lawmakers examined H.R. 4624, the “Investment Adviser Oversight Act of 2012,” sponsored by Reps. Spencer Bachus (R-Ala.) and Carolyn McCarthy (D-N.Y.).
The legislation would amend the Investment Advisers Act of 1940 to provide for the creation of a National Investment Adviser Association (NIAA), registered with, and overseen by, the Securities and Exchange Commission (SEC). Investment advisers conducting business with retail customers would be required to become members of a registered NIAA and the SEC would have the authority to approve the registration of any NIAA.
In particular, the proposed legislation requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act, the SEC’s rules, and the NIAA’s rules before the association can register as an NIAA.
Under the legislation, the SEC is permitted to suspend or revoke an NIAA’s registration, censure or impose limits on an NIAA’s activities and operations if the NIAA is in violation of the Advisers Act, SEC rules, and the NIAA’s rules, and is able to suspend or revoke an NIAA’s registration if the association fails to enforce compliance with any provision by an NIAA member firm or associated person.
All costs associated with the authorization and functioning of an NIAA will be borne by the regulated, through an “equitable allocation of dues and fees.”
The proposed bill is a response to an SEC study required by the Dodd-Frank Act, which found that the SEC lacks the resources to adequately examine the nation’s nearly 12,000 registered advisors.
For additional information on the bill, please click here.
Opening Statements
In his opening statement, Bachus said of the three options the SEC study presented Congress with, the option authorizing one or more self-regulatory organizations (SROs) to examine investment advisers “is, in my opinion, the most practical, comprehensive and streamlined approach to address this weakness.” Bachus reiterated his readiness to work with anyone who has ideas to improve the bill, specifically mentioning concerns about the exemptions in the bill adding, “I am more than willing to work with any Member or interested stakeholder to address those concerns….”
In his opening statement, Ranking Member Barney Frank (D-Mass.) said “too often… we act as if states are not a factor here. State regulation is very important.” He added, “we have a federal statutory authority here that we have given to the SEC, and when we talk about how to share that, we should not subject the states to this role without their full participation.”
Turning to the SEC’s budget, Frank said the President “did not ask for enough.” He added, “the very fact that we’re considering an SRO argues strongly against the inadequate funding that this Congress has given the SEC. We need to, and can very well afford, the relatively small amounts of money to increase their funding.”
Rep. David Scott (D-Ga.) said he thinks investment advisers and broker-dealers are in fact, “inherently different. If that is the case, why subject investment advisers to the same type of SRO that broker-dealers are currently subjected to?” He added “if this bill preempts the states from regulating registered investment advisors, then the question becomes, aren’t the states preempted from regulating brokers?”
Rep. Carolyn McCarthy (D-N.Y.) said the bill is a “great start.” However, McCarthy said she would have preferred to go through the SEC, but since the SEC is not going to get the required funding, “it’s just not going to happen.”
Testimony
In his testimony, Dale Brown, President and CEO of the Financial Services Institute (FSI), applauded the proposed legislation “as an essential step in creating and enhancing the trust essential for financial stability, and in making sure that all American investors receive equal protections, regardless of where they do business with a broker-dealer or an investment adviser.” Investment advisers subject to routine examination would improve public confidence in the U.S. marketplace, Brown said. An independent regulator under SEC oversight “will help close this unacceptable regulatory gap, by assuring regular examinations for a sector of the industry that currently has almost no meaningful oversight,” he said.
Brown added that passing the legislation would establish a balanced playing field for all financial advisers, streamline the examination process for dual registrant firms operating as both broker-dealers and investment advisers, and remove the uncertainty surrounding how the investor protection problem will be resolved.
In his testimony, Thomas Currey, speaking on behalf of the National Association of Insurance and Financial Advisors (NAIFA), said the bill “is an important step in the right direction for protecting consumers and enhancing public faith in all financial professionals.” Currey added that the Financial Industry Regulatory Authority (FINRA) is “best equipped” to serve as the self-regulatory organization (SRO) for investment advisers as it “would be the least disruptive and most cost-efficient way” to instill confidence in consumers that their investment advisers are subject to regular supervision and testing.
Currey also said the bill “appropriately establishes a benchmark that all states must examine registered investment advisers at least once every four years.” In addition, Currey said if FINRA or any other SRO is given the examination authority over investment adviser representatives, there must be an independent investment adviser representative on that entity’s governing board as they “have a unique perspective on their business model – one that is not shared by investment advisers or their affiliated representatives.”
In his testimony, Chet Helck, Chairman-Elect of the Securities Industry and Financial Markets Association (SIFMA) and the CEO of the Global Private Client Group at Raymond James Financial, spoke on behalf of SIFMA and in support of H.R. 4624. Helck said SIFMA’s support of an SRO for retail advisers “is premised on the recognition that broker-dealers provide some of the same services as investment advisers – including providing personalized investment advice to individual clients.” Since both provide the same service, “they should be held to the same standard,” Helck said, adding that this is why SIFMA “supports the establishment of a uniform fiduciary standard for broker-dealers and investment advisers when they provide personalized investment advice about securities to retail customers.”
Helck added that H.R. 4624 will help ensure uniform examination and oversight of investment advisors and broker-dealers, while alleviating the SEC from using its constrained budgetary and financial resources to examine registered investment advisers. Since the SEC is currently not fulfilling its examination mandate with respect to investment advisers, “we do not believe that the SEC is a viable or practical candidate to fill the “examination enhancer” role contemplated by Dodd-Frank Section 914.”
Helck went on to say that the FINRA examination of dual-registrants alternative “would not provide any enhanced oversight or examination…. This option is not only grossly under-inclusive, but also inconsistent with taking a uniform approach to the examination and oversight of advisers who provide the identical services to retail customers” and would encourage brokers to flee from the highly-regulated broker-dealer environment.
Instead, Helck said SIFMA believes that the retail adviser regulatory organization alternative… “is the most practical and prudent approach and “would be an effective supplement to the SEC’s resources” as such an alternative would be able to devote “sufficient” examination resources, and be able to focus on specific activities and challenges unique to registered investment advisers (RIAs).
Concluding, Helck said the regulatory enhancements in the bill should be “equally extended” to broker-dealers under FINRA, and other SROs that oversee broker-dealers, and that both the rulemaking procedures and cost-benefit requirements applicable to the retail adviser’s independent, self funded, retail organization (IRO) should be “equally extended and applied” to regulatory organizations under the Securities Exchange Act of 1934. Helck added that SIFMA would be supportive of the Committee’s efforts “to ensure that retail advisers are subject to IRO oversight and institutional advisers remain under the jurisdiction of the SEC.”
In his testimony, Richard Ketchum, Chairman and CEO of FINRA, said H.R. 4624 “represents a direct, bipartisan response to the SEC’s study and recommendations” that will help “fill the gap” in the protection of investment advisory clients. The U.S. “has had a long and successful experience with the SRO model, and H.R. 4624 would represent a tailored extension of the SRO model to the investment adviser industry,” Ketchum said.
Ketchum called the Boston Consulting Group’s cost projections of FINRA becoming an SRO for investment advisers “inaccurate and based on flawed methodology,” and went on to describe FINRA’s own analysis which offers “a realistic estimate for extending FINRA’s examination program to covered investment advisers.”
In his testimony, John Morgan, Securities Commissioner of Texas and speaking on behalf of the North American Securities Administrators Association (NASAA), said Congress “should focus its attention on improving deficiencies in the oversight of federally registered investment advisers, while allowing the states to continue to focus on our distinct responsibility for the oversight of state registered investment advisers.”
Morgan said the proposed legislation “embraces a ‘one size fits all approach’ to regulation,” and for the “overwhelming majority of states,” H.R. 4624 is unnecessary as registered investment adviser firms are already subject to strong state oversight and inspection.
Morgan went on to explain the job-killing impact this bill would have on small and mid-sized investment adviser businesses if enacted and offered the following proposals to address critical flaws in the bill including: 1) State registered investment advisers should not be required to become members of an SRO; 2) States should be able to adopt examination practices that are best suited to their pool of investment advisers; 3) State securities regulators should not be required to report to an SRO; 4) The exemptions in H.R. 4624 undermine the legislation’s goal and purpose.
Morgan added that the “most appropriate way” to improve the oversight of federally registered investment advisers is to provide the SEC with the resources needed to do the job, “either through increased appropriations or by authorizing the SEC’s Office of Compliance Inspections and Examinations to collect user fees from the investment advisers it examines.”
In his testimony, David Tittsworth, Executive Director and Executive Vice President at the Investment Adviser Association (IAA), said the IAA “strongly opposes” the bill and cited the following drawbacks: minimal transparency and accountability, insufficient oversight by the SEC and Congress, conflicts of interest, excessive costs, and the lack of meaningful due process protections and cost-benefit analysis restraints, outweigh the potential benefits.
Like Morgan, Tittsworth explained the bill’s impact on smaller advisers and the bill’s attempt “to impose on investment advisers the same regulatory framework that currently exists for brokers.” Tittsworth pointed out that if enhancing investment adviser examinations is the objective, H.R. 4624 “represents both the least effective and most costly option.”
Tittsworth also said the IAA is particularly opposed to extending FINRA’s jurisdiction to investment advisers “due to its lack of transparency and accountability, questionable track record, the costs involved and its experience and bias favoring the broker-dealer regulatory model.” He went on to explain how the SEC is “best-positioned” to provide effective oversight and to ensure it has the resources, Tittsworth said the IAA supports a user fee on SEC-registered investment advisers “to be used solely to fund additional examinations by the SEC.”
Question & Answer
Questions voiced by lawmakers touched on user fee issues, the bill’s potential affect on small and medium sized investment practices and the diminishing roles of existing state and federal authorities.
Bachus opened up the question and answer session by questioning Tittsworth’s comments that the SEC, in their SRO report, said they favored the use of user fees. Tittsworth said the report suggests that there’s “the greatest number of advantages to user fees.” When pressed further on whether the report actually suggests this, Tittsworth said that was his interpretation, to which Bachus said “I’ve read it, and I don’t see that.”
In a follow up question, Bachus said Rep. Steve Stivers (R-Ohio) has an amendment to make a de minimis fee for small investment advisers to the SRO, and asked Tittsworth whether he supported this idea. Tittsworth said “it’s always hard to support any new fees,” adding “the bottom line is, whatever approach you’re going to take, there are going to be additional costs” and someone will end up having to bear those costs. He said, “spreading the pain is something that, I think, has to happen.”
Bachus also said he would like to follow up with Morgan and others to possibly find a de minimis fee “that the states could be satisfied with, or maybe some credit for states that have a vigorous program.”
Rep. Maxine Waters (D-Calif.) asked Tittsworth why his organization supports a user fee model instead of an SRO model.
Tittsworth said his organization supports “appropriate” user fee legislation as it would be “the most direct, the most efficient, and the most effective way to enhance investment adviser oversight.” Tittsworth said an appropriate user fee provision would be made up of several elements including: 1) in lieu of an SRO, an investment adviser should not have to pay the SEC user fees and an SRO; 2) a dedicated to an enhanced level of oversight, beyond the SEC’s current level; and 3) a review mechanism to ensure that the SEC is using this money for the intended purposes.
Waters said she is drafting legislation that would allow the SEC to collect user fees to enable the examination of investment advisers. Tittsworth said he would be happy to continue discussions with Waters on her legislation.
Rep. Judy Biggert (R-Ill.) discussed the concerns of small advisory firms with SRO regulation. She said it was her understanding that the SROs, like FINRA, are not required to go through a formal rulemaking process and do not conduct “any meaningful economic analysis of the rules.” She added that SROs are not subject to appropriations or directly accountable to Congress. She asked Tittsworth whether it made sense to require SROs to conduct a more robust cost-benefit analysis on their rulemaking.
Tittsworth said, “absolutely.” He added that the current bill takes a “very meager swipe at this issue,” yet the bill does not require FINRA or another SRO to conduct cost-benefit analysis. “You can sue the SEC… but I don’t think under the legislation that you would have that option with an SRO,” he said.
In a follow-up question, Biggert asked whether “it would be possible to achieve the goals of H.R. 4624 by allowing an SRO like FINRA to have a targeted set of authorities to examine investment advisers and enforce SEC promulgated rules.”
Tittsworth said deleting the rulemaking authority for an SRO in the bill “would be an improvement” as that would mitigate the opportunity for it to have a different set of regulations than the SEC. He added that the SEC is going to bear “significant costs in overseeing FINRA. And I think that’s the point that’s lost in this debate that the SEC is being criticized for not doing enough to oversee FINRA and this bill would require greater expenditure to achieve that.” Tittsworth also said having one set of rules “is always most desirable” for regulatory certainty.
Turning to Morgan, Biggert asked whether the bill makes clear which entity, the SEC or an SRO, would conduct audits of state regulators’ exams of investment advisors.
Morgan said its NAIFA’s position “that we should be excluded from this altogether.” In addition, Morgan said states should not be required to report to an SRO.
Rep. Carolyn Maloney (D-N.Y.) said “it would seem to me that we would want to share the burden” and not inappropriately target small businesses with additional costs and regulations, yet the bill “apparently” exempts large investment advisers and those with sizeable institutional assets, and allows them to choose one regulator over another. She asked the panel what the policy reasons were behind the exemptions.
Ketchum said, from the standpoint of small advisers and in response to Morgan’s concern, “we would entirely support an amendment that any SRO fee be de minimis, certainly with respect to any entity that does not have compliance problems.”
Ketchum added that from FINRA’s reading, “the bill does not exempt large investment advisers. The bill only exempts those advisers who provide advice to mutual funds or unregistered funds, and to those entities predominately providing advice to institutional investors.” Ketchum agreed that “there’s the potential that the exemptions are too broad,” and further stated that FINRA would work with the Committee to ensure the exemptions “don’t result in customers facing large investment advisors being outside.”
Rep. Scott Garrett (R-N.J.) also touched on cost-benefit analysis issue and whether it was necessary to include it in statute form to the bill.
Tittsworth said from the IAA’s reading, the bill “does not require FINRA to conduct cost benefit analysis, and there’s certainly no remedy other than the SEC taking FINRA to task if they do not do that.”
In a follow-up question, Garrett said the bill goes into some “prescriptive language as to what the SEC can look at as far as what an SRO would be going forward.” He asked the panel whether the legislation should be more prescriptive or less prescriptive with regard to a potential new SRO.
Helck said the rules should be extended to amend provisions in the Securities Exchange Act of 1934 that apply to FINRA “so that there would be a requirement for transparency and cost-benefit that would be consistent among all providers and therefore broker-dealers would be affected by that as well as investment advisers.”
Rep. Randy Neugebauer (R-Texas) asked the panel how creating another regulator fixes the problem, “if we’re not holding regulators accountable already.”
Brown said the bill creates an opportunity to hold FINRA more accountable. He said he did not believe that the bill creates a new regulator, “rather it is leveraging the benefits of an existing regulatory body to expand to address an important investor protection concern that’s inadequate frequency of investment advisor exams.”
Helck said “we’re not looking for more regulators; we’re looking for consistency among all providers of the same services. If one of the choices is to create a new regulator, that would be problematic. If we have one regulator that consistently applies the same high standards, than I think we’ve accomplished what we came here to do.”
Scott turned to concerns about the bill’s impact on smaller operators. He said the bill “clearly states” that such operators with under $100 million in assets would not be affected “if they are not already covered by state regulation.” He asked the panel whether this refutes the argument that this bill would be damaging to the operation of smaller investment adviser firms.
Morgan said smaller firms would be affected as they would be required to join the SRO and be subject to increased compliance costs and fees. If adequate regulation is already in place, “it’s absolutely an unnecessary layer of cost…. It makes no sense.”
Rep. Francisco Canseco (R-Texas) asked how the bill would make dual-registered representatives (broker-dealer and investment advisers) more effective.
Brown said it would create a lot more consistency as there’s one regulator looking at both sides. The bill would also close the regulatory gap as independent registered investment advisers, “who are subject to virtually no oversight would finally have someone verifying that they are complying by the rules.”
Rep. Patrick McHenry (R-N.C.) asked Helck whether “most investors” understand the difference between broker-dealers and investment advisers. He also asked whether the public understands the difference between the two regulatory structures.
Helck said the public “can’t be expected, nor should they have to understand this distinction to receive the same and consistent investor protections.” He added that the public does not understand the distinction between these regulatory structures.
In response to comments from Tittsworth that the bill would create opportunities for regulatory arbitrage, Helck argued that “we have regulatory arbitrage today, and that’s part of the problem we’re trying to address here. To have consistent policy and oversight across all providers of individual services would clarify for the public and remove the need to understand the differences between various structures and provide consistent protection.” He added that in today’s world, firms like Raymond James are governed by “all of the above.” In other words, “we are a broker-dealer, we are an investment adviser, we have all 50 states and have the SEC and FINRA.” Those firms that are “escaping portions of that” are where the inconsistencies lie, “and that’s where we need to make the level playing field.”
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