There's a tried and true tactic that politicians have used since the beginning of time: Propose a major tax hike while intending to impose a less drastic one. More often than not, they get precisely what they want but they are still able to take cover and tell their constituents, "See what I saved you from?" The psychology is simple: When faced with a sweeping change, people are more willing to accept or even embrace an incremental one.
Now this same tactic is being employed in the fight over a self-regulatory organization for financial advisors. The legislation proposed by U.S. Rep. Spencer Bachus, chairman of the House Financial Services Committee, that would have given oversight of financial advisors to a self-regulatory organization (likely Finra), was summarily and unexpectedly shelved for the foreseeable future. It's been passed over for another proposal by U.S. Rep. Maxine Waters recommending that the SEC charge a user fee for exams.
Advisors across the nation are breathing a sigh of relief and rejoicing now that Finra's sword of Damocles
no longer hangs over their heads. Many, in fact, seem to be embracing the concept of SEC user fees with open arms and apparently without question. But the simple fact remains: The lesser of two evils is still evil.
A Flawed Premise
This whole game of regulatory three-card monte is the result of a massively flawed premise-that more frequent examinations by regulators inevitably result in better regulation. And since Finra (the self-regulatory organization for advisors' sister industry) examines brokerage firms about every year on average, it has been held up as the poster child for "success."
But we've yet to be presented with a shred of empirical evidence that more frequent examinations would benefit either advisors or their clients. The spate of recent fraud cases-from Bernard Madoff to Lehman Brothers' Repo 105 balance sheet manipulations-have all been perpetrated by broker-dealers under Finra's watch, despite the annual examinations. (The SEC also examined Madoff, and Lehman had SEC examiners there full time.) The underlying premise, that more exams will help prevent advisor fraud, is fundamentally flawed on two counts: The cases of fraud among independent advisors are practically nonexistent, and there is absolutely no tangible proof that more frequent examinations have any impact on minimizing fraud in the first place.
How can anyone with even a rudimentary understanding of this industry not realize that the average risks involved in the day-to-day investment activities of an RIA are light-years removed from the risks inherent at brokerage firms? When did a fiduciary business, one in which advisors provide unconflicted investment advice adhering to a fiduciary standard of care and then fully disclose their fees, suddenly become the laboratory for a Ponzi scheme?
Abracadabra! Where Did The Money Go?
In no way am I saying user fees are an inherently bad thing. But before embracing the concept and high-five one another for averting the disastrous SRO proposal, let's stop and try to accurately assess how reasonable Rep. Waters' user-fee proposal is.
The last time I looked, the SEC's Office of Compliance Inspections and Examinations (OCIE) receives significant budget increases each year to do its job. Yet as far back as February 2003, the SEC identified staffing problems, when it reported to Congress:
"The number of funds and advisers (and the amount of assets they control) has grown significantly. This growth has substantially exceeded the growth in our resources as well as those resources we have been able to allocate to our investment company and investment adviser programs. Although the commission's resources may increase substantially in the future, other program areas will have competing needs for those resources. Moreover, even if we are able to substantially expand our examination staff, it is unlikely that future growth in our resources will ever keep pace with future growth of investment advisers and investment companies."
To help the SEC with these problems, Congress both added to its budget and added language to the Dodd-Frank Act that effectively shed about 4,000 advisors from the SEC's rolls this year. Yet the SEC still says it cannot effectively conduct advisor examinations. Most people wrongly surmise that the user fee proposal would remedy any remaining staffing concerns. But Waters' bill would not stop the SEC from shifting resources to other areas.