NSMIA was a flop. In the years after the $25 million threshold was created, the SEC lost its ability to credibly regulate RIAs. One regulator estimated that the time between SEC exams of RIAs increased dramatically to an average of 28 years.
Denise Voigt Crawford, president of the North American Securities Administrators Association (NASAA) and Commissioner of the Texas State Securities Board, says that since the 1996 reforms, the SEC has failed to examine thousands of RIAs, dealing only with the largest because of its limited resources.
"As a consequence, over 3,000 RIAs over which the SEC had exclusive jurisdiction have never been examined," she says. She calls the 1996 law an "experiment that failed" and says the results to investors have been disastrous.
The Dodd-Frank regulatory reforms are an attempt to address these shortcomings. But you have to wonder if the new law is any better conceived than the one that came out in 1996.
It might not seem like a lot of work to add 4,200 Form ADV reviews, since they will come over a period of months and be distributed throughout the 50 states. But the challenge is greater than you might think. That's partly because the transition is going to occur in the eight-month period between January 1, 2011 and July 21, 2011, and the way the rules are designed, there could be a registration bottleneck.
Chris Winn of AdvisorAssist, a compliance consulting firm in Boston, says RIAs with less than $100 million in assets have been free to register with the states since the July 21, 2010 enactment of the new threshold. But few RIAs have moved forward because they would be paying duplicate registration fees, one to the state on top of the one they already paid to the SEC for 2010.
This encourages RIAs to register with their states after January 1, 2011, Winn says. That will force regulators to deal with a torrent of new registrations after that date-and create a bottleneck because the new law requires firms coming under state jurisdiction to file their registration papers by July 21 of next year.
Also, the reality is that a lot more than 4,200 ADV forms are going to be submitted to the states during this eight-month period. That's because the majority of RIAs transitioning to state regulation must file registration documents in two or more states. So it's more likely there will be 10,000 or 15,000 new registrations up for state review.
An RIA large enough to be regulated by the SEC is required to file a single Form ADV with federal authorities. If the firm has more than five clients in a single state, most states will require it to submit a relatively simple state notice filing. Such an RIA must also generally submit its Form ADV to state regulators and pay a fee to do business in the state, but the state does not review the ADV.
When RIAs come under state oversight under the new law, however, they must submit their ADV forms to each state and these will be reviewed by each state's securities regulator.
Bryan Hill, CEO of RIA Compliance Consultants in Omaha, Neb., says state regulators are far more rigorous than the SEC in approving initial applications from RIAs who want to do business in the state. "There's not a single state that I have seen that does not do more thorough reviews of initial applications than the SEC," says Hill.
In many instances, he says, the SEC will approve a new RIA registration after a telephone interview with the firm. By contrast, state regulators have a reputation for being far more diligent in performing initial reviews.
According to Winn, state regulators routinely compare Part I of Form ADV to Part II. State regulators also examine an RIA's client agreement to see if fees are properly disclosed to prospects and clients and to ensure that the explanation of a firm's fees in its agreement is consistent with disclosures in its ADV. An RIA's termination clause, the description of its services and other disclosures in a client agreement are cross-referenced against the firm's ADV Part II.