The SEC’s Investment Advisory Committee has recommended that the regulator institute third-party exams to increase the regulator’s RIA exam rate and charge firms fees for the service.
The IAC yesterday voted to put its sweeping proposal out for industry comment. It now goes to the commission for a vote.
The agency currently oversees 15,000 RIAs, who are examined every seven years on average.
“The seven-year exam cycle is inadequate to detect fraud,” IAC member Paul Roye said. The fact that the industry is growing exponentially and works with 65 million investment advisory clients makes the situation more dire, he added.
“We believe that RIAs should be examined every four to five years with higher-risk firms being examined more frequently,” said Roye, who retired as chief legal officer of the American Family of Funds in 2022.
Roye said that the IAC and SEC staff would prefer that Congress provide the funding to increase the SEC’s own examination staff, but noted that Congressional appropriations have not allowed that.
Since 2016, the number of SEC RIAs has increased 25%, while the number of private funds managed by SEC registered advisers has increased 40%, but SEC exam staff has increased only 4%. In 2021 alone, 900 new advisors registered with the SEC, the committee said.
As a result, the IAC said it is concerned about whether the seven-year exam cycle can even be maintained, as the SEC returns to on-site examinations post-pandemic, according to the recommendation.
Roye said the committee considered four potential approaches to enhancing oversight of SEC registered advisors, including the following:
• Reallocating more advisor oversight responsibilities to state regulators.
• Creating a self-regulatory organization to examine registered advisors.
• Giving Finra authority to examine firms that are dually registered as broker-dealers and investment advisors.
• Permitting third-party examinations of registered advisers.
“Of the alternatives considered, we believe that the approach that offers the most appeal is third-party compliance examinations of investment advisers. The SEC could adopt a rule requiring advisers to undergo a compliance exam conducted by an outside firm and that a copy of the exam results be submitted to the SEC,” the IAC said.
The committee also recommended that the SEC request congressional legislation that would authorize its Division of Examinations to impose “user fees” on SEC-registered investment advisors.
“The fees collected from investment advisers would be available to the SEC without further appropriations, used solely to fund the SEC’s investment adviser examination program, and set at a level designed to achieve an acceptable frequency of examinations (a minimum of every 4-5 years),” the IAC recommended.
User fees could be assessed based on the complexity of the firms, number of representatives, number of offices, complexity of products and assets under management. Larger and more complex firms could be charged higher user fees, the IAC said.
The House passed bipartisan legislation to allow the SEC to charge RIAs fees, but the Senate hasn’t taken up the measure.
The Investment Adviser Association, the leading trade group of the RIA industry, said in March that user fees would better enable the SEC to improve the effectiveness of its examinations through long-term strategic planning and the better use of modern technology.
“A stable source of funding would permit use of technology-based solutions that could take years to develop and implement. Moreover, stable and scalable resources would also provide the SEC’s adviser examination program with increased flexibility to react to emerging risks, and better target staffing and strategic resources as appropriate,” the committee said.
Not all SEC commissioners are onboard with the recommendation. Commission Hester Peirce submitted a number of questions in writing to the IAC yesterday.
“If the third-party option were chosen, would advisers and investors be justified in asking why we are outsourcing a key government function? Would this approach create a new set of quasi-governmental regulatory organizations? Given the regulatory origin of the demand for third-party examiners, would advisers have any leverage in fee negotiations with these third parties?” Peirce asked.
Roye said that the banking industry already uses third-party examiners and that banks pay individual fees, but that the committee welcomes questions, which is why they recommended putting their recommendations out for industry comment.