An SEC study mandated by the Dodd-Frank Act recommended users fees or an SRO as a way to enhance the effectiveness of the oversight of investment advisers. At a time when the Commission’s registered investment adviser examination program faces significant capacity challenges, the study recommended imposing user fees on SEC-registered investment advisers to fund an SEC examination program, authorizing one or more SROs to examine, subject to SEC supervision, all SEC-registered investment advisers, or authorizing FINRA to examine dual registrants for compliance with the Advisers Act. In a separate statement, Commissioner Walter supported the SRO option because it would have significant and long-term benefits to investors and the Commission, but she does not believe that there has to be a single SRO or that it has to be FINRA.
Section 914 of the Dodd-Frank Act requires the Commission to review and analyze the need for enhanced examination and enforcement resources for investment advisers and report to Congress on regulatory or legislative steps necessary to address concerns identified in the study.
The study comes amidst a fierce debate over whether FINRA could or should be an effective SRO for investment advisers. To deal with what FINRA has called an ``intractable resource problem,’’ FINRA has urged the SEC to seek legislation establishing an SRO for investment advisers to augment the government’s efforts in overseeing advisers. The debate over an SRO for advisers has intensified with industry associations voicing strong opposition to the idea.
According to the SEC study, user fees imposed upon registered investment advisers would provide scalable resources to support the examination of registered investment advisers. Under this approach, the Commission would continue to rely on appropriated funds to support its other programs, including other aspects of its administration of the Advisers Act. The fees collected from investment advisers would be available to the Commission without further appropriation and be used solely to fund the investment adviser examination program, as well as be set at a level designed to achieve an acceptable frequency of examinations. While the Commission collects transaction and registration fees under the securities laws from issuers of securities and other market participants, these fees currently are required to be deposited and credited as offsetting collections to the account providing appropriations to the Commission.
The idea of funding the Commission’s investment adviser examination program by charging user fees is not new. In 1992, a bill was introduced in the House of Representatives that would have provided that registered investment advisers pay a user fee to finance their oversight by the Commission
Imposing user fees to adequately fund the examination program may be a less expensive option than an SRO, noted the SEC, although the staff has not evaluated the potential start-up or operational costs of an SRO. User fees are also an option that some advisory organization support as an alternative to an SRO.
The costs of going the SRO route could vary substantially depending upon whether there were multiple SROs or a single SRO, and whether any SRO designated is already in operation and thus could potentially incur fewer start-up costs. Also, the Commission would continue to bear expenses associated with overseeing one or more SROs.
Congress could, alternatively, authorize one or more SROs for registered investment advisers in order to provide scalable resources to support the Commission’s examination of registered investment advisers. SROs are privately funded entities with market specific expertise that, subject to Commission oversight, can have the authority to adopt rules, examine member firms for compliance with those rules and the federal securities laws, and enforce those rules and laws.
However, the implementation of one or more investment adviser SROs would require resolution of a number of important issues regarding the number, scope of authority, membership, governance, and funding. These issues are complicated by the diversity of the investment adviser industry and strong industry opposition.
The diversity of the investment advisory industry, ranging from small, locally-operated financial planning firms to global money managers suggests the potential for multiple SROs, each of which could oversee a different type of investment adviser. However, multiple SROs also could lead to regulatory arbitrage, as SROs seek to attract members by offering a more accommodating regulatory and oversight program or by charging lower fees leading to inadequate funding for regulatory programs.
Congress could provide for an SRO with broad authority or opt for an intermediate approach and grant an SRO limited examination authority over investment advisers, while maintaining the Commission as the sole holder of authority to develop regulatory policy under the Advisers Act.
The governance of any investment adviser SRO is critical because governance is the primary mechanism through which an SRO can manage the conflicts of interest that exist when an organization regulates its own members that also compete with each other. Given the diversity in the investment advisory industry, an appropriate governance structure is important to prevent one business model from dominating the SRO or the SRO from providing a competitive advantage to particular business models.
A third and less comprehensive approach could be to amend the Exchange Act to expressly permit FINRA to examine all of its members that are also registered as investment advisers for compliance with the Advisers Act. Currently, the Exchange Act provides FINRA with authority to enforce its members’ compliance with the Exchange Act and SEC rules under the Act but does not provide it with express authority to enforce compliance with the Advisers Act. Thus, SEC staff conduct examinations of dual registrants for compliance with the Advisers Act in addition to, and separate from, FINRA’s examinations.
While only about five percent of investment advisers registered under the Advisers Act are broker-dealers and thus members of FINRA, almost all of the largest retail broker-dealers are also registered as investment advisers. These dual registrants have a substantial portion of retail advisory clients and employ a significant number of investment adviser representatives.
Authorizing FINRA to enforce the Advisers Act would free existing Commission resources spent examining dual registrants to be re-directed to other investment advisers. Moreover, it would partially address the inefficiencies that result from subjecting a dual registrant to two separate examinations. It would permit a single regulator, having obtained a more holistic view of dual registrants’ client activities and compliance environment, to conduct a more effective examination of a dual registrant. Such examinations also could be more cost efficient.
But authorizing FINRA to examine all operations of dual registrants is not without drawbacks. The Commission staff may lose experience examining these large retail advisers, and may not gain important information about their activities. Further, there would be a risk that, over time, different and inconsistent approaches to applying the Advisers Act to dual registrants and other advisers could develop. The Commission would have to exercise vigilant oversight to prevent this from occurring.
In her statement, Commissioner Walter said that the SRO model should increase the frequency of examinations of investment adviser and thus directly answer the question that Congress posed to the SEC in Dodd-Frank. Moreover, an SRO would allow the SEC to transfer more of its resources in this area to complex and emerging issues at a time when they are most needed and permit the Commission to do its job with fewer but more expert resources. The SRO option would also add significant resources outside the Commission to support the agency’s mission and increase speed and efficiency through SRO processes that are more expedited than those used by the government. Significantly, noted the Commissioner, the user fee option does not necessarily provide any of these benefits.
Commssioner Walter also noted that, while the study raised the specter that the SRO model would undermine the expertise of SEC staff, ``that certainly does not have to be the case.’’ Indeed, the SRO would allow the SEC to do its job with a smaller examination workforce and, by eliminating the need to perform a large number of routine examinations, provide the opportunity for that smaller group to be more expert and experienced.