Tuesday, January 04, 2011

NASAA Objects to Outsourcing Adviser Regulation to SROs

In a comment letter to the SEC, the North American Securities Administrators Association (NASAA) has opposed the designation of one or more self-regulatory organizations (SROs) for the purpose of enhancing the SEC's oversight of investment advisers. NASAA's comments came as the SEC undertakes the study required by Section 914 of the of the Dodd-Frank Wall Street Reform and Consumer Protection Act to assess the need for enhanced examination of and enforcement resources for investment advisers. During the study, the SEC must review the number and frequency of examinations over the five years preceding the Act and analyze current and potential approaches to examining the advisory activities of dually registered broker-dealers and investment advisers and affiliated broker-dealers and investment advisers. The SEC must also consider the extent to which congressional authorization to designate SROs to augment the SEC's efforts in overseeing investment advisers would improve the frequency of adviser examinations.

NASAA expressed strong support for existing regime of investment adviser regulation, which relies on governmental collaboration between the states and the SEC. Given the expected $1 billion increase in the SEC's budget under Section 991 of the Act, and the concurrent reduction under Section 410 of the Act of the number of advisory firms subject to SEC oversight, NASAA believes that the question of designating an SRO for improving the frequency of the agency's examinations of advisers is not yet ripe for consideration. If the SEC should introduce the question of designating an SRO for investment advisers, however, NASAA urged the SEC to conclude that investment adviser regulation is a governmental function that should not be outsourced to a private, third-party organization that lacks the necessary regulatory experience or expertise.

In NASAA's view, the SRO model inherently contains issues concerning collaboration, transparency, accountability, and conflicts of interest. NASAA commented that, although securities industry SROs have historically worked in collaboration with the states and the SEC, FINRA now restricts access to information and disavows active collaboration with governmental regulators in order to avoid classification as a "government actor." Accordingly, NASAA believes that previous regulatory synergies with the SRO have been lost, and it has become increasingly difficult for state and federal regulators to control in a meaningful way oversight or investigations of registrants subject to the current SRO model.

NASAA also believes that the regulatory work performed by SROs lacks transparency. NASAA noted that, unlike the SEC or state securities regulators, industry SROs are not subject to Freedom of Information Act and public records requirements. Even where FINRA provides public disclosure concerning its members, such as on FINRA's BrokerCheck website, the SRO has placed limitations and filters on regulatory records that far exceed Freedom of Information Act provisions, NASAA wrote. As a result, vital information necessary for making informed investment decisions has been withheld from the public.

Finally, NASAA expressed concern over the accountability and conflict issues raised by the current SRO model. NASAA stated that, even where they have independent boards of directors, SROs remain built on the premise of "self-rule." As a result, SROs are accountable to their members rather than the general public. Additionally, SROs by their nature have substantial conflicts of interest that governmental regulators do not, particularly in situations where industry and investor interests conflict, such as in mandatory arbitration clauses and the disclosure or expungement of information concerning customer disputes. Accordingly, NASAA believes that SROs simply cannot match the accountability and proximity of governmental regulators, particularly state regulators, when considering investor protection and regulatory thoroughness.