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Fiduciary Links: 3d Party Fiduciary Assessments Would Enhance SEC Inspection Cycle

Posted by Duane Thompson on March 17, 2014

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>>>The Securities and Exchange Commission once again faces bleak prospects that Congress will approve its budget request for the next fiscal year, which begins October 1st.  Earlier this month the Obama Administration requested $1.7 billion for the agency, a 26 percent increase over fiscal year 2014.  Last year budget gridlock resulted in almost no new funding for the SEC, which would have added 250 examiners to its inspection program of advisory firms.  This year the SEC is asking for similar increases in personnel with probably even less chance of securing approval.

House Appropriations Chairman Hal Rogers, R-Ky., last week confirmed that he would stay with the spending cap agreed to in last year’s budget deal, meaning few if any federal agencies will see much in the way of meaningful budget increases.  If that wasn’t enough to kill the SEC’s proposed budget request, then the House Financial Services Committee’s blistering review of the agency’s performance during the financial crisis undoubtedly sealed the deal.  The Committee on March 13th voted 32-25, along party lines, to adopt a performance report that “ripped the SEC,” as one publication described it.

Rep. Scott Garrett, R-N.J., chairman of the Subcommittee of Capital Markets, said the agency had not been a “good steward” of its funds.  “The SEC has not made the case they deserve additional funding,” Garrett said.

The annual budget fight has broader implications for federally registered investment advisers and future regulation of investment fiduciaries.  With the annual surprise examination cycle of SEC-registered advisers slipping from a once in five years during the early 2000s to about once every 13 or 14 years, it’s possible that calls for off-budget solutions could be renewed if a new Madoff scandal hits the headlines.   Two years ago he Republican-controlled House reviewed a proposal to create a self-regulatory organization for advisers, but wasn’t able to muster consensus.  The Democratic alternative, user fees paid by advisers to fund SEC inspections, did not receive a hearing.

In reviewing the examination issue more broadly, fi360 recently submitted detailed comments on the SEC’s five-year strategic plan suggesting the Commission re-consider the concept of third-party audits.

Noting that the SEC has considered the possibility of third-party audits on at least two occasions – in 2003 and 2009 – fi360 and the CEFEX Centre for Fiduciary Excellence, an affiliated company, wrote that by leveraging third-party exams, the SEC’s inspection arm would be able to work more efficiently, increase its examination cycle, and more readily identify problems.  For example, during the height of the recent financial crisis, then-SEC Chairman Mary Schapiro testified before Congress that the SEC was considering annual third-party audits of RIAs on an unannounced basis to confirm advisers were in fact in possession of client assets, reflecting widespread concerns at the time when Madoff and other Ponzi scheme were exposed.  Schapiro went on to say that she expected SEC would soon recommend a new rule that would require certain advisers to be subject to third-party compliance audits.  For whatever reason, though, a rule was never released for public comment.

The fi360/CEFEX letter suggests the SEC revisit the issue in its five-year strategic plan for 2014-2018.  We point out in the letter that in addition to budget gridlock, there is also a legislative impasse on Capitol Hill in terms of advancing either the SRO concept or user fees as a way of enhancing the examination program.  Moreover, we advanced the idea that, given the Commission’s ongoing interest in a fiduciary standard for brokers, conducting third-party fiduciary assessments of firms that rely on ISO standard 19011, similar to CEFEX’s fiduciary review program, would improve the fiduciary culture at all firms and establish a quality control system for measuring fiduciary processes both quantitatively and qualitatively.  Our letter also questions the third option suggested by SEC staff for enhancing adviser examinations, which would be farming out inspections of dually registered broker-dealer/investment adviser firms to FINRA.  The letter cited concerns expressed by other advisor groups regarding FINRA’s lack of experience in fiduciary regulation.

With positive news on the budget front for the SEC unlikely this year, we believe it’s time the SEC thought outside the box and looked to more creative but proven ways, specifically CEFEX’s assessment program, to improve its lagging inspection cycle of RIAs.  We hope the Commission takes our comments seriously and moves in that direction.

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