The Financial Planning Association is encouraging its members to write to the Securities and Exchange Commission protesting a proposed regulation that will require investment advisors to undergo surprise annual accounting audits by an outside accounting firm.

The audit would affect SEC-registered advisory firms that automatically deduct client fees through a qualified custodian, said Duane Thompson, managing director of the FPA. The SEC deems these firms to have some form of custody and control over clients’ assets.

More than 9,500 financial planning firms would be subject to the surprise inspections, which might cost $150,000 to carry out, Thompson said. Currently, only advisors who self-custody client assets undergo audits, but they are not required to use a firm registered with the Public Company Accounting Oversight Board, which oversees accountants. There has never been an audit requirement specifically for the practice of automatically deducting client fees. 

This is one way the SEC is trying to prevent Bernie Madoff-type scams that go on for years. Generally, the audit would verify that clients’ money is still in their accounts.

Accounting firms doing the audits would have to notify the SEC of any suspicious problems in the advisory accounts.

But the regulator’s solution is too hard on RIAs, said Thompson: “Advisors are upset with this approach to curbing Ponzi scams by applying the audit requirement for all, simply because fees are automatically deducted through the custodian.” The automatic deduction of fees from client accounts, especially when assets are held by outside firms, rarely causes problems, he added. “The approach taken by the SEC in this rule is directed at a problem that does not exist,” he said.

The SEC proposed another audit requirement in the same rule, requiring firms that don’t use an outside custodian to obtain a written report from an independent public accountant that includes an opinion regarding the sufficiency of its internal accounting controls, Thompson said. In practice, that audit would affect large, dually registered independent broker-dealer firms and wirehouses. This element of the proposed rule seems like a more effective way to control Ponzi schemes and other fraud relating to clients’ assets.

“That is where there is a higher risk,” Thompson said. “We of course support strengthening investor protection in light of the scandals, but think the more effective approach is giving the SEC additional staff resources and better training.”

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