A Georgetown University professor has proposed a different idea in the ongoing debate over how investment advisors should be effectively regulated: outsource the heavy lifting to accounting firms.
In a 36-page report now circulating through the industry, James J. Angel, a professor at the McDonough School of Business at Georgetown, says routine examinations should be outsourced to seasoned accounting professionals. TD Ameritrade Institutional commissioned the report, titled “On the Regulation of Investment Advisory Services: Where do we go from here?”
Angel presented his findings to TD Ameritrade Institutional’s advisor panel, which has about 30 members.
The SEC and FINRA habitually hire recent college or law school graduates as examiners, yet these examiners often lack industry experience, according to Angel’s report. Audits then become perfunctory “check the box” events that are unlikely to uncover wrongdoing, according to Angel. It is better to end the practice of hiring examiners with little industry experience and upgrade the skills of existing ones.
As for the audits themselves, Angel suggests examiners should verify the information in the Form ADVs that companies file with the SEC, and verify that a given firm has procedures in place to comply with U.S. securities laws. Each firm’s regulatory history and risk profile would determine its frequency of exams, so that larger firms with more complex businesses would be examined more often than smaller firms.
Angel’s proposal might not solve every problem, but it is more intriguing than some of the conflicting ideas now circulating through the industry and Congress, according to Richard S. Brown, CEO of JNBA Financial Advisors, based in Minneapolis. Brown has a seat on the TDAI advisor panel, and listened to Angel’s presentation.
Brown suggested that audits could be more streamlined, as well. This could make the process for routine questions less cumbersome, helping regulators and firms alike use their resources more efficiently. “The SEC now has a uniform process for what they look for,” Brown said. “If I sat down and looked at that list [of procedures], there are things that could be done electronically, I bet.”
Client billing processes and trade blotters are just a couple of routine procedures at advisory practices that could be reported electronically, Brown said.
When it comes to the safety and protection of clients, though, exams should not be shortchanged. Detailed questions about compliance procedures and investment products, for example, should be asked in person, Brown said. “Those should be subject to some sort of audit,” he said. “You need to ask questions that are not electronic.”
When it comes to regulating investment advisors, the industry is certain about one thing: no self-regulatory organizations. Organizations like the Investment Advisers Association have long called for a self-funding mechanism that would allow the SEC to collect user fees from the companies it examines. Angel’s proposals dovetail with that, too.
Angel estimates that the all-in costs of one examiner, including wages, benefits and overhead, is about $200,000. If the SEC examined RIA firms once every five years, the annualized cost per firm would be $8,500, according to Angel.
Angel suggests that any user fees be related to the cost of examining the firm and this is where a firm’s size and complexity come into play again. The firm’s number of representatives, branches, complexity of products and assets under management would all be considered.
The report included a fee schedule based on a firm’s assets under management. Firms with less than $25 million in AUM would pay a proposed annual fee of $300. The fee schedule increases proportionately, with firms with more than $500 million in AUM paying a proposed $5,000.
User fees might make perfect sense to some in the industry, but getting the idea past Congress has always been a tough sell. In 1992, Angel said in his report, the House passed the Investment Adviser Regulatory Enhancement and Disclosure Act, which called for user fees from RIAs for examinations. It died in the Senate that year, however.
This article originally appeared in Financial Planning.
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