Investment Adviser Oversight Act of 2012

Bauchus-McCarthy Bill to Authorize IA SRO

House Financial Services Committee Chairman Spencer Bachus (R-LA) and Rep. Carolyn McCarthy (D-NY) today introduced the payday loans

Investment-Adviser-Oversight-Act-of-2012.pdf”>Investment Adviser Oversight Act of 2012. The bill would allow for the creation of a self regulatory organization (SRO) for investment advisers, similar to FINRA for broker-dealers. Below we have reprinted the press release from the House Financial Services Committee website which can also be found here.

In addition to the press release, we will be posting other thoughts related to this story in the coming days and weeks. Links to this story will appear below along with other articles we have already posted on this topic:

GAO Report on SRO for Private Fund Advisers (September 2011)

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Chairman Bachus and Rep. McCarthy Propose Bipartisan Bill for More Effective Oversight of Investment Advisers

Washington, Apr 25 –

Financial Services Committee Chairman Spencer Bachus and Rep. Carolyn McCarthy, a member of the Committee, introduced bipartisan legislation today to create more efficient and effective oversight of the retail investment advisory industry.

Chairman Bachus and Rep. McCarthy introduced their proposal in response to a Securities and Exchange Commission (SEC) study that revealed the agency lacks resources to adequately examine the nation’s nearly 12,000 registered advisers. As part of its study, which was a requirement of the Dodd-Frank Act, the SEC recommended a self-regulatory organization as one option for Congress to consider as it looks for ways to help the agency monitor the industry.

The Bachus-McCarthy bill would authorize one or more self-regulatory organizations (SROs) for investment advisers funded by membership fees.

Investment advisers and broker-dealers often provide indistinguishable services to retail customers, yet only 8 percent of investment advisers were examined by the SEC in 2011 compared to 58 percent of broker-dealers.

“The average SEC-registered investment adviser can expect to be examined less than once every 11 years. That lack of oversight, particularly in the aftermath of the Madoff scandal, is unacceptable,” said Chairman Bachus. “Bad actors will naturally flow to the place where they are least likely to be examined. Therefore, it is essential that we augment and supplement the SEC’s oversight to dramatically increase the examination rate for investment advisers with retail customers.

“Customers may not understand the different titles that investment professionals use but they do believe that ‘someone’ is looking out for them and their investments. For broker-dealers that is true, but for investment advisers, it is all too often not true and that must change,” concluded Chairman Bachus.

The legislation would amend the Investment Advisers Act of 1940 to provide for the creation of National Investment Adviser Associations (NIAAs), registered with and overseen by the SEC. Investment advisers that conduct business with retail customers would have to become members of a registered NIAA. The SEC would have the authority to approve the registration of any NIAA.

The legislation permits the SEC to suspend or revoke an NIAA’s registration, or censure or impose limits on an NIAA’s activities and operations, if the SEC finds that the NIAA has violated the Advisers Act, SEC rules or its own rules. The SEC would also be able to suspend or revoke an NIAA’s registration if the association has failed to enforce compliance with any provision by an NIAA member firm or associated person.

The proposal requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act, the SEC’s rules, and the NIAA’s rules before the association can register as an NIAA.

The proposal also recognizes the authority given to the states over small investment advisers in Title IV of the Dodd-Frank Act by preserving state authority over investment advisers with fewer than $100 million in assets under management, so long as the state conducts periodic on-site examinations.

In addition, the SEC must determine that the NIAA’s rules:

are designed to prevent fraud and protect investors;
are consistent with the Advisers Act and fiduciary duties under the Act and state law;
do not impose any burden on advisers that is not in the public interest or for investor protection;
provide for periodic examinations of members and their related persons, and for coordination of those examinations with the SEC and state securities authorities;
assure a fair representation of the public interest and the investment adviser industry in its selection of directors and administration of its affairs, and provide that a majority of its directors do not come from the securities industry; and
provide for equitable allocation of dues and fees and establish appropriate disciplinary procedures for members and their associated persons that violate the Advisers Act, SEC rules or NIAA rules.

Click here to view a copy of the bill.

Key Leaders Agree an SRO Will Result in More Effective Oversight and Stronger Protection for Investors

SEC Chairman Mary Schapiro: “I think self-regulatory organizations, with close oversight from the federal government – can bring tremendous value to the protection of investors. So, it’s an area we are willing to explore because even though our budget is growing, we’re likely to never have all the resources we need to do everything that we’d like to do and the extent to which we can leverage SROs, accounting firms, whistleblowers, I am game to do that because I think it will allow us to do a better job.”

Testimony before the Capital Markets, Insurance and Government Sponsored Enterprises Subcommittee, July 14, 2009

Former SEC Commissioner Roberta Karmel: “After the financial meltdown of 2008 and the Madoff bankruptcy, it would seem the height of political irresponsibility to allow the current inadequacies in the SEC’s examination capabilities to continue.

New York Law Journal, June 16, 2011

Consumer Federation of America’s Director of Investor Protection Barbara Roper: “Having spent the better part of two decades arguing for various approaches to increase SEC resources for investment adviser oversight with nothing to show for our efforts, we have been forced to reassess our opposition to the SRO approach. Specifically, we have concluded that a properly structured SRO proposal would be a significant improvement over the status quo.”

Testimony before the Senate Banking, Housing and Urban Affairs Committee, July 12, 2011

SEC Chairman Mary Schapiro: “…we have to find a way to have better oversight of intermediaries who have such enormous interplay with retail investors, and an SRO is one of the vehicles to do that.”

Testimony before the House Financial Services Committee, September 15, 2011

Securities Industry and Financial Markets Association Chairman John Taft: “In the case of broker-dealers and independent investment advisers who provide personalized investment advice to retail customers, we believe comparable examination, oversight, and enforcement is most practically and readily achievable through use of an SRO.”

Testimony before the Subcommittee on Capital Markets and Government Sponsored Enterprises, September 13, 2011

SEC Commissioner Elisse Walter: “We also have precedent, spanning more than seven decades, that SROs can significantly enhance the Commission’s examination and enforcement resources relating to its regulated entities … We need to address this issue now. It must not be relegated to another day—as has happened in the past. For far too long, in the investment advisory area, the Commission has been unable to perform its responsibilities adequately to fulfill its mission as the investor’s advocate, and investment advisory clients have not been adequately protected. This must change.”

Statement on Study Enhancing Investment Adviser Examinations, January 2011

House Budget Resolution FY 2012, Report 112-58: “During a time when trimming the deficit is imperative, the SEC should create headroom in its budget by streamlining and making more efficient its operations and resources; defraying taxpayer expenses by designating self-regulatory organizations (subject to SEC oversight) to perform needed examinations of investment advisors; and enhancing collaboration with other agencies, such as the Commodity Futures Trading Commission, to reduce duplication, waste, and overlap in supervision.”

Department of the Treasury: “Treasury notes the rapid and continued convergence of the services provided by broker-dealers and investment advisers and the resulting regulatory confusion due to a statutory regime reflecting the brokerage and investment advisory industries of decades ago. An objective of this report is to identify regulatory coverage gaps and inefficiencies. This is one such situation in which the U.S. regulatory system has failed to adjust to market developments, leading to investor confusion. Accordingly, Treasury recommends statutory changes to harmonize the regulation and oversight of broker-dealers and investment advisers offering similar services to retail investors. In that vein, Treasury also believes that self-regulation of the investment advisory industry should enhance investor protection and be more cost-effective than direct SEC regulation. Thus, in effectuating this statutory harmonization, Treasury recommends that investment advisers be subject to a self-regulatory regime similar to that of broker-dealers.”

Blueprint for a Modernized Financial Regulatory Structure, March 2008

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Cole-Frieman Mallon & Hunt LLP provides legal and investment adviser registration and compliance services to the hedge fund community. Bart Mallon can be reached directly at 415-86-5345.

SRO for Private Fund Adviser could be established, but not without challenges

Over the last few weeks we have heard much talk about the potential formation of a self-regulatory organization (“SRO”) for registered investment advisers (i.e. hedge fund managers). In July the U.S. Government Accountability Office (“GAO”) released a report on the feasibility of forming an SRO to provide oversight to private fund advisers. The report was required by the Dodd-Frank Act and it discusses the feasibility of establishing the SRO as well as the potential advantages and disadvantages of forming such an organization. This report comes on the heels of an SEC study of IA examinations which analyzed whether an IA SRO would be feasible. [We concluded: This study simply states the obvious – the SEC does not have the resources it needs to adequately do its job. It seems like the major conclusion has already been reached – IA firms are going to need to pay for their oversight because Congress will not pay for it.] In the GAO report, the issue is examined further and the conclusion states that an SRO could be established and there would be potential advantages and disadvantages for doing so.

Feasibility of Establishing the SRO

The report discussed the feasibility of establishing the SRO. In general there are a number of items which would need to be put into place before an SRO could be formed and operating. The main item is that Congress would need to specifically authorize, through legislation, the creation of the SRO which would then be subject to SEC oversight. After authorization, a determination would be made as to whether the SRO would be created ab initio or if an existing SRO would take over the responsibilities of overseeing private fund advisers. It is likely that, given the costs of establishing an entirely new entity, an existing SRO (such as FINRA or the NFA) would simply be given the new oversight responsibilities. Once an SRO was determined, bylaws and operational issues will need to be addressed including fee and governance structures, board of directors, compliance rules and enforcement rules.

In any event, establishing an SRO for private fund advisers is likely to be resource intensive and subject to various levels of the political process – Congress, the SEC, (potentially) the CFTC, NASAA, and the SRO would all have agendas with respect to the SRO. Additionally, even within the private fund advisers group there is likely to be political positioning – large managers are going to have different concerns

than small managers and are most likely going to want to have a larger say with respect to operations (especially if they are paying a disproportionate amount of the fees to support the IA oversight functions of the SRO).

Potential Advantages of a Private Fund Adviser SRO

The report listed the following as potential advantages of the SRO:

Advantages of a private fund adviser SRO include its potential to (1) free a portion of SEC’s staff and resources for other purposes by giving the SRO primary examination and other oversight responsibilities for advisers that manage private funds, (2) impose higher standards of conduct and ethical behavior on its members than are required by law or regulations, and (3) provide greater industry expertise and knowledge than SEC, given the industry’s participation in the SRO.

Potential Disadvantages of a Private Fund Adviser SRO

The report listed the following as potential disadvantages of the SRO:

Some of the disadvantages of a private fund adviser SRO include its potential to (1) increase the overall cost of regulation by adding another layer of oversight; (2) create conflicts of interest, in part because of the possibility for self-regulation to favor the interests of the industry over the interests of investors and the public; and (3) limit transparency and accountability, as the SRO would be accountable primarily to its members rather than to Congress or the public

State Registration Issues

One of the questions which this particular report did not address is whether managers registered with a state securities division (instead of the SEC) would be subject to oversight by the SRO. The discussion of the advantages and disadvantages did not include state jurisdictional issues, but these issues are important. The state securities divisions are subject to the same budgetary limitations as the SEC and many times the states do not (contrary to reports by NASAA) have the expertise necessary to properly examine fund managers and other investment advisers. If state managers are not required to be part of the SRO then you are likely to see a wide disparity in examination and oversight between state registered managers and SEC registered managers (who would also be subject to SRO oversight). Expect to see this discussed in greater depth going forward.

Conclusion

The issue of whether or not there should be an IA SRO is not going to go away any time soon – especially with the SEC under intense budget pressure and the looming deadline for hedge fund IA registration (March 30, 2012). It is clear that in the race to be the SRO for investment advisers, FINRA is the leader and really probably the only viable option. While having FINRA oversee both BDs and IAs may not make the most sense, it is probably better than the alternatives which right now include (1) the NFA (which oversees managed futures firms) or (2) starting an SRO from scratch. Expect to hear more on this issue soon from both Congress and the SEC.

For the full GAO report, please see GAO Private Fund Adviser SRO Report.

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Cole-Frieman & Mallon LLP is a law firm which provides adviser registration, compliance and legal support to SEC registered hedge fund managers. Bart Mallon can be reached directly at 415-868-5345; Karl Cole-Frieman can be reached at 415-352-2300.

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Tag Archives: ia sro

Investment Adviser Oversight Act of 2012

GAO Report on SRO for Private Fund Advisers