Professor Suggests Using External Auditors to Increase Investment Adviser Examinations

November 04, 2011

Section 914 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) required the U.S. Securities and Exchange Commission (“SEC”) to review the frequency of investment adviser examinations and to consider various ways to increase the frequency of such examinations, such as forming an investment adviser self-regulatory organization (“SRO”).  As a result, Congress has begun to look at different ways to increase the frequency of examinations of investment advisers.  The solutions that have been proposed and are being debated include forming an independent SRO, giving FINRA the authority to serve as the investment adviser SRO, increasing the SEC’s funding, charging investment advisers a user fee, or shifting the regulatory authority to the Bureau of Consumer Financial Protection.  James Angel, a professor at Georgetown University’s McDonough School of Business has proposed another solution.  In his article titled “On the Regulation of Investment Advisory Services:  Where do we go from here?” Angel suggests that the best solution to provide increased regulatory oversight of investment advisers is to require investment advisers to hire external auditors to conduct compliance reviews.  Angel’s research paper was supported by a grant from TD Ameritrade and his research paper indicates that his research included numerous conversations with broker, regulators, advisors, scholars and industry trade groups.

According to Angel, requiring investment advisers to hire external auditors is the best solution for several reasons.  Angel suggests that requiring audits by external auditors would increase the frequency of examinations and would allow the SEC staff to focus more on “for-cause examinations.”  Also, he suggests that allowing investment advisers to choose their auditor would lower the prices for such services and result in better service.  Angel stated that the SEC has already “started down this path by requiring RIA firms that have custody of customer assets to have surprised audits once a year.”

Under Angel’s suggested plan, external compliance reviews would be conducted every five years and compliance audits would be “tailored to the size and risk of the firms.”  These reviews would be conducted by qualified industry professionals who hold certain designations like the CFA or CPA and have experience working as an examiner.

Angel dismissed the use of an SRO for several reasons.  He notes that SROs have “a strong financial incentive to side with the industry against the consumer.”  He references that one of the findings of  the investment adviser oversight study that was required by Section 914 of the Dodd-Frank Act was that the only area where the SEC’s investment adviser oversight is deficient is in examination frequency.  According to this study, the SEC is still meeting expectations for the rulemaking process and is adequately addressing other industry deficiencies.  Based on this, Angel concludes that forming an SRO or allowing FINRA to serve as the SRO for investment advisers is the wrong approach.  According to Angel, “[An] SRO’s industry expertise makes it, in theory a better rule-setter,” but the SEC does not have an issue with serving as a rule-setter.  Therefore, Angel states that “[e]stablishing a new SRO with new rulemaking authority whose rules must be approved (and likely micromanaged) by the SEC merely adds another level of bureaucracy.”

Stayed tuned to RIA Compliance Consultants for further updates as we will continue to follow this story.

Posted by Bryan Hill
Labels: SEC, SRO