New Year, New Promise

As we begin 2012, we have the opportunity to look back at the Dodd-Frank Wall Street Reform and Consumer Protection Act to determine its impact on the advisory community. Where many of us are
still grappling with the underlying requirements of such legislation, advisers should note that regulators face similar difficulties.

The SEC and state securities regulatory authorities have been struggling with the issue of how to conduct their regulatory responsibilities under increased budgetary constraints. In its January 2011 Study on Enhancing Investment Adviser Examinations¹, the SEC noted that without increased funding from Congress, the Commission would have difficulty maintaining its current examination program.
(The Commission examined just 9 percent of those under its jurisdiction in 2010.) The study further explores the practicality of placing the SEC’s examination responsibility under a self-regulatory organization and/or imposing a system of user–based fees. While each of these solutions has yet to
be debated in earnest before Congress, it is worth noting that states face many of the same realities.

In an August 2011 working paper² released by the Mercatus Center at George Mason University, researcher Jeffrey Miron argues that states face many of the same debt-heavy obligations that plague the federal government and that without corrective action made towards spending and other policy changes, many states will face fiscal disaster. Indeed, recent headlines demonstrate that many states carry significant burdens in the form of public pension and health care costs. Accordingly, one must view such crises in light of the demand for more regulatory responsibilities on the part of state securities regulators.

Despite the negative financial outlook and its effect on the regulatory framework, the passage of Dodd Frank only creates more requirements for both advisers and regulators. Issues related to custody, conflict of interest, and compliance strength will continue to be looked at in depth by regulators. In a recent study released by the Center for Financial Markets and Policy at Georgetown University³, study author James J. Angel argues that the responsibility to examine federally covered advisers should be “…outsourced to accounting firms or specialized compliance consulting firms.” Angel further argues that since most advisers are required to demonstrate their financial wherewithal in one form or another on an annual basis, such accountants and compliance consultants would be well suited for the task.

Angel’s approach is perhaps the most reasonable given the current regulatory climate. Accounting
and compliance professionals serve to understand the business practices of advisers on an ongoing and comprehensive basis. Such professions thrive on providing quality assurance in accordance with the practical application of law. By allowing such professionals to conduct examinations, the SEC and states (if amenable) would remain free to carry out their licensing and enforcement obligations. As
such obligations remain essential to investor protection efforts, regulators should be granted the opportunity to focus their efforts on such tasks wholeheartedly.

Advisers will soon be joined by a new complement of firms that had previously been exempt from
the registration requirement. Private fund advisers and those that are now subject to a reporting requirement will serve as the primary focus for federal and state examination efforts. Such firms
will have their records and practices reviewed extensively for two purposes: a) to ensure that their practices meet state and federal requirements and b) to train and inform regulatory staff as to how such firms operate and manage client assets. Newly registered advisers will be unfamiliar with the examination process and that of the recordkeeping requirement. Accordingly, such examinations
stand to exhaust the resources of regulatory staff and further stall state and federal efforts to examine a wider complement of investment advisers.

If the examination of investment advisers is designed to protect the interests of the investing public, then we must give more attention to the process. Where the budget constraints of both state and federal regulators are often pointed to as the reason for the lower number of examinations performed on an annual basis, perhaps it is time we listen to Angel and lend the examination authority to those who share the regulators’ professional obligation to promote transparency and full disclosure amongst advisers. These accountants and compliance professionals could more than meet the goals of state and federal regulators and do so on a competitive basis. Such an effort would put thousands back to work and contribute to our stalled economy, if only government would get out of the way.

For more information on new registration requirements and how regulatory reform might impact
your firm, please contact the investment adviser specialists at Regulatory Compliance by calling
1-617-606-7211.

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