Advisers Worry About Potential Costs Of Third-Party Exams

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Hungry Fox

Consumers think that additional government regulations keeps them safe. It does not. Primarily it adds costs which far exceed any benefit.

Mark Schoeff Jr writing for Investment News published an article entitled “Advisers worry about potential costs of third-party exams” in which he explains:

Investment advisers are wary of the costs involved in a proposal by a Securities and Exchange Commission member that would require advisers to hire third-party contractors to conduct examinations now performed by the SEC for free.

At the annual conference of the Financial Industry Regulatory Authority Inc. in Washington on Tuesday, SEC Commissioner Daniel Gallagher recommended that the SEC write a rule that would require advisers to hire an examiner to review their operations.

The commission based brokers and agents would like to heap as much regulation as possible on the smaller personal financial planning firms whose practices have little or no questionable practices and whose behavior makes them a much lower risk. Regulation, more often than not, is requested by an industry to impede its competition.

In this case you have SEC Commissioner Daniel Gallagher at the annual conference of the Financial Industry Regulatory Authority (FINRA) suggesting that government heap additional regulations on FINRA’s primary competition, fee-only fiduciary registered investment advisors. As this Reuters article points out, brokerage firms being overseen by both the SEC and FINRA have a terrible track record of complaints and concerns. They are losing customers primarily to firms like ours, firms which avoid many of the practices which fail to safeguard client assets. They would like nothing better than to swamp these smaller firms with regulatory compliance and then make them pay for the grief.

The bill for an audit is about $20,000 — a price that would rock small advisory firms, he said.

“Some would find that tremendously crushing in terms of the financial cost of it,” Mr. Roberts said.

David Edwards, president of Heron Financial Group, prefers to pay a surcharge to the SEC to fund examinations. A bill that would implement such a charge has been introduced in the House but has not gained much support.

Many fee-only financial planners are solo practices with one person or one person and an assistant at the most. We aren’t talking about the huge broker-dealers that FINRA is supposed to oversee.

Imagine someone suggesting that, in order to make sure that you are personally doing your job correctly, you be required to have an annual audit of your work at a price tag of $20,000 which you personally will have to pay for. Don’t you feel like that would make all the people you serve in your employment be better protected from whatever it is that you do?

The article then adds this wonderful comment:

“The marketplace will drive the cost of the exams because prices will be set by competition,” said Mr. Thomas, former chief compliance examiner for South Dakota. “What better way to keep the cost down? What better way to benefit the consumer?”

The best way to benefit the consumer might very well be focusing on the high risk practices which deserve examination and rewarding low risk behaviors by specifically not making them pay excessive fees. This would make the best financial planning practices have a lower market place cost rather than punishing smaller firms who can’t afford the $20,000 entrance fee.

Even if third-party examiners are used, it’s not a free ride for the SEC, according to Marilyn Mohrman-Gillis, managing director of public policy and communications at the Certified Financial Planner Board of Standards Inc.

“The SEC will still have to provide oversight, perhaps more oversight than in an SRO model,” Ms. Mohrman-Gillis said. “We don’t believe it would be the most cost-effective solution.”

Mr. Gallagher said that Finra would be among the candidates to conduct the exams — a notion that meets resistance from advisers.

Two years ago, adviser opposition to legislation that would establish a self-regulatory organization to oversee advisers helped kill the measure. The argument was that Finra oversight would be too costly and that Finra, the broker-dealer regulator, wasn’t qualified to monitor the fiduciary standard that governs advisers.

“I think Finra’s a very bad choice,” Mr. Roberts said. “They are not fit to do it.”

Asking FINRA to oversee fee only fiduciary financial advisors is like asking the industry organization of those with the most questionable practices to oversee the group with the best practices. Asking the fox to oversee the hen house is always a bad idea.

Mr. Gallagher came up with the proposal because the SEC currently examines annually only about 9% of the approximately 11,000 registered investment advisers. It says it lacks the resources to increase that number substantially.

If the SEC can only examine 9% of the registered investment advisors they will focus on the most questionable practices. This is a good outcome.

Here is my suggestion:

  1. If we must have the SEC, then let the SEC continue to focus on targeting for the most frequent review the highest risk financial practices.
  2. Let fee-only fiduciaries distinguish themselves with the highest ethical practices in a free market of choices.
  3. Let investors continue to migrate away from commission-based agents and broker dealers and toward fee-only fiduciaries by their own free choice.

Photo by Digimist used here under Flickr Creative Commons.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.