Now that you’ve seen what ACA Insight has to offer, don’t be without it. Subscribe now!

The weekly news source for investment management legal and compliance professionals

Current subscribers - please log in to the website in the upper right-hand corner

News January 21, 2008 Issue

Adviser SRO One of Several Issues That SEC ‘Might Consider,’ Says SIFMA General Counsel

On January 3, following the publication of the RAND IA-BD report, SIFMA issued a press release urging the SEC to "work towards preserving customer choice." The press release asserted that brokers are "more heavily regulated and scrutinized" than any of their "peers or competitors, including financial planners," since brokers are subject to a "robust regulatory regime" that includes "oversight by FINRA."

Sounded to us like SIFMA was dropping a pretty big hint that financial planners should be subject to a self-regulatory organization, or "SRO," such as FINRA.

Then, in last Mondayís edition of Investment News, SIFMA general counsel Ira Hammerman was quoted as saying that the SEC "should consider whether investment-adviser-only firms should be subject to SRO supervision so that customers are assured the high level of supervision and oversight that brokerage customers already have." He was additionally quoted as saying that it would be "logical" for the SEC to explore whether FINRA could "provide that function."

"Wow!" we thought. "That ainít no hint!"

But SIFMA, it turns out, is not advocating an adviser-only SRO.

In an interview, Hammerman said that his statement about an adviser-only SRO "was not an official SIFMA position." Instead, he explained, he was merely trying to "articulate or predict what the SEC might do now that they have the RAND study." By putting himself "in the SECís shoes," he said, he came up with three issues that the SEC staff might consider.

First, he said, is the issue of preserving customer choice. He noted that RAND found that investors are highly satisfied with their financial service providers, regardless of whether their service provider is a broker-dealer or an adviser. Investors, he said, should continue to be able to choose whether they want to deal with a broker or an adviser.

But didnít RAND also conclude that investors were more than a little murky on whether their financial expert was an IA or BD? How, we wondered, can investors make a choice if they donít understand what they are choosing between?

Hammerman explained that investors can choose on the basis of how they want to pay for their services. "If you want to pay by being charged a percentage fee on the assets that you give them, you are going to end up in an advisory relationship," he said. On the other hand, an infrequent trader who prefers to pay on a commission basis will select a brokerage relationship.

The second issue that the SEC might consider, said Hammerman, is disclosure. "I would anticipate that the SEC would look toward improving disclosure as a way of addressing some of the facts identified in the RAND study," he said. He noted, however, that the report found that "customers donít really read all of the disclosures that they are provided." The SEC, he suggested, should consider ways of improving the clarity and readability of disclosures provided to investors by financial service providers. "Can they build a better mousetrap?" he asked.

"The third area that I would anticipate" that the SEC staff would "think about," said Hammerman, is the issue of an SRO. The RAND study, he noted, "talks about something like 10,000 advisers or financial planning firms out there." Many of those firms, he noted, have fewer than ten employees. "One question for the SEC to look at is whether the level of supervision of those relatively small financial planning firms is adequate to ensure customer protection," he said. "On the broker-dealer side," he noted, "all broker-dealers, whether small firms or large firms," are subject to SEC as well as SRO regulation.

In conclusion, Hammerman reiterated that he was merely listing issues that the SEC staff might mull over when reviewing the RAND report. "I classify those three as areas that the SEC might consider," said Hammerman. "But I canít really predict how theyíll play out. The ball is really in their court."

And just to be sure that SIFMA is not advocating an adviser-only SRO, we asked Hammerman one last time:

Does SIFMA have an official position on whether or not there should be an adviser-only SRO?

"We do not have a position at this time," he replied.

So there you have it.

Is Hammerman right? Should the SEC consider an adviser-only SRO in light of the RAND report?

It's worth noting that the SEC formally raised the adviser-only SRO idea up the flagpole just a few years ago, when it asked for public comment about the idea in its 2003 compliance program proposing release. At that time, the SIA (SIFMAís predecessor) apparently did have a position about an adviser-only SRO: It opposed it. "Given the significant impact which existing SROs Ö have on investment advisory and investment company activities," said the SIA, "there would be little, if any value added by creating more SROs."

The SIA wasnít alone in its opposition. According to the SEC, all but four commenters on the issue "strongly opposed" the idea of an adviser SRO. Among other things, commenters questioned the SECís authority to establish an SRO and argued that forming an SRO for advisers would add an unnecessary and costly regulatory layer.

But that was 2003. And now itís 2008. In those intervening years, the Financial Planning Association has proven itself to be a pretty large thorn in SIA/SIFMAís side. Specifically, the FPAís successful legal challenge to the SECís fee-based brokerage rule forced the brokerage industry to scramble to convert a bajillion fee-based brokerage accounts just this past fall.

So, as they say, SIFMAís got motive.

And if SIFMA really wanted to yank the FPAís chain, suggesting that the SEC consider an adviser-only SRO would certainly be one way to go about it.

Of course, such a suggestion also would yank a number of other organizationsí chains, such as those belonging to the Investment Adviser Association, the Investment Company Institute, and even SIFMAís own Asset Management Group, which is primarily comprised of investment advisers.

"We have always strongly opposed an SRO," said IAA executive director David Tittsworth. "We donít believe that there is any compelling evidence that justifies the creation of an SRO." And, he added, " we doubly oppose it if it is FINRA."

Informed of Hammermanís remarks, Tittsworth questioned how the RAND report could lead to the conclusion that the SEC might want to consider an adviser SRO. "Itís Alice in Wonderland," he said. "How anyone ó Hammerman, SIFMA ó can read that report, which says investors are confused, and then come to the conclusion and say, ĎHey, hereís this report. How can we fix this? Letís have an SRO for advisers!í What the hell will that do? How does that address any issue raised in the RAND report?"

Short answer: As far as we can tell, there is nothing in the report that suggests that investors are concerned about lack of oversight at smaller advisory firms. After being presented with fact sheets explaining the differences between advisers and brokers, investors in RANDís focus group expressed a preference for brokersí certification requirements. They also expressed a preference for the legal duties imposed on advisers. Other than that, however, we really didnít see any discussion that seemed relevant to the virtues, or vices, of an SRO for advisers.

"You want to talk about the real issues in RAND?" Tittsworth continued. "Okay, letís talk about disclosure." He pointed out that following the publication of the RAND report, the IAA publicly urged the SEC to propose the new Form ADV Part 2, in an effort to improve disclosure to investors. "What has SIFMA said, other than ĎLetís preserve choice,í whatever the hell that means, and ĎLetís get an SRO for advisersí? To me, that has no relation to the issues we are talking about."

Tittsworth dismissed Hammermanís comment that the group has no position on an SRO for advisers. "They need to have a position on that. They either support an SRO for advisers or they donít. Dancing around, saying ĎWeíre just throwing out options that the SEC can consider,í" isnít sufficient, he added. "Letís get down to it. If you want to talk about an SRO, letís do it."