In an effort to better police its force of 11,800 registered investment advisors (RIAs), the SEC has issued a proposal to its board members that calls to outsource the advisor exam process to a third party. This proposal comes in the wake of the fact that the agency has had the chance to annually examine only about 10% of all advisors in recent years. The SEC maintains that it has done a risk analysis on a much larger percentage of advisors than that, but it would still like to expand its program of examinations to cover about 50% of all advisors each year through the use of a third-party examiner.

But hopes that this matter would be dealt with have dimmed because one of the board members has vetoed the idea of voting on it until other matters already on the table have been decided. Read on for more about this issue, which faces an uncertain future in the short-term. (For related reading, see: SEC to Audit RIAs on Mutual Fund Share Classes.)  

Examining RIAs an Ongoing Issue

The SEC has attempted to expand its division of RIA examiners for the past several years, but efforts to accomplish this have been negated by lack of Congressional funding. Congress has made it clear that it will not be allocating money to this cause any time soon. The SEC has therefore proposed this idea as a way to achieve its goal in a more cost-effective fashion. There would be several advantages to outsourcing advisor exams, including:

  • There are many compliance firms in the financial industry that would be qualified to conduct thorough exams of advisors.
  • Free market competition could keep the cost of these exams at a reasonable level.
  • The process isn't complicated and could be implemented quickly and easily.
  • The SEC will be better able to allocate its remaining resources to perform other tasks while third-party companies conduct their examinations.
  • The SEC could focus more attention on the biggest RIA firms with the potential to pose the highest risk to the investing public.

The main factors in the argument against the SEC outsourcing its examinations include:

  • Establishing and policing a uniform set of standards for all compliance firms to use could be difficult.
  • The program would still require the SEC to maintain a dedicated group of staff and resources to oversee the compliance firms, which could lead to inefficiencies.
  • The compliance firm used might end up being FINRA, which would directly involve the self-regulatory organization (SRO) in the oversight of the RIA industry.
  • The price tag for this service could heavily tax smaller SEC-registered RIA firms.
  • The daily operations of RIA firms across the board vary substantially and are quite complicated in many cases, so a uniform set of standards for oversight by a third-party firm may not work very well.
  • This proposal was previously voiced back in 2003, and industry reaction was broadly negative. (For related reading, see: Is Greater Oversight of RIAs Coming?)

The Investment Adviser Association has expressed concern over the possibility of using third-party examiners, citing many of the points listed above. Neil Simon, the IAA vice president for government relations, recently told InvestmentNews, “We have many serious concerns about the SEC's possibly outsourcing exams to third parties. It is critical that the SEC's primacy be maintained in all areas of investment adviser regulation.”

Other figures in the industry have a more optimistic view of the proposal. Todd Cipperman, a principal at Cipperman Compliance Services, stated at an ICI conference that “it's not politically feasible for the SEC to add the resources they need to add [for more exams]. The time has come. I applaud [Ms. White] for recognizing that, and understand that she can partner with the private sector to accomplish their ends.” Cipperman also stated that RIA firms would have the freedom to shop around for the right examiner. “Each firm can select the best resource for them and not be chained to a particular model,” he said.

The actual nature and scope of the exams themselves and how they would be administered has not been released to the public at this point, and this will most likely not occur until the SEC is ready to vote on the matter. There are currently several major factors delaying this, as the board is waiting for Congressional approval to fill its two vacant slots, and the present board members have several other issues to vote on in the meantime.

The Bottom Line

There is currently no timeline on when the SEC will vote on whether to outsource their examinations of RIA firms. Congress will need some time at this point to tend to other matters and approve the two vacant slots on the SEC board of directors. Time will tell how this issue plays out; some advisers have suggested that it may make more sense for the states to begin administering the exams-or even take over regulatory duties entirely. (For related reading, see: How to Avoid Risk in Your Practice.)