Concerned that outright fraud or abusive practices might not be detected or prevented, the SEC’s Investor Advisory Committee (IAC) on June 22, 2023, voted to provide a set of recommendations for the Commission to consider. The recommendations include establishing a third-party exam program to supplement the staff’s compliance reviews, whereby an outside firm, such as an accounting, law or consulting firm, could perform the exam, and a copy of the results would be submitted to the SEC. In addition, the panel asked the SEC to request legislation from Congress that would authorize the Division of Examinations to impose user fees on investment advisers. The SEC would use the revenues to enhance its investment adviser exam program. The IAC also recommended support for efforts by the North American Securities Administrators Association (NASAA) to enhance adviser compliance programs.
Investment adviser oversight and regulation is bifurcated between the SEC and State regulatory authorities. Generally, advisers with at least 100 million dollars in assets under management must register with the Commission. Investment advisers that are not eligible to register with the SEC must register in the states where they have their principal places of business and/or have more than a de minimis number of clients.
The IAC noted that, as of 2021, there were over 32,000 investment advisers in the U.S. with over 375,000 associated investment adviser representatives. Since 2016, the number of SEC registered investment advisers has increased 25% to over 15,000. Over the same period, the number of private funds managed by SEC registered advisers has increased 40% to approximately 50,000. This is a growth rate that far outpaces SEC staff increases. This growth is due at least in part to many in the broker-dealer industry migrating to the investment advisory industry. Unlike broker-dealers, there is no self-regulatory organization to assist the SEC in overseeing the investment adviser industry. In 2022, the SEC’s Examination Division conducted examinations of 15% of registered investment advisers. This equates to a seven-year exam cycle, assuming the SEC examines every investment adviser. In contrast, in 2022, the SEC and FINRA together examined nearly half of registered broker-dealers. In the view of the IAC, the current exam cycle of approximately seven years is inadequate to detect or credibly deter fraud in the investment adviser industry. Revenue from the IAC’s recommended user fees would allow the SEC to have a stable source of funding to allow for an effective exam cycle and to keep up with growth in the industry.
Of the approaches considered by the IAC to enhance oversight of SEC registered advisers, the IAC believes that the approach that offers the most appeal is third-party compliance examinations of investment advisers, whereby the SEC could adopt a rule requiring advisers to undergo a compliance exam conducted by an outside firm and that a copy of the exam results be submitted to the SEC. This approach could be structured to leverage the expertise of the private sector but maintain critical SEC oversight of advisers.
SEC Panel Recommends Enhancements to Oversight of Investment Advisers
The IAC recommended that the SEC consider issuing a Request for Comment on third- party compliance examinations of registered advisers to support and supplement the SEC’s Investment Adviser Examination Program. The Panel noted that there are many organizations, including accounting, law and consulting firms that provide compliance reviews or mock audits for investment advisers and the organizations have experience in assessing the effectiveness of compliance programs. The IAC observed that the SEC has clear statutory authority to impose such a requirement and has used this authority to require registered advisers that have custody of customer assets to have surprise annual audits to verify assets. Similarly, a third-party compliance examination firm could focus on routine examination issues and make factual findings on the accuracy of Form ADV and website disclosures, verify assets, the maintenance of required books and records, and compliance policies and procedures.
The IAC recommended that the SEC request legislation from Congress that would authorize its Division of Examinations to impose user fees on SEC-registered investment advisers, the revenue from which could be retained by the SEC to fund and enhance its investment adviser examination program, including more frequent on-site examinations of SEC- registered advisers. The fees collected from investment advisers would be used solely to fund the SEC’s investment adviser examination program and set at a level designed to achieve an acceptable frequency of examinations (a minimum of every 4-5 years). The assessed user fees could be based on attributes such as the complexity of the firms, the number of representatives, the number of offices, the complexity of products and assets under management, whereby larger and more complex firms could be charged higher user fees.
Enhancement of Adviser Compliance Programs
Included in the Panel’s comments were recommendations echoing efforts made by NASAA which has adopted rules to enhance oversight of investment advisers through the development of model rules to be considered for adoption by States. Recent examples include the adoption of a model rule requiring written compliance and supervision policies and procedures and a new continuing education requirement for investment adviser representatives. The IAC recommends that the SEC join NASAA in encouraging more States to adopt these rules.