In his response to “Financial Advisers, Police Yourselves” the RIA lawyer derides the confusing message and demands cops, not community watch

August 6, 2012 — 10:57 PM UTC by Brian Hamburger, with Daniel Bernstein


Brooke’s Note: No sooner did Rep. Bachus table his bill aimed at making FINRA the SRO for advisors than he, today, made an appeal directly to the public in the Wall Street Journal in support of it. This move is rather bizarre and confusing and Kelly O’Mara has spoken to everyone in the industry from the House Financial Services Committee to the Wall Street Journal to piece together what the heck is going on. See: Amazed and confused: Advisors struggle to make sense of Bachus’ Wall Street Journal Op-Ed salvo if you’re Brian Hamburger, who lives and breathes this stuff, you don’t need to be quite so circumspect. You know what you need to say, and you say it — and we can be grateful for such a real-time, no-nonsense response.

It is impossible for me to reconcile the opinion offered by Rep. Spencer Bachus to The Wall Street Journal earlier today, asking financial advisers to police themselves. See: How RIA forces squashed the Bachus bill by calling the implicit FINRA bluff.

Yet I stand at the crossroads of the “move to independence,” the movement that has freed some of the country’s most successful brokers from the bounds of employment at the world’s largest global financial institutions and allowed them to pursue their dream as entrepreneurs and reduce conflicts of interest, increase transparency and disclosure, and act in their clients’ best interests, all at a personal and more intimate level. I am as familiar with the issues as anyone.

So if I am confused, it’s time to level-set.

The Dodd-Frank Act moved 4,000 investment advisers out of the SEC’s jurisdiction and into the hands of state securities regulators and required the SEC to deliver a report to Congress addressing three concepts to improve examinations of investment advisors. The SEC artfully responded by acquiescing that any and/or all three of the proposals would improve examinations. But, of course they would. See: Brian Hamburger hammers the FINRA SRO proposal in a letter.

Critical questions unasked

One required investment advisers to police themselves (relieving the SEC of direct oversight), the second invited the SEC to collect “user fees” from investment advisors (making the SEC less accountable to the American people), and the third would move brokerage firms, already subject to an SRO, to that SRO for adviser examinations. The report failed to turn scrutiny on the SEC, however, and failed to ask it the critical questions:

How does the SEC receive significant budget increases year after year, yet continue to complain that it is unable to fulfill its mission due to resource constraints? See: Brian Hamburger answers the questions about an SRO future that has RIA stomachs in turmoil.

Brian Hamburger, center, confers with Daniel Bernstein, right, and Donald Rice, an RIA principal in Rep. Spencer Bachus' Alabama district.
Brian Hamburger, center, confers with Daniel
Bernstein, right, and Donald Rice, an
RIA principal in Rep. Spencer Bachus’
Alabama district.

With a commission loaded with ex-FINRA executives, how can the SEC continue to absolve FINRA for missing virtually every major fraud in the financial services industry in the past several years?

Why has the SEC allocated as many examiners to brokerage firms as it did for investment advisers when (a) there are far more advisors than brokerage firms and (b) brokerage firms already have their own self-regulatory organization (FINRA) with direct oversight of their activities? See: Cheat sheet on Wednesday’s Bachus fracas.

Devoid of factual premise

Under the guise of moving the issue forward, Rep. Bachus introduced a bill in April that would require investment advisors to join a self-regulatory organization, one of three possible solutions the SEC recommended in its Dodd-Frank-mandated report to Congress. See: Avoiding FINRA oversight may depend on talking sense to an options-trading House Republican. Investment advisers opposed this bill because it is devoid of any factual premise that an SRO would best serve investors or the country’s financial markets. Beyond that, since the SRO would almost certainly be FINRA, the industry believes that investor protections would be further eroded while the costs for supporting the SRO would be abominable.

Rep. Bachus’ position centers on the assumption that financial firms that are subject to SRO membership are better regulated because they are examined more frequently. The logic completely jumps past any comparison amongst brokerage firms and investment advisers. It’s like saying that private home pools need to have lifeguards on duty at all times because water parks are required to do so. Investment advisors’ activities are far less risky than their financial services counterparts’. Investment advisors provide advice about securities for compensation on a fully-disclosed basis while mitigating conflicts of interest and holding themselves to a fiduciary standard of care. See: RIAs and B-Ds don’t mix, says Duane Thompson at MarketCounsel Summit 2011.

Unlike broker-dealers who operate in a business model that is rife with conflicts of interest, investment advisors get paid no differently when a client buys/sells one or a thousand securities per year; or when a client holds shares in Fund X compared to Fund Y. Broker-dealers do. Not to mention that the vast majority of investment advisers have no physical or legal custody over their clients’ assets. Assets are typically held in the client’s name with an independent custodian. That custodian is typically subject to SEC and SRO regulation as well. Rep. Bachus continues to sidestep why he thinks investment advisors should be subject to more frequent examinations. See: SEC presses case for user fees in much-anticipated report to Congress.

Assuming for argument’s sake, however, that investment advisers should be examined more frequently, it is the SEC that should be conducting these examinations, not an SRO. Rep. Bachus makes two claims regarding why he thinks that an SRO would be superior to the SEC, which currently oversees those investment advisors with at least $100 million in assets under management. First, he implies that the SEC is incapable of increasing the number of examinations it conducts.

He quotes the SEC report, cited above, in which the agency says it does not have the capacity to conduct additional examinations and recommends that an SRO for investment advisers be considered. In that same report, however, the SEC also recommended that Congress consider charging user fees to investment advisers to better fund examinations. This solution was proposed in a bill by Rep. Maxine Waters (D.-Calif.) last month.

Bear Stearns, Lehman legacy

Rep. Bachus proceeds to claim that self-policing under an SRO model is so superior to the current regulatory scheme that even increased funding to the SEC would not help. This, he claims, is evident because the SEC has missed too many problems in the past, such as the Madoff and Stanford frauds. So, despite the more frequent examinations, why has every major fraud and institutional failure, such as those of R. Allen Stanford, Bernie Madoff, Bear Stearns, Lehman Bothers, MF Global and Peregrine Financial Group, been perpetrated under the watchful eyes of an SRO?

Finally, Rep. Bachus claims that investment advisors have focused their lobbying efforts on stopping this bill. Investment advisor lobbying efforts are minuscule, and it is astonishing that he has heard them. Perhaps he, like many investors, has them confused with their financial services counterparts. Because on this topic of great interest to investment advisors, only one of their industry groups was invited to testify at the hearing held on Rep. Bachus’ proposed bill.

The House Financial Services Committee, however, heard testimony from lobbyists for broker-dealers, insurance companies, mutual funds, and the SRO waiting in the wings on that very same day. And it is those financial services counterparts that have shaped Rep. Bachus’ bill thus far. Mutual funds and their investment advisors and hedge fund managers have all been granted an exemption from joining an SRO. Yet it is these groups that pose the most significant risks for fraud because they have custody of client assets.

What independent voices say

It’s time to quiet the noise on this topic and focus on what’s best for investors. One should discount the position of investment advisors out of self-interest as well as the conflicted voices of their competitors from which they have acquired business over the years. That leaves us with independent voices such as the Consumer Federation of America and the Project on Government Oversight both of which have opposed Rep. Bachus’ bill.

Rep. Bachus shines his light on Bernard Madoff and two alleged wrongdoers, Matthew Hutcheson and Mark Spangler. He says “that thousands of investors lost billions in savings” because of these individuals. But Madoff was already subject to SRO examinations by FINRA, and Spangler allegedly perpetrated his frauds through private funds, which would be exempt from Rep. Bachus’ bill. That leaves Hutcheson, who was recently indicted and from whom the federal government is seeking to recover less than $6 million. If that is the best “most wanted” list that Rep. Bachus can present, we think it’s clear that his bill is completely unnecessary and serves no one but the established financial services industry.

Examine the examiner

There is common ground here. We all agree that the SEC can be a more effective regulator and better serve the interests of investors. We all favor better quality — and, yes, even quantity — of adviser examinations. But we diverge when it comes to how to go about that objective. While Congress has been unable to make the SEC accountable for its results over the past few years, requiring an SRO for investment advisers is merely sidestepping the problem, not solving it. The American taxpayers deserve a financial regulator that’s accountable to the people and not to industry interests. Examine the examiner and hold it responsible for spending taxpayer dollars to effectively regulate the country’s financial markets and its intermediaries.

Brian Hamburger, CRCP, AIFA, is the founder and managing director of MarketCounsel, a leading business and regulatory compliance consulting firm to preeminent entrepreneurial, independent investment advisors. Daniel Bernstein is the firm’s director of research and development.

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