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What advisors should know about the next sweeping change: the switch from SEC oversight to state regulation

It could impose most on advisors spread out across multiple states

Wednesday, August 25, 2010 – 12:56 PM by Elizabeth MacBride
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Denise Voigt Crawford: Advisors who haven't had an SEC audit recently -- or ever -- should expect an examiner's knock on the door soon after they switch to state oversight.

State regulators have a nickname for the upcoming transfer of 4,200 SEC-registered RIAs to state oversight: They’re calling it “the switch.”
On July 21, 2011, advisors with less than $100 million in AUM will be required to register with states. That’s exactly one year from the date that Dodd-Frank financial reform was signed into law.

There’s a lot about the law’s effect on advisors that is not yet clear. But there are three top-line conclusions, detailed further down:

• The burden is likely to fall heaviest on advisors who will be required to register with more than one state, but in fewer than 15. Because of the growing mobility of the population and the way the requirement is defined, the group of advisors with multi-state registrations may be larger than expected.

• It’s not clear yet how many states will step up to the plate and begin a truly robust regulatory regime for this new group of advisors. Two key questions: how much will states help each other; and how much will state budgets increase to pay for more resources.

• It’s likely to be another month or two before the SEC issues any guidance about the transition to state oversight.

Multi-state filings likely to be burdensome

The law’s burden is likely to fall heaviest on advisors who will be required to register with more than one state, but in fewer than 15. An advisory firm that would be required to register in 15 or more states under the law can opt to remain SEC-registered.

An advisory firm must register itself and all of its representatives in each state in which it has an office or more than 5 clients, said experts and regulators.

Exactly how burdensome that multiple-state registration and compliance is likely to be is a matter of debate.

State laws and registrations have become more uniform over the years, says Patricia Struck, administrator of the securities division with the Wisconsin Department of Financial Institutions. “We all follow the same exam and registration modules,” she said. “Advisors can expect a very high level of consistency from state to state.”

The laws have grown more consistent – indeed, the adoption of the new ADV Part II form that applies to the SEC and the states was a major win for consistency. The Investment Adviser Registration Depositor also helps makes registering in different states easier, noted David Tittsworth, executive director of the Investment Adviser Association. (It’s here: https://www.iard.com/).

Yet, the states are far from perfectly consistent. That means that advisors who need to register in more than one state will have to keep track of the varying laws.

“Considering how easy it is, relatively speaking, to get approved by the SEC, I think a great number of the SEC firms will be shocked at how tedious and more demanding the state registration process is,” said Zachary Gronich, owner of Manhattan-based RIA-IN-A-BOX. He is doubling his staff because he expects a boom in business.

Even though the forms are consistent, Gronich said, “they all have their own interpretations and “pet peeves.” There are some disclosures that, for example, North Carolina will ignore but that would make Michigan send out a three-page letter that borders on an investigation.”

Dan Bernstein, director of professional services for New Jersey-based MarketCounsel, a compliance firm, highlighted a few of the areas in which states have different requirements, including on the custody rule, the use of solicitors, and the books and records retention requirements. Unlike the SEC, many states, but not all, have a net capital requirement that firms keep a certain amount of cash on hand. California, for instance, has a $10,000 net capital requirement. Advisors must account for it every month – and some states specify that the accounting be done on an accrual basis, not a cash basis, Bernstein says.

Will the states do a better job?

The question of whether states can do a better (read: more frequent) job than the SEC auditing advisors has been grabbing most of the attention – and indeed, the case made by the North American Securities Administrators Association that states would, indeed, do a better job is most likely what carried the day with Congress. The Commission has been auditing only about 11% of RIAs a year. Many states are on a three- to five-year audit cycle.

But the complete answer to the question of whether states will do a better job depends a lot on the staff and compliance regime in individual states. Almost all of state securities regulators are in the process of asking for more resources to cope with the influx of advisors, said Denise Voigt Crawford, Texas Securities Commissioner and president of NASAA. How much cash-strapped states will pony up remains to be seen. States could also increase user fees to pay for more staff.

Struck, for instance, is in the midst of an analysis of how many RIAs will be added to her caseload, but she is guessing the increase will be about 25%, or about 50 or 60 advisors added to the current total of just over 200. When that analysis is complete, she may ask for more resources to hire more staff. (For contact information for state securities regulators, go the RIABiz Directory home page. There’s a button to the right.)

To go part of the way to creating a nationwide blanket of regulation, all but one of the states has signed on to a memorandum agreeing to share resources, Crawford said.

But NASAA would not provide a copy of the memorandum, saying that it is an internal document. And it’s not clear how much cooperation there will be across state lines.

As a for-instance, Crawford suggested that state regulators in Connecticut and New Jersey might be able to pick up some of the slack for New York. New York has a confusing law that makes some question whether state securities regulators have the power to examine advisors. It also has about 350 advisors moving to state regulation, according to the IAA.

New Jersey state regulators did not return a call for comment about how involved they could potentially be in New York advisory firms, and a spokeswoman for Connecticut’s state regulator sounded surprised by the whole idea.

“This is not going to be Kumbaya,” Bernstein said, pointing out that taxpayers in one state would most likely object to footing the bill for another states’s regulator work.

In general, he said, “we have some serious questions about whether or not certain states are going to be able to handle this.”

Struck, Wisconsin’s chief regulator, said she anticipated that the cooperation would be mostly along the lines of training. Of course, states have long cooperated in cases where advisors have an office in more than one states.

David Tittsworth of the IAA pointed out that the Dodd-Frank legislation does not require a robust examination regime by the states; it doesn’t even suggest that the SEC evaluate whether a state has adequate resources. Rather, the legislation merely requires that a state have a registration and an examination process. That puts advisors into two states into special classes. Only Wyoming, according to Tittsworth, does not require registration; so those (few) advisors will remain SEC-registered.

What will happen to advisors in New York isn’t clear yet, though Tittsworth and others said they expect that the SEC will issue transitional rules to answer some of these questions.

Another possibility, of course, is that New York itself could change its law.

One conclusion on the audit side is fairly clear: advisors that have not recently – or ever – been examined by the SEC can expect a fairly prompt knock on the door after registration, said Crawford. State regulators are asking the SEC for firms’ audit histories and those that have not been examined in the recent past will rise to the top of state regulators exam lists.

When will questions be answered?

With so many questions looming, many advisors are demanding answers – which are not yet forthcoming.

NASAA plans to put up a web site with information sometime in September. Some states are beginning to schedule sessions to offer information to advisors. Struck said she is telling advisors with more than $25 million AUM and less than $100 million AUM who wish to transition early that they can’t do so, yet.

Tittsworth said he expects the SEC will issue transitional rules, as it did when advisors with less than $25 million in AUM were transferred to state oversight in 1997. At that time, the SEC created an ADV-T form.

An SEC spokesman, who said there is no timetable for the rules yet, pointed out that any rules would have to go through a proposal process before being adopted.

The SEC has been holding biweekly phone calls with the transition team at the North American Securities Administrators Association, according to the commission.

Crawford said the SEC staff has yet to schedule the time for the face-to-face meeting the state regulators have requested.

She said she understands the delay. Though the switch is the number one item on NASAA’s agenda, the SEC is charged with conducting dozens of major studies and rulemakings.How financial reform gives the SEC new bite; plus at least five other things advisors ought to know about the legislation.

Elizabeth’s note: I asked for a copy of the memorandum of agreement between the state regulators. A NASAA representative told me it was an internal document – yet it strikes me that an agreement signed by state regulators should be public record. I’ll keep asking for it.

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Todd E. Schwartz

Todd E. Schwartz

September 3, 2010 — 6:27 PM

Best summary of outstanding questions and little known developments I’ve seen.

Thank you for keeping up the pressure on NASAA.


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Elizabeth MacBride

Elizabeth MacBride

September 3, 2010 — 6:37 PM

Thanks for the kind words. In fact, I did get a copy of the agreement between the state regulators. I’ll have it up on the RIABiz site on Tuesday. I’m planning on covering NASAA’s conference late next month — where the switch is sure to be the number one agenda item.

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