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Brian Hamburger hammers the FINRA SRO proposal in a letter

In his muscular style as a lawyer and insider in the regulatory realm, the MarketCounsel principal pulls no punches

Tuesday, June 5, 2012 – 10:53 PM by Brian Hamburger and Dan Bernstein
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Brian Hamburger: The Bill's supporters are promoting a devious shell game to hinder the growth of an industry that has flourished by doing the right thing for investors.

Brooke’s Note: Brian Hamburger is a serious lawyer, a successful small business owner, somebody who rubs elbows with hundreds of RIAs every year and an expert on advisor regulations and the ins and out of Washington. Better than all that if you speak with him is his ability to communicate things with a storyteller’s flair. Hamburger also suffers scantily-clad emperors badly, generating a useful outrage. All of these qualities are brought to bear in this letter he co-wrote with Dan Bernstein to Rep. Bachus saying what he feels about the prospect of making RIAs answer to FINRA as an SRO.

Dear Chairman Bachus, Ranking Member Frank and Members of the Committee:

Please accept our comments on H.R. 4624, “The Investment Adviser Oversight Act of 2012” (the “Bill”), in advance of tomorrow’s hearing on the Bill to express our strong opposition.

For perspective, MarketCounsel is a business and regulatory compliance consulting firm to some of the country’s preeminent independent entrepreneurial investment advisers. From the startup of an investment adviser through our RIA Incubator program to the outsourced compliance capabilities of the RIA Institute for Compliance Management, MarketCounsel provides counsel throughout an adviser’s lifecycle. We represent a diverse range of advisers including those with limited assets under management to those with billions of dollars under management. All, however, would be considered “small businesses” using your
vernacular. See: Testy words pass between advisors and regulatory panelists at MarketCounsel conference.

In addition, our affiliated law firm, the Hamburger Law Firm, renders legal counsel to over 1,000 entrepreneurial companies, investment advisers, broker-dealers, hedge funds, family offices, and registered securities personnel.

Good for us, bad for RIAs

In short, we spend a great deal of time in this arena and both MarketCounsel and the Hamburger Law Firm would be direct beneficiaries from the requirement of investment advisers to join a self-regulatory organization (“SRO”) as the Bill requires. In spite of that, however, we feel that the Bill would result in significant economic harm to the small businesses that make up this great industry, stripping due process rights of those who work in the industry, while negatively impacting the investing public. It is in this light, commenting contrary to our own business interests, which we think our comments are especially beneficial to the Committee.

Investment advisers are the white knights of the financial services industry. They serve as the most unbiased and transparent resource for investors, are ardent public company watchdogs, and apply pressure on investment products to perform efficiently. They have changed the face of financial services, with investors finding themselves as the primary beneficiaries.

How we got here

There has been plenty written about why an SRO would harm the investment advisor industry as well as the investors they serve. See: Creating an SRO would cost 100% more than SEC exam program, study shows. But there has been little analysis on how we got here.

Without going into a long history lesson, broker-dealers and investment advisers are supposed to provide quite distinguishable services to their clients. Broker-dealers are more akin to sales people and therefore, there is an inherent conflict of interest between their compensation and the sale of investment products.

Investment advisers, on the other hand, are fiduciaries, whose interests are generally aligned with their clients. Investment advisers get paid for advice, not the distribution of investment products or facilitation of transactions. In fact, investment advisers are presumed to be free from any material conflict of interest unless it is disclosed to their clients.

Throughout the last decade, broker-dealers were simultaneously responding to two distinct pressures: regulatory pressure from the SEC on frequent claims of “churning” client accounts (the practice of executing trades for an investment account in order to generate commissions from the account) and competitive pressure from clients that were looking for personalized advice under a predictable fee arrangement where the interests of the advisor were aligned with their own.

In response, the SEC allowed broker-dealers to look more like investment advisers. The brokerage industry proposed to render its brokerage services for a fee based upon the value of the portfolio, as opposed to its traditional commission fee structure for each transaction. Seeing only the immediate relief that this solution provided, the SEC acquiesced to this arrangement. And in 1999, the SEC proposed Rule 202(a)(11)-1 (the “Merrill Rule”) based on this emerging practice of allowing customers to pay for full service brokerage, including advice, for an asset-based fee. The proposed rule kept broker-dealers from being subject to the Investment Advisers Act of 1940 (“Advisers Act”) as a result of re-pricing their services.

In an unusual move, the SEC granted “no-action” relief to broker-dealers within the proposed rule:

_Until the Commission takes final action on the proposed rule, the Division of Investment Management will not recommend, based on Commission take any action against a broker-dealer for failure to treat any account over which the broker-dealer does not exercise investment discretion as subject to the Act._1

The modified rule was adopted in April 2005 pursuant to the SEC’s rulemaking authority contained in Sections 211(a) of the Advisers Act. But in March 2007, the final rule was vacated by the U.S. Court of Appeals for the District of Columbia Circuit in Financial Planning Association v. Securities and Exchange Commission (482 F.3d 481).

The court held that section 202(a)(11) of the Advisers Act was very specific as to who could be exempt from the definition of investment adviser. The court further held that section 202(a)(11)(C) provides the exclusive exemption for broker-dealers rendering advice
incidental to brokerage transactions and thus, the Merrill Rule went beyond the SEC’s authority.

This co-mingling of the business models, without any awareness campaign or significant consumer disclosures led to widespread consumer confusion. Adding to that, often times registered representatives are called “financial advisors” or “advisors.” The whole thing has left investors confused.

Representative Bachus has been quoted as saying that “often [investment advisers and broker-dealers] provide indistinguishable services to retail customers….“2

And he is not alone in his perception. The SEC has since commissioned several studies that confirmed that investors are confused. 3

I would suspect you’d be hard-pressed to find anyone on either side of this issue with a different perspective.

A wolf in sheep’s clothing

In response to investor confusion, the SEC made a major misstep that brought us here today, leading us down a path under the guise of “harmonization.” In other words, an active decision to live with the consumer confusion but work to eradicate the distinctions or ramifications of choosing either a broker-dealer or investment advisor. See: The dark side of the 'good’ regulatory changes get scrutinized at MarketCounsel Summit 2011.

The SEC artfully began with a change-up pitch to investment advisors, proposing that broker-dealers be held to the same standard of care as investment advisors. Without the benefit of seeing the big picture unravel before them, investment advisors were generally supportive of this proposal. However, the SEC has proposed that harmonization should go so far as to eliminate any meaningful distinction between broker-dealers and investment advisors, in effect nullifying any meaningful distinction between broker-dealers and investment advisors. 4

So, in effect, a lack of leadership and vision at the SEC has set us on a course where the seemingly obvious conclusion is to appoint the same regulator as that of broker-dealers.

But, alas, the “obvious” conclusion is not our best answer. In fact, this proposal has yet to gain the support of any investment advisor or consumer group. See: Barbara Roper sends stern letter to Rep. Bachus raising new FINRA-as-SRO issues.

Yet it is widely supported by other financial services intermediaries, both broker-dealers and insurance groups, as well as the self-regulatory organization that is the “heir apparent” to this regulatory dilemma. The Bill’s supporters are promoting a devious shell game to hinder the growth of an industry that has flourished by doing the right thing for investors.

Mum… FINRA was supposed to be watching the kids

It is safe to assume that we would not be debating increased examinations had it not been for the major frauds that have been perpetrated by financial services firms over the past decade. They are frauds that have shaken the American public’s confidence in our financial markets and economic system. From mutual fund market timing to late trading, from Lehman Brothers to Bear Stearns, and from Allen
Stanford to the notorious Bernie Madoff; all were subject to FINRA oversight including routine examinations. See: “New FSI chairman isn’t sugarcoating FINRA’s shortcomings but blasts the SEC on porn and Blackberries in this letter. Others were perpetrated by banks or hedge fund managers that were not required to be registered at all.

Rep. Bachus was quoted as saying:

“The average SEC-registered investment advisor can expect to be examined less than once every 11 years. That lack of oversight, particularly in the aftermath of the Madoff scandal, is unacceptable. Bad actors will naturally flow to the place where they are least likely to be examined. Therefore, it is essential that we augment and supplement the SEC’s oversight to dramatically increase the examination rate for investment advisers with retail customers. 5

So, why haven’t these bad actors flowed to the investment adviser industry in the past? This belief fails to acknowledge that Bernie Madoff’s firm was examined by an SRO — FINRA. The only major frauds that seem to involve investment advisers that are not also registered as broker-dealers involve hedge fund managers that have custody of client assets as well. But the Bill exempts hedge fund managers from any requirement to join an SRO. See: An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2.

MarketCounsel believes that an incorrect assumption has been made that investment advisers need to be examined as frequently as broker-dealers. Not only has there been no evidence that more frequent examinations results in less problems, the Bill fails to acknowledge that FINRA’s more frequent examination cycle has missed the majority of the major frauds that have impacted the financial services

What about FINRA?

SROs in general, and FINRA in particular, have many fundamental problems. And the current Bill would all but name FINRA as the next SRO for investment advisors. FINRA has established itself with clear conflicts of interest which encourages broker-dealers to churn accounts and generate transactions in the financial markets. FINRA recently announced that they were raising fees by as much as 50% for certain services to its members. They cite as their reason, “To offset significant losses of revenue due to lower
trading volumes.” 6

This dynamic, whereby FINRA turns to its member firms to recoup any shortfall in projected revenues could not be a more clear conflict which encourages broker-dealers to churn accounts. And don’t think for a moment that these fee increases are necessary to merely keep FINRA afloat. Their spending habits have been widely reported. FINRA executives are paid the kind of salaries that make the public question Wall Street’s grasp of what Main Street is feeling. SEC Chairman Mary Schapiro disclosed receiving a “final distribution” of $8.99 million when leaving FINRA to join the SEC (where she is now paid $163,000). FINRA’s current chairman and CEO, Richard Ketchum, reported earnings of $2.6 million in 2010. According to Mr. Ketchum, “FINRA strives to have a compensation structure that is competitive with the comparable segment of the market.”

And these compensation practices are not limited to one individual. FINRA’s annual report shows that the organization’s top 10 executives received nearly $13 million, up from roughly $11 million the year before. 7

We are unaware of any compliance personnel which demands similar earnings.

Finally, FINRA’s lack of transparency and accountability has reached epic proportions. As a private organization, FINRA is not subject to the same transparency as a government agency. And that means not subject to the Freedom of Information Act, the Administrative Procedures Act, or the Sunshine Act (among others). Individuals appearing in front of FINRA as adjudicator of matters are not entitled to
ordinary due process rights. The U.S. Government Accountability Office (the “GAO”) released a report in May 2012 recommending that the SEC enhance its oversight of FINRA. 8 See: Why advisors see FINRA as the devil. 8

FINRA has long been criticized for having too much power, and using that power to inflict harm against smaller firms. The case against FINRA is another matter altogether, and one that we cannot give justice while fulfilling our pledge to be concise.

This Bill is a devastating blow to small business

As you are well-aware, our economy continues to struggle. A common refrain is that we must support small businesses that are the engine for jobs in this country. Most fee-based investment advisers are small businesses. The vast majority of advisers (over 90%) have less than 50 employees. 9

The same cannot be said of broker-dealers.

This Bill is counter to current policy supporting small businesses. In fact, the recent JOBS (Jumpstart Our Business Startups) Act was signed into law to increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies. The JOBS Act made it easier for emerging companies to go public (despite trouble with some recent IPO disclosures) and for hedge fund managers to advertise their funds (despite many Ponzi schemes utilizing hedge funds).

SRO would unnecessarily add significant expense burden to investment advisers at a time when small businesses cannot afford additional overhead. Those expenses would eventually be passed on to investors or result in the shuttering of numerous investment advisers. The Boston Consulting Group published research showing that an SRO would cost $550 to $610 million per year during start-up and $460 million to $510 million per year thereafter while enhancing the SEC’s budget would only cost between $240 to $270
million. 10 See: FINRA attacks Boston Consulting Group over SRO study.

No matter which numbers you believe, an SRO will significantly add costs for investment advisers without any promise of adding to investor protection. The Bill will put many advisers out of business, resulting in significant job losses that will never come back. In addition, many advisers will find it necessary to consolidate (like broker-dealers have over the past decade) with other advisers. With
consolidation there is always reduction of “redundant” staff, leading to additional job losses.

We are additionally concerned that an SRO will stifle innovation and lead to commoditization, much like what has occurred among broker-dealers over the past couple of decades under FINRA’s watch. If an SRO can be effective, it has only been so when enforcing rules, not principles as the SEC is called on to do.

Excuse me, we’re standing here

The independent fee-based adviser industry does not have a powerful centralized voice because, by its own definition, they are fiercely independent. But the spirit of America lives in their independent, entrepreneurial spirit. Yet they are under attack by well-organized, global financial services organizations and their powerful lobbies. Investment advisers do not have their version of the Investment Company
Institute (“ICI”), the Financial Services Institute (“FSI”), FINRA, or even the Managed Funds Association (“MFA”) to speak on their behalf.

It seems as if those organizations have negotiated for their hedge fund manager constituents and any adviser that has an investment company client to be exempt from joining an SRO. Published numbers show the paltry amount of money spent by the adviser industry on lobbying efforts compared to these other organizations. 11

Investment advisers should not be punished simply because they don’t have the same lobbying dollars at work as their more organized financial services firms. None of these organizations have independent fee-based investment advisers in mind. It’s naive to assume that they are looking to require investment advisers to join an SRO to protect the investing public.

In a message from FSI chair Joe Russo, he states “we truly believe, with FINRA in place regulating RIAs, we’ll find help level [sic] the playing field for you, eliminate an unfair competitive advantage and better protect consumers.” 12

His clear directive is to require advisers to have to deal with an SRO, despite his broker-dealer constituents clearly needing more oversight than investment advisers. The sole voices in favor of investment advisers being forced to join an SRO are those that have lost
significant market share to investment advisors in recent years, and SEC Commissioners such as Ms. Schapiro and Elisse Walter that are alumnus of FINRA. Even the Consumer Federation of America, who “has long been concerned with the lack of adequate funding for investment adviser oversight,” is in opposition to this Bill. There is simply no independent organization that has expressed support for this Bill.

Where do we go from here?

Despite all of this, there is plenty of good news. There already exists a strong regulatory framework for investment advisers. The U.S. Securities and Exchange Commission and state securities regulators are the best organizations to continue to regulate and furnish oversight of investment advisers. See: Frustration mounts: Experts, RIAs identify six most important unknowns about the switch to state oversight.

These organizations have decades of experience and a solid track record in regulating investment advisers. And while the SEC suffers from a lack of leadership and the states may not be as ahead of regulatory examinations as NASAA suggests, these are reparable problems that do not call for the dismantling of the existing framework.

There has not been any credible evidence offered by the SEC to support its repeated claims that it lacks the resources to fulfill its mission.


The answer should not be to make these industries even more indistinguishable. The answer is to do the opposite. There was a reason that investment advisers were not traditionally required to join an SRO. The industries are different and the broker-dealer model requires more oversight. Draw the line where it was meant to be drawn and stop broker-dealers from dressing up as investment advisers and causing further investor confusion.

MarketCounsel hopes that our comments, made on behalf of us and our entrepreneurial, closely held investment adviser clients are beneficial to this process. We hope that you see the damage that this Bill would do to an industry that provides a valuable service to investors with less conflicts than its competitors who are the sole supporters of this Bill. Thank you for the opportunity to provide input and should you have any questions or require any additional information regarding any of the foregoing, we remain available at your convenience.

Best regards,

Brian S. Hamburger, JD, CRCP, AIFA
Managing Director

Daniel A. Bernstein, JD
Director, Research + Development


64 FR 61226, Nov. 10, 1999
See AdvisorOne, Bachus, McCarthy Introduce SRO Redraft (4/25/2012) (www.advisorone.com/2012/04/25/bachusmccarthy-introduce-sro-redraft)
See RAND Institute for Civil Justice, Investor and Industry Perspectives on Investment Advisers and Broker-Dealers (2008); United States Securities and Exchange Commission, Study on Investment Advisers and Broker-Dealers: As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (2011); and Daniel P. Tully, Thomas E. O’Hara, Warren E. Buffet, Raymond A. Mason and Samuel L. Hayes, III, Report of the Committee on Compensation Practices (1995).
See Mary L. Shapiro, United States Securities and Exchange Commission Chairman, “The Consumer in the Financial Services Revolution” (December 3, 2009) at the Consumer Federation of America 21st Annual Financial Services Conference Washington, D.C.
See Id.
industry and our nation’s economy. Another point of irony stems from Representative McCarthy’s co-sponsorship of this Bill when her home state of New York is the only state in the country that does not conduct any routine examinations of investment advisers.

See www.finra.org/Industry/Regulation/Guidance/CommunicationstoFirms/P126046

See https://dealbook.nytimes.com/2011/07/01/finra-executives-get-big-payday/

See www.gao.gov/assets/600/591222.pdf

See NRS and Investment Adviser Association 2010 Evolution Revolution, www.nrs-cmax.com/company/pdfs/NRS%20Evolution%20Revolution%202010%20White%20Paper.pdf

See https://www.fpanet.org/docs/assets/42D88D3C-CCA5-CF42-0867AB1B1B620112/BCGPressReleaseStudyandSurveyonIAOversight.pdf

See InvestmentNews, Insider: Advisers ignore Washington at their peril (2/3/2012)(www.investmentnews.com/article/20120203/FREE/120209968)

See www.financialservices.org/page.aspx?id=3692PAGE 6 OF 6

Mentioned in this article:

MarketCounsel | Hamburger Law Firm
Consulting Firm, Compliance Expert, Legal Services for RIAs
Top Executive: Brian Hamburger



June 6, 2012 — 6:09 PM

Thank you for sending your thoughtful comments. We need supporters of RIA firms to take action, and I appreciate your leadership.

Frederick Van Den Abbeel

Frederick Van Den Abbeel

June 5, 2012 — 11:08 PM

Thank you Mr. Hamburger and Mr. Bernstein for sharing your views. I and I’m sure many others are eagerly waiting for a final resolution.

Jay Hutchins

Jay Hutchins

June 7, 2012 — 1:29 AM

When I left the brokerage industry to become an RIA and align my interests with those of my clients and saw how much better I could serve them and at a fraction of the price they paid the brokerage houses in often hidden fees, I asked myself how long the brokerage industry would let this go on. Seventeen years later I have my answer. They will use FINRA to squash us like bugs and get back to the business of shafting the middle-income consumer who will no longer have an option. Thanks for your noble efforts Brian and Dan.

Elmer Rich III

Elmer Rich III

June 7, 2012 — 2:29 PM

The bitter adversarial polarization dominating the legitimate problem-discussion and problem-solving around the search for safety for an expanding advisory business is making advisors appear narrowly self-interested with little concern for investors.

No one is the good guy, no one the bad guy. Not even the regulators. Everyone is struggling, in good faith, to wrestle with a very fast growing global financial system and unprecedented complexity, technology and velocity.

Mistakes will always occur — on all sides. It’s human nature. However, self-righteousness, moralizing, demonizing and finger pointing are factually wrong and block real problem-solving.

If RIAs want to claim the moral high ground, they need to act to earn it. Right now, they are just sounding reactive, defensive and holier-than-thou. Acting impulsively on reactive fear and inopportune screeds hurt RIAs and their customers.

Jay Hutchins

Jay Hutchins

June 7, 2012 — 3:31 PM

I believe the point Brian, Dan, and many others of us are making is precisely that this is an illegitimate discussion around solutions to a problem that exists solely for the business interests of the retail brokerage industry. In place of “good faith” we have inserted millions of dollars in lobbying budgets to further those narrow self interests. And, we all know where nearly all of those dollars originate.

Polarized? Yes. Claims to higher moral ground? Yes, again. Right to higher moral ground? Look at the list of broker-dealers and their representatives who have been sanctioned, sued, or imprisoned. Then, look to non-duel-registrant RIAs who have been similarly cited, and draw your own conclusion.

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