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FINRA Urges SEC to Create SRO for Investment Advisers Amid Fierce Debate Spurred by Dodd-Frank Study

By Jim Hamilton

FINRA has entered a fierce debate over Dodd-Frank?s call for an SEC study on enhanced examinations of investment advisers by urging the SEC to create a self-regulatory organization (SRO) for investment advisers. In a letter to the SEC, FINRA said that, given the Commission?s funding limits, it is unlikely that the SEC will be able to accomplish more frequent adviser examinations on its own. To deal with what FINRA called an ``intractable resource problem,?? the SEC was urged to seek authority to establish an SRO for investment advisers to augment the government?s efforts in overseeing advisers. The debate over an SRO for advisers has intensified with industry associations voicing strong opposition to the idea.

Section 914 of the Dodd-Frank Act requires the Commission to review and analyze the need for enhanced examination and enforcement resources for investment advisers and revise its regulations as necessary, as well as reporting to Congress on regulatory or legislative steps necessary to address concerns identified in the study.

In its letter to the SEC, the Investment Advisers Association said that it strongly opposes the creation of an SRO for investment advisers. The IAA does not believe that the effectiveness of the SRO model has been demonstrated and is concerned about the lack of transparency and accountability of non-governmental regulators. The SRO model is particularly inappropriate for investment advisers, said the IAA, given the diverse nature of the investment advisory profession and its principles-based regulatory framework.

FINRA called ``highly impractical?? the Investment Advisers Association?s contention that SEC resources will be able to address the problem. FINRA said that the status quo under which an investment adviser may be examined once every decade is an unsustainable disservice to advisory clients.

Moreover, FINRA said that disingenuous mischaracterizations of how SROs operate under the federal securities laws is a disservice to both investors and SEC staff. Noting that the lAA letter urges the Commission to resist the illusory solution of recommending an SRO for investment advisers simply to increase the number of exams, FINRA said that it is not clear what this statement means. If it is intended to suggest that an examination program must evolve to remain effective, FINRA agrees, but if it intends to suggest that an SRO is incapable of effectively enforcing statutory and SEC rule requirements for investment advisers, FINRA disagrees.

Citing its own long history of tough, effective enforcement of the regulatory requirements applicable to broker-dealers, FINRA said that SRO activities offer more than illusory benefits to investors. To suggest otherwise is irresponsible, said FINRA, adding that if a FINRA affiliate were to seek authorization as an investment adviser SRO it would establish equally effective examination and enforcement of SEC requirements for investment advisers.

More broadly, FINRA said that an investment adviser SRO should be subject to exacting requirements similar to those set forth in Sections 15A and 19 of the Exchange Act for registered securities associations. These standards would ensure that an investment adviser SRO is publicly accountable, its regulatory activities are transparent, and its governance is free of undue industry influence. Importantly, these standards require continuous, stringent Commission oversight, which has been a major factor in the long and successful history of self-regulation as an adjunct to the Commission's regulation of broker-dealers. Even more broadly, FINRA cited the historical congressional reaffirmation of the wisdom of SROs for the securities industry.

Describing governance as a key aspect of a successful SRO, FINRA urged that any SRO for investment advisers have a governance structure that ensures that its governing body, committees and staff act independently and in the public interest. In particular, its governing body should have a majority of its seats allocated to public representatives, and representatives of the investment adviser industry should hold a substantial portion of the remaining seats.

Echoing the IAA, the Investment Company Institute said in its letter that the SEC should have exclusive authority to oversee investment advisers since the oversight of an industry so intertwined with ordinary investors should be conducted by an independent agency directly accountable to Congress. Further, a delegation of authority would be extremely disruptive to a longstanding and, by and large effective system of regulation.

The ICI doe not believe that the SRO model is appropriate for oversight of the principles-based system of adviser regulation, which is critically important to protect the fiduciary culture of the adviser industry. The advisory experience is not readily transferable to the type of prescriptive, rules-based model that works best in the SRO context. Further, the conflicts of interest inherent in industry self-regulation, or even the illusion of such conflicts, could harm the public perception of investment advisers. The ICI said that the cost of developing an adviser SRO or building such an SRO capacity in FINRA is an inefficient use of resources.

However, if the SEC determines to create an SRO for investment advisers, the ICI urged that the SRO have the structure and governance appropriate for adviser regulation, adding that FINRA's governing body is not structured for this role since its expertise is with the suitability standard for broker-dealers and not the higher fiduciary standard followed by investment advisers. Finally, the ICI noted that a far more efficient approach to enhancing the oversight of investment advisers would be to increase the SEC's resources and strengthen its qualitative abilities in this area.

Full post as published by Jim Hamilton's World of Securities Regulation on November 08, 2010 (boomark / email).