More On Legal & Compliancefrom The Advisor's Professional Library
- Nothing but the Best Execution Along with the many other fiduciary obligations owed by RIAs, firms owe a duty to seek best execution of clients transactions. If they fail to do, RIAs violate Section 206 of the Investment Advisers Act.
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
The SEC has a number of initiatives on its plate this year that could make advisors' lives easier, or not. For instance, advisor regulation will be on the securities regulator's mind as SEC Chairman Christopher Cox receives early this month recommendations from two of the Commission's top staff members on the steps the securities regulator should take in light of the recent findings of the Rand report.
Andrew Donohue, director of the SEC's Division of Investment Management, said at the Investment Adviser Association's (IAA) compliance conference in Washington March 25 that he and Eric Surri, director of the SEC's Trading and Markets division, would deliver the recommendations to Cox by May 5. While he declined to divulge details about the recommendations, Donohue did say at the IAA event that it was "enormously important for us to get it [the recommendations] right." Donohue told me in a separate interview in early April that it would be up to Cox to decide when, and if, to make those recommendations public.
The Rand report, which studied whether investors are clear on the differences between broker/dealer and investment advisor services, found that while those investors are confused about who's a broker and who's an advisor, they are nonetheless pleased with the services they get from their financial professional of choice.
The issue of whether to put advisors and B/Ds under one set of regulations is heating up. David Tittsworth, executive director of IAA, told conference goers there could be a "complete change of advisor regulation" as there's talk now of advisors being subject to B/D regs and vice versa. But he, like others at the conference, argued that B/D and advisor regulation should remain separate because they are two distinct businesses.
Discretion, C Shares, Wrap Accounts
In my April conversation with Donohue, he said he did not foresee advisors and broker/dealers being put under one set of regulations. "I do think there are certain areas where [advisors and B/Ds] are doing very similar things, and then there are certain areas where they are doing totally different things," Donohue said. An example, he said, is discretionary investment management. "All of the things we're talking about in Rand is really non-discretionary. So non-discretionary advisory versus what broker/dealers do, you could look at that and say some of those things could be similar. But once you get into the discretionary area, people managing other people's money, that's much different than a broker/dealer relationship."
Donohue said there are clear signs that the advisor model is taking on more broker/dealer attributes. "I think it's quite clear that there's been a number of folks that had previously been registered as broker/dealer reps who have opted to move over into the advisor space and get paid on an asset basis, and yet not do much different for their clients, at least ostensibly, than what they had done when they were broker/dealers."
One area of concern where broker and advisor services are similar is the use of C shares and wrap accounts, Donohue said. "You could look at C shares of a mutual fund not being that dissimilar from a wrap account--yet they are subject to two totally different regulatory regimes. There is a concern, and FINRA talks about this from time to time, that [this is] an uneven playing field; folks [are] doing very similar things [with C shares and wrap accounts], one subject to an advisor regulatory regime and another subject to the broker/dealer regulatory regime, and is there opportunity for folks to arbitrage--in terms of selection--of being under one regime or another. That isn't really based on what's best for clients."
The IAA's Tittsworth says that one recommendation that Cox could get from Donohue and Surri is that there be an SRO created for investment advisors. (Treasury Secretary Henry Paulson's blueprint for a broad overhaul of financial services regulation--see separate story on page 48) also calls for an SRO for advisors. I asked Donohue if he thought an SRO for advisors was warranted, and he replied that while he doesn't have "a view at this point on whether an SRO is necessary in the advisor space or not," there are advantages to having an SRO. "One advantage is that there's another body out there that may have resources that might exceed ours."
The Associations Weigh In
Naturally, both IAA and the Financial Planning Association (FPA) are opposed to an SRO for advisors (FPA President Mark Johannessen addresses the issue on the Soapbox on page 136). Treasury's blueprint argues that investment advisors should be overseen by an SRO because of the "continued convergence of the services provided by broker/dealers and investment advisers," but Tittsworth says this does not justify establishing an SRO for advisors. Furthermore, he said in a prepared statement that direct regulation of advisors by the SEC is "appropriate and effective," adding that "the reasons that persuaded Congress to authorize the creation of an SRO for broker/dealers--the high level of interconnectivity between broker/dealers and the technical issues related to settlement, execution, and reconciliation involving broker/dealer transactions--simply do not exist in the investment advisory profession."
Another area that Donohue says SEC examiners will be scrutinizing this year is separately managed accounts. He told IAA conference goers that managed accounts have experienced rapid growth, and have "been an innovative way for firms to meet client demands for more unified portfolio management and possibly provide cost savings through the bundling of advice, brokerage, and custody."
However, he said, managed accounts also "create challenges for compliance personnel and the firm's regulators." SEC staff, he warned, will be "interested in learning about [advisors'] experience in placing clients in managed accounts." For instance, he said, the SEC wants to know "how firms determine that a managed account is the appropriate account for a client and how firms determine that clients are receiving the full value of these accounts and particularly of the 'bundled' brokerage services." Plus, he said, SEC wants to learn what brokerage services clients typically use in these accounts and how frequently they use them.
Washington Bureau Chief Melanie Waddell can be reached at email@example.com.