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Schapiro: “Harmonize” RIA And B/D Obligations

Testifying before the Senate Committee on Banking, Housing And Urban Affairs Thursday, SEC Chairman Mary Schapiro submitted documents saying the agency anticipates “harmonizing investment adviser/broker dealer obligations.”

“We are studying whether to recommend legislation to break down the statutory barriers that require a different regulatory regime for investment advisers and broker-dealers, even though the services they provide often are virtually identical from the investor's perspective,” Schapiro said in prepared testimony. “Some of our rules regulating financial intermediaries need to be modernized, and the Commission is considering what, if any, legislation to ask for from the Committee.”

Along with her prepared remarks addressing the SEC’s priorities and possible reforms for restoring investor confidence, Schapiro submitted an appendix to her testimony to provide “an overview of the major functions of the SEC, a summary of recent activity, and the resources allocated to each function.” The document says that “anticipated 2009 activities” of the SEC’s Division of Investment Management and Division of Trading And Markets, which regulate RIAs and B/Ds respectively, included “harmonizing investment adviser/broker dealer obligations.”

In 2008, according to the appendix submitted by Shapiro, the SEC, using risk-based targeting, conducted examinations of 1,521 investment advisors (14% of registered universe of 11,300 registered investment advisors). During the same period, the agency conducted examinations of 720 broker/dealer firms (together with FINRA, 55% of universe of 5,500 registered broker/dealers examined).

Schapiro, who served as CEO of Financial Industry Regulatory Authority, the self-regulatory organization for broker/dealers, was appointed by President Barack Obama on January 20 and was confirmed unanimously by the Senate and sworn in as SEC chairman on January 27, becoming the first woman to serve in the post.

With her strong ties to FINRA, many RIAs have speculated that Schapiro would act to bring regulation of RIAs into alignment with brokers, a development most RIAs do not welcome and most B/Ds cheer. RIAs managing more than $25 million are regulated by the SEC while those with less than $25 million under management are regulated by state securities bureaus. Brokers are licensed by FINRA and supervised by broker/dealers.

Compliance regimes imposed by most B/Ds on registered reps are generally far more invasive and bureaucratic than the compliance system faced by RIAs. However, B/Ds have a long history of violating rules governing sales to retail investors, while instances of abuses by RIAs been comparatively rare.

The $65 billion Ponzi scheme by Bernard Madoff has created an environment in which investors and legislators are demanding change to the regulatory framework, which is widely considered to have been outmoded in recent years by the growing use of complex derivatives, unregistered hedge funds, and private equity partnerships, and the conflicts of interests at credit rating agencies responsible for passing judgment on debt issues that pay huge fees to the rating giants. In her prepared remarks, Schapiro’s promised to address a number of these issues.

While Schapiro offered no details about how she might bring BD and RIA regulation into closer alignment, her remarks make it clear that a review of the regulatory framework faced by RIAs is high on her list of priorities for 2009. An area affecting RIAs that she offered some details about are instances in which an RIA takes custody of assets. While few RIAs accept custody of client assets, the Madoff fraud would likely have been discovered sooner if stricter rules had been in effect governing instances in which RIAs take custody of client assets.

“I have asked the staff to prepare a proposal for Commission consideration that would require investment advisers with custody of client assets to undergo an annual third-party audit, on an unannounced basis, to confirm the safekeeping of those assets,” Schapiro said. “I also expect the staff to recommend proposing a rule that would require certain advisers to have third-party compliance audits to review their compliance with the law. And to ensure that all broker-dealers and investment advisers with custody of investor funds carefully review controls for the safekeeping of those assets, I expect the staff to recommend that the Commission consider requiring a senior officer from each firm to attest to the sufficiency of the controls they have in place to protect client assets.”

Schapiro said the list of certifying firms would be publicly available on the SEC's website so that investors can check on their own financial intermediary. In addition, the name of any auditor of the firm would be listed, which would provide both investors and regulators with information to then evaluate the auditors.

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