As a follow-up to the article in our December 2010 Investment Management Update discussing whether an SRO will be created by Congress to help further regulate SEC-registered investment advisers (http://tinyurl.com/6fhhk85), the SEC's staff offered its views on the subject in a recent report.
The staff report accompanying its study on enhancing the examination of investment advisers (another study mandated by Congress through Dodd-Frank) offered three alternatives to provide the SEC with additional examiners and financing to meet the examination enhancement mandate Dodd-Frank imposed upon the SEC. The first alternative recommended by the staff is to have Congress create one or more SROs to regulate investment advisers under the SEC's supervision. That alternative would be similar to the regulatory oversight model currently used for SEC registered brokers and dealers under which the Financial Industry Regulatory Authority (FINRA) under the SEC's supervision regulates brokers and dealers. Some industry groups and the National Association of State Securities Administrators, Inc. (NASAA), the members of which constitute the securities administrators of all 50 states, oppose the idea of a self-regulatory organization taking over direct regulation of investment advisers. The second alternative recommended is for Congress to authorize the SEC to charge registered investment advisers a fee for conducting an examination and to allow the SEC to use those funds to conduct the examination program instead of depositing those fees in the U.S. Treasury. Many of the state securities administrators have the statutory authority to charge fees for examinations they conduct over state registrants. The third alternative recommended by the SEC staff is to authorize FINRA to conduct examinations over their broker-dealer members who also are registered as investment advisers.
It appears clear to almost all that Congress will need to act if the SEC is going to fulfill its mandate to increase the number and quality of examinations of registered investment advisers.
Dodd-Frank authorized Congress to appropriate $1.3 billion for the SEC in fiscal year 2011, a nearly 20-percent increase from the SEC's 2010 budget to cover its mandates. However, as of this date, Congress has failed to approve such appropriations. Instead, currently what is authorized by Congress is to continue funding all federal agencies at the 2010 levels. Adding to the mix is that some of the congressional critics of Dodd-Frank, instead of seeking to repeal the entire Act, may wish to keep a close hold on the purse strings for such agencies as the SEC and CFTC. SEC Chairwoman Mary Shapiro has publicly stated that the SEC will not be able to meet its mandates without increased funding. Supposedly, the staff has already imposed, due to budget constraints, some reductions on staff travel to conduct examinations of out-of-the-way registered investment advisers and has postponed some other on-site investment adviser examinations previously scheduled.
According to SEC Commissioner Elisse Walter, the SEC would have to add approximately 2,000 examiners to its current examiner force just to equal the rate of broker-dealer examinations currently conducted by FINRA. Although Dodd-Frank requires so-called mid-sized investment advisers (those with assets under management of between $30 million and $100 million to withdraw from registration with SEC and register at the state level), it is expected that with the new requirement under Dodd-Frank for private fund advisers to register with the SEC (to the extent that they have assets under management of $150 million or more), and with the increasing number of investment advisers entering into the industry, the net reduction of SEC registered investment advisers will not be at a sufficient number to take meaningful examination pressure off of the SEC's shoulders.
Adding to the discussion is the Executive Council of the American Bar Association's Securities Law Committee that, on January 25, 2011, urged Congress to either significantly increase the SEC's budget or remove the SEC from the current appropriations process to that of a self-budgeting agency (i.e., the SEC could charge registrants for conducting examinations and could keep those fees for operational costs, which is the staff's second recommendation described in this article).
The Council, in support of its position, cited that banking agencies use the self-budgeting approach and that has worked well over the years.
It is likely that the issue over funding for the SEC will come to a head in the early part of this congressional session.