Advisors are so accustomed to this dysfunctional dynamic that they never stop to realize how strange it is among American professionals. Do doctors have to deal with on-site inspections? Are there strict financial record-keeping requirements for CPAs who fill out your tax returns? Does an attorney who may administer millions of dollars of trust assets have to worry about whether a tweet he sent out could be interpreted as a solicitation or a testimonial?
HEAT, BUT NO LIGHT
I bring this up because I think we're all caught up in the wrong debate about more effective advisor regulation. It seems nobody - not even advisors who are most affected - is questioning it. Congress has held hearings on whether FINRA would be able to provide more on-site inspections than the underfunded SEC. In watching the hearings on C-SPAN, I was bowled over by the questions that were not asked, the issues that were not explored.
We assume the solution to RIA fraud is more frequent inspections of advisory offices. But have SEC or FINRA inspectors ever uncovered a Ponzi scheme in its early stages? They certainly didn't catch Bernie Madoff or Allen Stanford.
We assume that the goal of the Dodd-Frank Act is to tighten up lax RIA regulation. But wasn't Dodd-Frank the congressional response to the reckless investment recommendations (junk collateralized mortgages) made by the people who have been fighting for decades against being included in RIA regulation? Why are we focused on tightening RIA regulation when RIAs were never the cause of the 2008 economic meltdown?
We assume the SEC is too underfunded to regulate the RIA community properly. But the average SEC examiner conducts only three on-site inspections a year, according to a study by the Boston Consulting Group. I know this is a crazy idea to propose for a government agency, but is it possible that the SEC might be able to raise the productivity of its staff?
In thinking how the debate really should be framed, I took a long step back and assumed the overarching goal is to actually protect consumers against malfeasance and incompetence, from harmful or self-serving advice from their professional advisor. We know there will be bad people posing as legitimate RIAs. We know some advisors are incompetent - in fact, you can probably name a local advisor without hesitation. The question becomes: What is the best way to put those protections in place?
By framing it this way, I don't think "more of the same" is the answer that jumps out. I think we start by recognizing that the SEC (or some other regulator) actually has a powerful ally in this search for effective consumer protection: the RIA community itself. Think about it: Who benefits most when consumers see a much safer professional environment? Who loses when clients read constant headlines about Bernie Madoff and realize they have no easy way to know whether your office is run under a similarly self-serving business model? Honest advisors have a big stake in this game; they are arguably the people who most want the weeds pulled out of the RIA garden.
The best regulatory model would ideally be a partnership between the honest RIAs who make up the vast majority of the profession and their regulator, a coalition against the incompetents and fraudsters. Then you ask yourself: How would that work? First, the RIA firms would find ways to make themselves more regulatable. They might buy audit software that allows the SEC to randomly spot-check that client assets are at the custodian's office rather than in a numbered account in Uruguay. They might see that fees debited from client accounts match the schedule on electronic file.
The regulator, meanwhile, would serve as a consultant on best practices to promote office efficiency and customer service. At the same time, it would show advisory firms how to incorporate consumer protection measures into their routine procedures. As those measures are adopted, a firm is automatically generating a paper trail, once again reducing or eliminating the need for that labor-intensive (and largely ineffective) on-site inspection.