If you read the press releases sent out by FINRA and the Financial Services Institute, you'd believe that dually registered advisors are tightly regulated while independent RIAs operate in a loosey-goosey regulatory environment that is dangerous to individual investors. According to this view, FINRA's risk-based inspection program has an examiner in the broker-dealer's home office every two years or so, on average, and sometimes every four years - while rogue RIA firms host an SEC examiner once every eight to 10 years. The only reason these RIA firms have given up commissions, the argument continues, is so they can evade regulatory supervision of their dark and dangerous activities.

It's true that advisors who gave up commission revenues are woefully undersupervised when it comes to their sales activities - although perhaps (I'm speculating here) that's because they aren't actually engaged in any sales activities. It's also possible that the SEC has, over the years, recognized that independent RIAs who are mostly allocating funds for clients don't pose a grave public threat.

The SEC's budget has increased to $1.3 billion from $250 million over the last 20 years, but the organization has allocated most of this additional money to policing insider trading, market regulation and (ironically) FINRA oversight - including redundant visits to the same broker-dealer offices FINRA visits regularly.

SEC officials find support elsewhere for their regulatory priorities. At the recent MarketCounsel Summit in Las Vegas, Barney Frank and Chris Dodd (co-authors of the Dodd-Frank law) told the audience that nobody they talked to, in the months-long debate over the law's provisions, said that independent financial planners and investment advisors contributed to the crisis or posed any kind of systemic risk.

Yet I wonder whether the FINRA/FSI press releases are giving us a complete picture of the consumer protection equation. A recent conversation with Mark Tibergien, CEO of Pershing Advisor Solutions, helped me think through the fiction vs. reality.

A fair equation would have, on one side, all the protections that consumers receive from the (allegedly) nefarious antics of independent RIAs - including the SEC inspection regime, even if everyone believes it is too infrequent. The other side would include all the safeguards built into the FINRA regulatory system, including FINRA's biennial B-D inspections.

Let's start on the FINRA side. In addition to those inspections, we have the broker-dealer compliance departments, which have to approve every message their affiliated reps send out, since it is all deemed to be sales material. They also monitor sales transactions. But how often does FINRA visit each of the investment advisor rep offices affiliated with the broker-dealer - the places where advisors actually meet with clients?

I asked FINRA, and the answer was interesting: Where a B-D "employs" (that was the word the FINRA official used) dually registered individuals, the broker-dealer is examined, not the offices. I asked some investment advisor reps directly, and my anecdotal poll says these offices have never seen a FINRA inspector. For the sake of comparing apples to apples, shouldn't we weigh the SEC's actual RIA office visits against FINRA's inspections of actual offices? In that case, we compare "every 10 years or so" with "never."

Now turn to the independent RIA side. Advisors custody assets through independent companies like Pershing, TD Ameritrade Institutional, Schwab Advisor Services, Fidelity Institutional Wealth Services and Shareholders Service Group. The advisors are not supervised by their custodians, but are watched carefully, Tibergien says. Any advisor who tries to set AUM fees outside Pershing's tolerances can expect to be questioned before the fees are debited from a client account, for instance. Tibergien says a custodian often watches for a lot more: potential money laundering, compliance, investment activity and suitability.


Our conversation also included Pershing Chief Compliance Officer Kevin Taylor and Pershing Chief Operating Officer Karen Novak. Taylor points out that Pershing's various operations, too, are supervised by FINRA, and Fed inspectors actually have offices at the headquarters of Pershing parent BNY Mellon. We are not talking about having visitors every two years; we're talking about every day.

"Everything in the 4,500-page FINRA rule book is our responsibility," Taylor says, "as it relates to a custodial account or a registered investment advisor who comes to our platform, [and] as it covers know-your-customer procedures and customer identification programs." Custodians provide confirmations of every transaction to clients. Pershing has internal monitoring tools that generate 600 reports, many of which are also made available to advisors so they can monitor and manage their own firms.

Novak focuses on RIAs' internal operations. "We're trying to make sure we're comfortable with the control environment they have in their organizations," she says. "We'll have a conversation with our advisors if we see anything that gives us discomfort. The conversation helps us make a decision to keep them on our platform or move toward some separation."

Tibergien argues that one of the untold stories of the custodial world is how carefully each RIA firm is vetted before it is allowed to do business on any of the larger firm platforms. At Pershing, he says, three different committees have to approve every RIA, after having looked at registrations, asset mixes, expected account activity and, of course, regulatory history.

Interestingly, Tibergien says compliance professionals at all the major custodians share information regarding RIA firms under consideration - a joint effort to keep potential bad actors out of the system as a whole. I contacted two other custodians to confirm this. Although everything they said was off the record, they were generally surprised that any custodian would talk openly about these cooperative efforts, possibly because of antitrust concerns. None, however, denied either on or off the record that these firms cooperated with each other when it came to vetting the character of RIAs - despite vigorous competition in every other area.

These surveillance protocols are generally comparable to the IBDs' oversight of reps, and they seem not to be dramatically less rigorous. I'm going to go out on a limb to speculate that the custodians are nearly as eager not to be sued for the actions of the RIAs who custody with them as the IBDs are not to be sued over the activities of their affiliated reps.


Let's score the various sides of this equation: You have FINRA oversight of the custodians, on one side, and of the B-Ds, on the other. You have fairly comprehensive custodian surveillance of the RIA offices on one side and detailed B-D compliance oversight over the investment advisor rep offices on the other. You have SEC examiners visiting RIA offices once every 10 years or so, and FINRA examiners apparently visiting investment advisor rep offices much less frequently - if at all.

If you drill down a bit, the equation also depends on the soundness of the decisions. As Tibergien puts it: "What you worry about is: Are you affiliating with an organization that is associated with bad people? I know certain independent B-Ds who, in the past, have taken on people who have terrible compliance records; and as long as the money was flowing in, they didn't seem to care very much."

When I weigh both sides of the regulatory equation, it feels like the FINRA side is actually a bit lighter on consumer protections. And the vastly higher number of client arbitration claims and disputes coming from the brokerage/B-D world, plus all the reckless activities that nearly brought down the global financial system in 2008, suggest FINRA oversight might be at least a tiny bit leakier than the SEC's. Plus - and I think this is vital - the SEC/RIA side doesn't have the conflicts involved in selling in-house products, annuities or non-traded REITs for generous commissions.

The next time FINRA trumpets its superior compliance regime, or the trade organizations tell us that independent RIAs are totally unregulated, I hope the conversation includes this more comprehensive look at both sides of the consumer protection equation. In this light, what we have on the RIA side doesn't look so terrible after all.


Bob Veres, a Financial Planning columnist in San Diego, is publisher of Inside Information, an information service for financial advisors. Visit financial-planning.com to post comments on his monthly column, or email them to bob@bobveres.com.

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