SEC Rule Would End Surprise Audits for Some

Industry groups across the independent advisory channel expressed approval over a proposed rule by the Securities and Exchange Commission that would exclude advisors whose only access to client funds is to deduct fees from surprise audits. The groups insist, however, that they are waiting to see the final rule – due out in several days at the earliest – before making any judgments.

Under the new rule, advisory firms which custody clients’ assets with an independent firm and only debit client’s accounts to withdraw management fees will not be subject to any surprise audits by third parties.

David Tittsworth, executive director of the Investment Adviser Association in Washington, D.C. is happy to see the result the IAA has been lobbying for in comment letters to the SEC and in meetings with commissioners for many months.

“We estimated in conversations that the cost of these surprise audits would range from $20,000 to $300,000 a pop, and this would be an annual requirement,” Tittsworth said. “Other comment letters went as high as half a million dollars or even $1 million depending on how many clients and custodians a firm has."

Tittsworth also pointed out that the vast majority of investment advisors use third-party custodians.

“There are about 6,000 advisors who would have had to do these surprise audits just because of the fee deduction, so this was very big news," he said. "The devil is in the details though; we certainly want to see the final rule before making any detailed pronouncements about this.”

Dave Bellaire, general counsel and director of government affairs at the Financial Services Institute, an advocacy group for independent broker-dealers, is pleased as well, noting that any other outcome would have raised costs for advisors without providing any additional investor protection.

“These firms do not have a history of converting clients’ funds to themselves that the rule is attempting to address,” Bellaire said. “We think it’s a significant improvement to the final rule.”

David Cohen, assistant director of government relations at the Financial Planning Association, an advocacy group for independent financial planners, also approved of the proposal.

“We’re very glad that the SEC dropped the surprise audit requirement for advisors whose soul access to clients’ accounts is to deduct fees from the surprise audits, but in cases like this it’s all about the details," Cohen said. "We are waiting to see what the final rule will look like.”

In accordance with the new rule, advisory firms who custody clients’ assets will be subject to annual surprise exams by independent third-party public accountants to verify that the client assets indeed exist. If the accountants discover assets are missing, they are required to contact the SEC.