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Veres to SEC: Leave Those RIAs Alone

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This is an open letter to SEC Chairwoman Mary Jo White. The rest of you can read along if you want.
Dear Chairwoman White:

I’ve been reading over the SEC’s 192-page Fiscal Year 2015 Congressional Budget Justification. May I just say that it made for surprisingly interesting reading? Right off the bat, on page 5, you note that “the SEC has focused its limited examination staff on those areas posing the greatest risk to investors,” and then go on to say, in the very next sentence, that “additional resources are needed to increase examination coverage of investment advisers.”

Reading what is clearly being said between the lines, I gather that the examination of investment advisors has not, until now, been a huge budget priority for the SEC. Why? Because advisors who manage investment portfolios of assets held at one of the custodians aren’t, in the commission’s long-standing view, posing a huge risk to investors. I agree!

You also talk about the SEC’s “results-oriented work environment,” which “maximizes the use of agency resources by continually improving agency operations and bolstering internal controls.” This is indeed a worthwhile goal; U.S. tax dollars should not be wasted.


But as I pored over the budget numbers, I was able to spot areas where I believe there is room for improvement. In the FY 2015 Request by Strategic Goal and Program, you show that the SEC’s Office of Compliance Inspections and Examinations was allocated more than $300.6 million for fiscal year 2014. Of that amount, $209.9 million is allocated to the salaries of 914 members of your inspection team, with the remaining $90.7 million going to other expenses.

You’re asking for 316 additional positions in order to properly examine the estimated 11,500 investment advisory firms who aren’t posing a huge danger to the investing public.

Then you show that the SEC examined 9% of RIAs in 2014, an estimated total of 1,000 examinations; there were also 100 examinations of investment companies, 450 of broker-dealers, 45 of transfer agents, and roughly 100 of market oversight organizations, municipal advisors, clearing agencies, etc.

I’m guessing that it’s probably more complicated to examine a mutual fund and a broker-dealer than it is an individual RIA office, so let’s suppose that those nearly 700 larger firm examinations required the same number of staff as exams for 1,000 RIA firms.

That suggests that roughly half your examination staff (about 450) are, in aggregate, performing those 1,000 investment advisor examinations. That comes to about 2.2 advisor examinations per staff person assigned to the RIA marketplace.

The SEC’s all-in cost per audit of each RIA firm that was examined in 2014 would have come to roughly $150,336.

If your request for more staff in 2015 goes through, and most of these new hires are allocated to RIA examinations, the cost per exam would actually go up. You propose to add $73 million to the compliance and inspections budget, but to conduct only 325 more audits in that next year. By my quick calculations, you will be paying more than $200,000 per advisory firm audit in fiscal 2015.


As I said earlier, I want to help you with the crushing burden of staying on top of those RIA firms that are not a huge risk to the general public, and I have some suggestions that might help.

First, ask yourself whether the whole RIA inspection regime isn’t simply a habit carried over from the 1940s and 1950s, when it was much harder to track what advisors were doing. The custody arrangements back then were recorded on paper rather than electronically; portfolios were individual stock certificates and bearer bonds; and often the client was the custodian, with these various pieces of paper locked away in a safe deposit box until it was time to sell on the open market.

In other words, there was a lot more room for abuse than today, when everything is recorded electronically. Clients now get statements from their custodian, and can match that against whatever their advisor is saying. In fact, it suddenly occurs to me that this very line of reasoning may be why RIA inspections have been such a low priority in the past.

Notice that other professionals are not routinely inspected as they provide advice to the public. Does any government agency undertake surprise inspections of doctors’ offices, or attorneys, or CPAs? Why are investment advisors treated differently?

Second, consider that the inspection process rarely uncovers Ponzi schemes, sales of non-registered securities or other scams. SEC examiners, some of them still on your staff, spent several weeks in the offices of Bernie Madoff, and failed to uncover any evidence of malfeasance.

I’m sure you already suspect that criminals seldom record the details of their scams in their books and records.

Frankly, it might be time to proclaim that the whole idea of ratcheting up inspections is an expensive waste, especially since the great majority of the firms you’re examining have client assets with custodians — who send clients independent verifications of the assets in their accounts — and have no way to touch the money themselves. Those who do have access to client assets are required to undergo an annual independent audit, which surely takes away some of the risk to investors.

Might it be better to recycle some or all of the estimated $185 million earmarked for inspections in 2015 toward reducing poverty, feeding the hungry or preventing Wall Street from carelessly, but profitably, bringing the global economy to the brink of collapse?


If you’re not moved by these arguments, and are determined to push ahead and raise the percentage of inspections, then I have another suggestion: Instead of asking for a lot more money from Congress, you might consider raising the productivity level of your examination staff.

I’m sure that your inspectors feel hopelessly overworked having to conduct those 2.2 field audits a year. But a lot of investment advisors hire summer interns who get more work done in three months than your staffers seem to accomplish in 12. By relying on the data in the budget proposal, I calculate that, last year, your employees devoted to office inspections and examinations took home an average salary of $229,658. Let’s make them earn it.

I’m guessing that at this point in my letter, your attention is beginning to wander. Let me make one final effort to relieve you and your agency of the burden of visiting and auditing those advisor offices that don’t present a huge threat to the public.

As a patriot and someone who believes in consumer protection, I’m willing to devote my time as an independent contractor to making my share of inspections. I believe I can do a thorough job of checking whether client assets are wandering off into numbered accounts in Uruguay, whether there is a true culture of compliance and an adequate disaster recovery plan in place.

I look forward to reading compliance manuals, and making sure that advisors make trades in their companies’ 401(k) plans only after they’ve traded for their client accounts. I will be picky but fair.

This fiscal year, you’ll spend more than $200,000 per RIA firm audit. I’m willing to shoulder the burden of 24 of those audits, two a month, and I’ll only charge half of the SEC’s internal cost per audit. Better yet, I have a number of friends and colleagues who would be willing, in a similar spirit of patriotism, to take on a similar burden on behalf of the SEC.

You want to conduct 325 more audits in 2015? I can round up 15 friends who will make that happen, and spare you the burden of asking Congress for a hefty increase in funding.

Please don’t thank me. The satisfaction of helping out — and, of course, the money — will be thanks enough. 

Bob Veres, a Financial Planning columnist in San Diego, is publisher of Inside Information, an information service for financial advisors. Follow him on Twitter at @BobVeres.

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