When you look at the regulation of registered investment advisory firms, what do you see? You see a big pain in the neck. You see a whole lot of vague guidelines that are enforced subjectively when an examiner - who often knows nothing about your business - comes into your office. You see a fundamentally hostile relationship between regulator and regulated.

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?



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.

Why are we not thinking along these lines already? I suspect the reason why the SEC views the RIA community as an opponent rather than an ally has a lot to do with its long experience dealing with the brokerage firms. When you have spent decades trying to regulate powerful entities that fight against any rule that might limit their ability to siphon off dollars from consumer portfolios, you are unlikely to see the potential for an alliance with the regulated. Meanwhile, the sloppy, not-to-the-point inspection regime at the SEC has encouraged advisors to think of the agency primarily in terms of busywork and the hassle factor, rather than as an ally against the Madoffs among us.

The right debate about consumer protection would not be a debate at all, it would be a dialogue among regulatory officials who have an open mind about how to do their job better and advisory firms who are willing to participate in creating a cleaner, safer RIA environment. It might involve better whistle-blower procedures whenever advisors take over a new client and see evidence of malfeasance in the advice the client received before. It will certainly involve 21st century technology, remote spot-checking and what Gary Davis Jr. of MarketCounsel, the business and regulatory compliance consulting firm, has described as practice integration of compliance procedures into normal day-to-day business practices.

The discussion would address competency issues in a profession that has not yet defined its minimum educational standards. For people who hold themselves out as financial planners, the CFP designation would eventually become a strict requirement. What credential would be required for those who hold themselves out as investment advisors?

Most important, this dialogue would allow for a fresh start. Regulators would see the honest advisor community as a powerful ally in their efforts to protect consumers - which would be a new experience for them, and probably require some getting used to. Advisors would recognize that, as the regulators become more effective, their businesses can market more effectively to less-fearful consumers.



Do I think this is going to happen? It won't unless or until the RIA community starts to change the terms of the debate. We need to move the discussion away from SEC vs. FINRA, away from whether Congress should impose a solution that has more to do with lobbying clout than consumer protection, away from how often on-site inspections should be conducted. I think most people know the current system isn't working and would be attracted immediately to a better solution than more of the same.

Let's take the whole regulatory debate back to its foundations, back to the central question of how to make the investment world work for the benefit of the consumer. Isn't that what fiduciary is all about?



Bob Veres, a Financial Planning columnist, publishes the Inside Information newsletter and website for advisors at bobveres.com. Post your comments on Financial Planning's discussion boards at financial-planning.com/forums. Readers can also send feedback to bob@bobveres.com.

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access