Imagine that you run what this industry considers a small advisory practice with about $100 million in client assets under management.
In times past, your business might not attract a lot of scrutiny from the Securities and Exchange Commission, or even the likes of Financial Industry Regulatory Authority. Although the SEC has decided that those firms should fall under state supervision, there is not a lot of convincing evidence that this shift will go a long way to providing meaningful solutions to financial regulatory reform.
The industry is operating in an environment where deficits are alarming. Conservative lawmakers and news outlets, ironically, are subjecting state and federal budgets to withering scrutiny. The raw numbers suggest that there is good reason for doing so. On the federal level, deficits are on track to hit $1.5 trillion this year, the nonpartisan Congressional Budget Office said in January. Among the states, 23 had each reported $40.5 billion in budget gaps for fiscal 2012, according to the Fall 2010 Fiscal Survey of States. Also, 17 had each projected shortfalls of at least $40.9 billion for fiscal 2012. Not all states had completed forecasts when the National Governors Association, and the National Association of State Budget Officers, which produce the survey, completed the roundup last October.
Funding consideration were part of the reason that the SEC decided to shift oversight of smaller advisors to states. The idea was to free up their resources to focus on larger firms. Federal and state securities agencies are facing similar problems, though. How will the states handle the added responsibility of supervising financial advisors?
John Gebauer, a managing director of consulting at National Regulatory Services, a division of Accuity, suspects the states might decide to shift priorities around to address their new responsibilities. (Full disclosure: Accuity and SourceMedia are owned by the same private equity company, InvestCorp.)
“They will be big fish in smaller ponds,” Gebauer said in a telephone interview about smaller advisory firms. “If I was running one of the examination programs, I would be looking at the advisors who are now the biggest advisors in my regime.”
Gebauer says states go about supervising technology and reporting in ways that are different from the SEC. Depending on the state, those methods could end up being stricter than what advisors had been used to, previously. He cites California as an example. California’s rules governing the privacy of client information differ from those at the SEC. There are more conditions under which a potential security breach would have to be reported in California than at the SEC.
“An advisor who has been 100% compliant with SEC regulations cannot just assume they are 100% compliant with state regulations, Gebauer said. “They’ll have to review all regulations … to see if they need to make changes to their compliance program.”
True enough, this year is turning out to be an extraordinarily busy one for advisors who manage $100 million or less. The conversion process begins in July, when the firms have to make a filing that defines what their assets under management are. Beginning on about October 21, those firms will have to begin complying with rules set out by state securities regulators, not the SEC. As Financial Planning reported earlier, the firms have to complete loads of paperwork before during the registration process.
Aside from that, smaller firms will inevitably be swept up in debates that affect all financial advisors and financial planners. Should there be a self-regulatory organization set up for independent advisors, similar to FINRA for brokers? How will the industry be affected by the move to a uniform fiduciary standard for all advisors? Also, larger advisory firms are getting adjusted to a new ADV Form Part II, which is filed with the SEC. Firms that are going stateside, at press time, were unclear as to whether states will accept that form.
Once the initial conversion is done, however, it seems that only time and money will determine how effective that move really is.
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