The Magic 8 Ball is a toy that was first enjoyed by children in the 1950s. The toy gave standard answers to important questions such as “Will I pass my spelling test?” Instead of studying, students relied on answers like “Signs point to yes.” After a surprising election, we’re left with questions regarding the regulatory environment facing Registered Investment Advisers (“RIAs”), and our guess is as good as one coming from the Magic 8 Ball.
Publications for RIAs offer differing opinions as to whether the Department of Labor’s Fiduciary Rule will be delayed, modified or rejected entirely. Two of the twenty answers from the Magic 8 Ball were “Reply hazy try again” and “Ask again later,” which seem to be right on the money.
There is even speculation that certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) are at risk of being overturned. Even before the election, however, it seemed to be certain that the SEC’s fiduciary rule was not moving forward in the near term. Adding to the uncertainty is the resignation of SEC chair, Mary Jo White.
For now, examinations are ramping up, not down
According to an article in The Wall Street Journal on October 20, 2016, the number of RIAs has grown over the past two years to 12,000. Although the SEC is reassigning more examiners to oversee investment advisors, RIAs have increased in number by 17 percent over the past two years. The SEC is also considering whether to have third parties conduct examinations of RIAs instead of their being examined by teams dispatched from the SEC’s Office of Compliance Inspections and Examinations (“OCIE”). Third-party examinations appear to be on hold for now.
The Wall Street Journal article observed that RIAs will manage more than $70 trillion of assets by the end of this fiscal year, which is up from $28 trillion ten years ago. Marc Wyatt, OCIE’s director, said the SEC is allocating more resources to keep up with the growing number of RIAs. According to the article, some experts believe that more financial advisors will migrate from broker-dealers to RIA channels because of the Department of Labor’s new Fiduciary Rule. Perhaps, this migration will slow down if the Fiduciary Rule falls by the wayside.
In another pre-election article from The Wall Street Journal on November 2, 2016, Jean Eaglesham reported that the SEC has failed to examine thousands of the money managers it oversees, even though the Commission’s annual spending has doubled to roughly $315 million in fiscal year 2016. A sizeable number of RIAs have never undergone an on-site examination, a result that is surprising since White called inspections the greatest protection her agency can offer to retail investors. Wyatt said that the number of RIA exams increased by one-fifth in the fiscal year ending September 30. He also took note of the SEC’s specific initiatives to address high-risk conduct by newly-registered advisers and those never examined previously. Approximately 4,800 RIAs have never been examined. About 500 RIAs become SEC-registered every year.
The Wall Street Journal’s article observed that there are sharp differences in efficiency, expertise, and procedures across the SEC’s twelve offices. The average RIA examiner reviewed 4.6 firms in fiscal 2015, which was almost double the 2.4 average of the slowest office. Red flags sometimes go undetected, especially among the smaller SEC-registered firms. According to the article, roughly eight percent of RIA exams result in referrals to the SEC’s enforcement division.
Take-away
Obviously, the Magic 8 Ball can’t tell us what the regulatory environment will be six months from now. While we cannot predict the regulatory future, we agree with the Magic 8 Ball’s answer as to whether RIAs can expect aggressive examinations by the SEC. Magic 8 Ball says “As I see it, yes.” And if advisers ask if they will be sanctioned for not fulfilling their compliance obligations, the Magic 8 Ball’s answer is “Yes, definitely.”
In all seriousness, the Magic 8 Ball’s predictions regarding regulatory changes are only slightly less reliable than those offered by Presidential pollsters. Regardless of the changes that take place in the new administration, Wyatt’s speech on October 17, 2016 at the National Society of Compliance Professionals national conference warned advisers that OCIE’s risk-based strategy enables it to oversee far more RIAs than the ten percent examined on-site. The Commission uses data analytics to identify firms that pose a threat to investors, and the SEC’s tools are far more sophisticated than the Magic 8 Ball.
Les Abromovitz can be reached at NCS Regulatory Compliance by calling 561-570-1813 or by e-mailing him at labromovitz@ncsregcomp.com. Les is the author of THE INVESTMENT ADVISOR’S COMPLIANCE GUIDE, which was published by the National Underwriter Company, a division of ALM.