MTPCR

“We believe that an SEC rule proposal requiring investment advisers to hire and pay for third party compliance reviews is a very real possibility for 2016. The scope remains unclear – the proposal could range anywhere from requiring costly full scope SEC-type mock examinations to more limited engagements in agreed-upon areas. It may also include determining what role an SRO, such as FINRA, could play in these reviews.”

Mandatory Third-Party Compliance Reviews

Overview

The SEC staff is actively developing a rule to mandate the use of third parties in connection with compliance examinations of investment advisers.

The IAA supports the goal of enhancing the SEC’s oversight of the advisory profession. However, we strongly believe that compliance examinations are inherently governmental functions and oppose any efforts to outsource this critical SEC responsibility. Examinations must be effective, substantive, risk-targeted, and conducted by examiners who understand relevant regulation, the nature of the businesses being examined, and the industry as a whole. We agree with Chair Mary Jo White when she says that SEC examiners are the most qualified to carry out this mission, and that’s why we have steadfastly argued that the best approach is to enhance the SEC’s own examination program by hiring more examiners and using existing resources more efficiently.

In an effort to significantly increase its annual on-site investment examination rate of approximately 10 percent – and faced with continuing Congressional opposition to increasing funding to sufficiently expand the agency’s examination program – the SEC staff is developing a rule requiring advisers to pay for third-party compliance reviews. This may also include determining what role an SRO, such as FINRA, could play in these reviews.

While admitting that it’s not the “optimal” approach, Chair White appears to be convinced that a third-party examination program may be the best remaining option available to the SEC to increase adviser examination rates, because it would not require Congressional approval.

On November 18, 2015, Chair White testified before Congress that at her direction the SEC staff is “preparing a recommendation to the Commission for proposed rules requiring third-party compliance reviews” for investment advisers. She added that the reviews would not replace examinations conducted by OCIE, but would be “designed to improve overall compliance by registered investment advisers.”

We believe that an SEC rule proposal requiring investment advisers to hire and pay for third party compliance reviews is a very real possibility for 2016.

The scope remains unclear – the proposal could range anywhere from requiring costly full scope SEC-type mock examinations to more limited engagements in agreed-upon areas.

"The IAA has been at the forefront on this important issue, recognizing the very real burdens and cost implications for investment advisers. IAA staff and officials of member firms have met with senior SEC officials several times to express our concerns. In particular, we tried to impress upon the SEC staff how much of an additional cost burden this requirement could impose, particularly for smaller advisers."

Position

The IAA has been at the forefront on this important issue, recognizing the very real burdens and cost implications for investment advisers. Very shortly after the idea of third-party exams was floated by former Commissioner Dan Gallagher on May 9, 2014, the IAA responded with a letter expressing deep concerns about the impact of such a program on individual advisers and outlining the many trouble points that would need to be addressed, some of which were expressed in our 2003 comment letter responding to a similar proposal.

In addition, the IAA has been proactively communicating with the SEC on this matter in an attempt to preclude potentially more costly and less effective approaches from being considered. IAA staff and officials of member firms have met with senior SEC officials several times to express our concerns, which are outlined below. In particular, we tried to impress upon the SEC staff how much of an additional cost burden this requirement could impose, particularly for smaller advisers.

Many difficult issues would need to be considered and addressed before any potential third-party involvement could be implemented. These include:

  • The standards applicable to the third-party engagements.
  • The scope of any reviews and the level of discretion afforded to third parties.
  • The types of voluntary third-party reviews that investment advisory firms currently employ and how these engagements could be efficiently leveraged.
  • The frequency of the mandated reviews and the need to avoid duplication with SEC examinations.
  • The qualification process for the third-parties.
  • The SEC’s oversight of third parties (including the cost of oversight) and whether the SEC has the requisite authority to regulate third parties.
  • The manner in which the results of these reviews would be provided to the SEC, including the confidentiality of any work product generated.
  • The cost to advisers, including the potential impact the requirement would have on the resources allocated to other compliance areas by the adviser.

The IAA remains committed to working with the SEC to identify effective solutions to enhance its examination oversight of investment advisers that do not involve an SRO, like FINRA. On the issue of third-party reviews, we will continue to engage the SEC staff to help inform any potential rulemaking as part of our ongoing advocacy efforts.

"The IAA supports the goal of enhancing the SEC’s oversight of the advisory profession. However, we strongly believe that compliance examinations are inherently governmental functions and oppose any efforts to outsource this critical SEC responsibility. We have steadfastly argued that the best approach is to enhance the SEC’s own examination program by hiring more examiners and using existing resources more efficiently."

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