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Do We REALLY Need More Examinations For Advisors? (Guest Post)

Posted by Michael Kitces on Wednesday, August 1st, 11:01 am, 2012 in Planning Profession

Most of us have read articles and weighty analyses about "The Problem" with current advisor regulation--which is, simply stated, that RIA offices are not currently examined nearly often enough for the protection and security of the general public. I think the current figure is that some advisors have to wait 11 years before an SEC examiner pays them a visit, and some of the analyses have suggested that every four years would be a more palatable schedule. What you never hear, in any of the discussions about advisor regulation, is a more basic question: why, exactly, do we need these examinations at all?

(Editor's Note: This post was written by guest blogger and financial planning commentator Bob Veres, in the July 2012 issue of Inside Information. If you're interested in his newsletter, you can sign up for a trial of Inside Information, or receive a discount when subscribing simultaneously to Inside Information and The Kitces Report. You can also follow Bob Veres on Twitter at @BobVeres.)

If you're sitting there in shocked silence, please hear me out.  The current SEC examination system asks a lot of questions, but what part of the examination would have uncovered the very scandals that have provoked all this hand-wringing about 11 years versus four?  We know these issues are not rigorously pursued by the current SEC examination process because Bernie Madoff managed to survive several examinations, as did Allen Stanford.  In fact, I have not heard of a single instance where an SEC examination uncovered a Ponzi schemer.  People whose trade blotter is not signed within 30 days, yes.  People who are actively stealing money, no.

The regulators typically find out about fraud and consumer abuse through consumer complaints or an internal whistle-blower.  So why aren't THOSE the areas where everybody calls for improvement at the SEC?

Law offices are not routinely examined by regulators.  Nor are accounting offices.  Why should RIA offices undergo regular visits?  You could argue that they handle client money, but if the money is at a large, recognized custodian, this really isn't true.  Lawyers serve as trustees of trust assets, but the money is housed elsewhere, and nobody is calling for routine inspections of their offices.

Somehow, along the way, it became an accepted article of faith that a certain number of regulatory inspections would protect the public, and Congress is attempting to rectify The Problem, with generous support from the brokerage firms and FINRA.  But before we all jump on this bandwagon, shouldn't we ask for the evidence that demonstrates the effectiveness of this proposed solution?

So what do you think? Is The Problem with the advisory industry really that there aren't enough on-site examinations of advisors' offices? Do you think that would be a more effective means to protect the public from "bad" advisors? Should there be a distinction in the oversight of advisors who have custody of client money, versus those who don't?


  • http://www.hullfinancialplanning.com/ Jason Hull

    We look to find quick fixes to everything. In this case, it's more regulators and inspections, rather than looking for the underlying, systemic problems which need to be fixed (e.g. fiduciary duty).

    The SEC regulators didn't catch on to the MBS fiasco until it was too late. Thrift regulators and inspectors didn't notice bad loans and mortgages until it was too late.

    Instead, we're faced with the Einstein definition of insanity: doing the same thing over and over again and expecting different results.

  • http://www.adviceiq.com Nicholas Stuller

    Michael-thanks for reposting this. Bob-many thanks for asking this very good question. I spent 7 years at the largest compliance consulting firm and have been supporting RIAs since the early 1990's so have some perspective here. The answer is the inspections are necessary, BUT, they need to be conducted differently. I have seen firsthand RIAs that were given deficiencies for correct reasons, and indeed the SEC has stopped wrongdoing. But, the inspections need to be much smarter and practical. Indeed, the SEC focuses too much on incorrect form completion, and not enough on the real areas of risk. Moreover, the bigger risk to investors are not those that are already registered, but unregistered advisors.

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  • Advisor

    Professional associations (and before them guilds) have throughout time sought to establish barriers to entry to keep out competition.

    Examinations and regulation are a fiction and we need to be extremely cautious of those that publicly are calling for these things (read - the leaders of all credible planning organizations; they do so for their own benefits, it will not benefit clients, whether they know that or not).

    The SEC has said a major focus will be making the amount of AUM correct on the ADV. That form no one but other advisors look at. That's their concern.

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