SEC Considers Third Party Compliance Reviews of Investment Advisers

SEC Considers Third Party Compliance Reviews of Investment Advisers

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Author: Andrew K. Sledd, CPA, CFE, Business Assurance & Advisory Services Senior Manager | Financial Services Industry Team

For the first time in 75 years the Securities and Exchange Commission (SEC) is considering allowing third-party exams of registered investment advisers (RIAs) to supplement the SEC’s current exam program.  Under the current SEC budget only 10% of the firms are inspected on an annual basis. Due to budget constraints it appears that the third-party exam program would put the burden on investment adviser firms to be inspected by an independent compliance expert and most likely bear the cost of the exam. The idea of third party reviews was first announced in May 2014 by former SEC Commissioner, Daniel Gallagher, who envisioned using self-regulatory organizations (SROs), such as the Financial Industry Regulatory Authority (FINRA) is to registered broker dealers, but it did not have to be limited to SROs. However, it is unclear how third-party exams would operate as no formal program has been announced or proposed at this point.

While only 10% of registered investment advisers being examined seem slim, let’s take a look at the overall numbers. There are approximately 30,000 RIAs in the United States but only 11,800 are registered nationally with the SEC. The remainder of the RIAs are registered directly with the state where their principal business is located. The SEC only requires RIAs to register nationally if they exceed $110 million in assets under management (AUM). SEC registered firms have approximately $62 trillion under management; however, the combined AUM of the 100 largest firms is around $31 trillion. Thus, looking deeper into the exam statistics the SEC focuses is resources on total AUM reviewed which comprised almost 30% of total AUM during 2014 (these statistics were according to public SEC documents made available by the Investment Adviser Association;

There are pros and cons to instituting a third-party exam system. The pros of the system would allow for the SEC to free up more time to focus on the higher risk advisers that pose a greater threat the broader public and to substantially increase the review of RIAs compliance programs to keep a better pulse of the industry. The cons include that it would be very difficult to control the standards of third-party firms performing these exams. It would most likely also create a new SRO that the SEC would need to interface with and monitor regularly.

Ultimately, a better solution to this issue as presented by RIA in a Box is for the SEC to allow more firms to register directly with their respective state. This could be accomplished by increasing the AUM limitation from $110 million to $500 million, which would allow approximately 7,200 RIAs with under $500 million in AUM to have the choice to stay registered nationally and bear the additional compliance costs or register with their state. This would really be a win-win situation for advisers and the SEC. More advisers would be subjected to examination by state commissions annually and the SEC frees up budget space to allocate more resources on larger advisers that serve the broader public. For a more detailed analysis of allowing advisers to register directly with their respective state follow this link (SEC 3rd party RIA compliance exams or a shift to state regulation?). Any new exam plan that was introduced by the SEC would include a public comment period to ensure the needs of all stakeholders were met. Only time will tell if this proposal will gain traction, dawning a new compliance era for RIAs.


About the Author

​​Andrew specializes in auditing broker/dealers in securities, non-registered investment funds and registered investment advisers. He is a member of the Firm’s Financial Services Industry team and possesses a comprehensive understanding of SEC and FINRA rules and regulations. Read more of Andrew’s insights on our blog.

More Insights from Andrew K. Sledd, CPA, CFE

The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.


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