July 9, 2009
I appreciate the opportunity to be able to express my views on this important issue.
As an SEC registered RIA, my firm is deemed to have custody solely because we have authority to deduct advisory fees from our clients' accounts all of which are maintained by an independent, qualified custodian. We strongly believe that the portion of the proposed Rule, which would require advisors with this form of custody to undergo a costly surprise audit, is not warranted.
The cost of the audits for a smaller firm such as mine would represent one of the largest if not the largest single expense my firm has other than salaries and taxes. Actually, the cost of these audits could cost as much as a staff person's annual salary.
In our case, the custodian sends comprehensive statements directly to our clients at least quarterly directly to our clients. We receive copies of these statements electronically. Our clients also may have 24/7 online access to their accounts provided by the qualified custodian. Our clients also agree, in writing, that our advisory fees will be deducted directly from their advisory accounts.
Our billings are based on values that the client can verify with their account statements. We send them a billing confirmation showing the account values being billed, how the fee is calculated, and how they can check the billing account value with their account statements provided by the custodian. Therefore, checks and balances are already in place. In addition, in the past audits my firm has been through with state and SEC auditors, these billings are closely scrutinized for accuracy as they should be.
My firm also checks the accuracy of the statements by cross referencing investment share prices from other independent sources to ensure accuracy. Whenever we execute a stock trade, we can quickly view what the price we bought it at was and check it with our streaming stock price quotes. If there was a discrepancy, we'd be able to see it quickly and bring it to the attention of the custodian.
I may be faced with a crippling cost of an audit, for an auditor to audit a qualified custodian's statements. These are not statements that we even generate. I assume that these companies like TradePMR, Fidelity, TD Ameritrade, and Schwab are already getting close scrutiny by regulators. With the sheer number of accountholders these custodians have, it would be very difficult for them to get away with making fraudulent statements.
Wouldn't it be more prudent to require this surprise audit to those companies that create account statements? I would think that any firm wishing to run a Ponzi scheme, such as Madhoff, would need to create the statements and not rely on an independent custodian for statements like my firm does. Since our clients' statements are mailed directly to them from the custodian, there is no opportunity for my firm to change or alter them in any way even if we wanted to.
If this Rule were to stand, the significant cost to all smaller firms would lead to advisor firms having to raise our management fees to our clients, layoff staff or both. If we tell them that it is because it is to cover the cost of an audit of statements that our firm doesn't even generate, they will be furious. I think they are intelligent enough to see that this is an extremely wasteful expense at a time when all industries are struggling with this economic downturn.
The cost of these audits would also create a significant barrier to entry for start-up RIA firms. I don't think that this is healthy for the industry or in the interest of our clients. For recent start-up firms being hit with this expense, it could cause them go out of business entirely even if they've been surviving this economic downturn and doing a good job for their clients.
Given that the existing safeguards in place are adequate for firms in our situation, and considering the adverse effects a mandatory surprise audit on advisors as well as clients, we respectfully request that the SEC leave current Rule 206(4)-2 intact and unchanged with respect to advisors who have custody solely because they have the authority to deduct advisory fees from client accounts. We thank the Commission for the opportunity to comment on this matter.
Dennis Delphenich, president of Capital Portfolio Advisors, Inc.