July 27, 2009
I am writing this comment on the Securities and Exchange's proposed custody rule (IA-2876) that would subject our firm to annual surprise audits by independent CPA firms because we have the authority to debit advisory fees from clients' custodial accounts. Those client accounts are being held at separate licensed and regulated broker/dealers (Schwab Institutional and TD Ameritrade). I recognize in light of the Madoff scandal and other high profile cases, the SEC and Congress are under pressure to do something. Let's be sure we are coming up with solutions to problems that exist and not make up solutions for non-existent problems. Is there any evidence of fraud and/or client abuse that is from debiting fees from custodial accounts? I have not heard of any.
This process of debiting our fees from our clients' accounts allows us to provide very cost effective services to our clients who most are not wealthy but just middle class folks. According to estimates from regulatory consulting firms, this annual audit will cost between $8,000 and as much as $20,000. If this proposed rule goes into effect, our firm will have two options -- pass the cost on to our clients or change the way we bill for our services.
If we pass these added costs along to our clients, we foresee that a significant number of our clients will no longer be able to be served as our costs will become prohibitive as we raise our fees. The other option would be to no longer debit our investment advisory fees from clients' accounts but rather bill them directly to the client. Since most of our clients have retirement accounts, this means they will lose the tax benefits of paying our fees from those retirement accounts where they are paying with before-tax dollars. This will raise the after tax costs to those clients by as much as 35%.
I am assuming it is not the objective of this new rule to increase the income tax liability for consumers nor squeeze out the smaller net worth consumer from using the services of a registered investment advisor. It is the unintended consequences that I am most concerned about. We are just one small firm among many whose future existence is threatened by this proposal. If we do not survive, who is left to provide financial services to consumers -- the Wall Street wirehouse firms. Look at the scandals and financial damage that those Wall Street firms have foisted on consumers and the public at large. Without a real choice that we independent RIAs represent, consumers are left to choose among broker/dealer firms that are conflicted with their objective to sell financial products over providing objective advice.
As a side note, I am pleased that the reform process is including an attempt to bring all firms including broker/dealers regulated under the 1933 and 1934 Acts under the same standard of care that RIAs currently have with their clients -- the fiduciary standard. I am very interested to see how the SEC and Congress will actually make this happen as this threatens the very culture of Wall Street that has generated untold profits from exploiting lack of transparency and liquidity as those firms manufactured and sold complicated financial products under the current disclosure and suitability standard.
In closing, please carefully consider the unintended consequences of this rule to both consumers and small independent RIAs. We (small independent RIA firms) do not have the same access to the regulatory rule making process as the large Wall Street firms because of financial limitations (lobbyists and public relations) so please hear our small voice in your deliberations. Be sure that this solution of annual, surprise audits for firms whose only form of custody is indirect (by debiting fees) does not cause more damage to both consumers and RIAs than any potential problem (which may not exist). There is no evidence presented that debiting fees is an area of abuse or consumer fraud so let us not create a solution for a problem that does not exist.
Michael Haubrich, CFP
A NAPFA Registered Financial Advisor
Financial Service Group, Inc.
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