Subject: File Number S7-09-09

July 8, 2009

File No. S7-09-09

I am writing in response to the referenced notice of proposed rulemaking.

General Observations:
1. This notice of proposed rulemaking (NPRM) is addressing issues that are already illegal under existing statutes.
2. Sanctions for violations of existing statutes are already in place and readily enforceable.
3. Existing SEC examination protocols should discover, and have discovered, the illegal behaviors that this NPRM is attempting to address.
4. The behaviors that this NPRM is attempting to address are an issue for a very small fraction of investment advisors.
5. The NPRM’s proposed remedy, i.e. surprise examinations of all client records by an independent CPA firm, “may (emphasis mine) deter fraudulent behavior by investment advisors” (NPRM, page 71) at a cost that is significant to investment advisors and substantially disproportionate to the potential benefit derived.
6. The NPRM would impose costs on ALL investment advisors which would, in turn, increase investment management fees for ALL clients, which would, in turn, adversely impact investment performance for ALL clients, which would, in turn, adversely impact the efficiency and performance of ALL financial markets.
7. The NPRM fosters neither a “more informed public” nor a “more efficient market place.” (NPRM, page 77) In fact, it reinforces the false notion that the SEC or its designated agents can eliminate the risks associated with investing thereby obviating the need for the investing public to seek all relevant information prior to investing.
8. This NPRM appears to be the first step in an attempt to shift the burden of regulatory compliance examinations from the SEC staff to CPA firms while simultaneously shifting the cost of regulatory compliance to investment advisors. This unfunded mandate would certainly enrich CPA firms while imposing a thinly veiled tax on investment advisors. If the SEC intends to shift regulatory compliance burdens in this way, the need for SEC examination staff and its attendant costs should come under immediate scrutiny with the goal of substantially reducing staff and personnel costs. All savings should then be used to reduce the financial cost to investment advisors of this proposal.

Specific Comments:

The NPRM is unnecessary. Existing statutes already prohibit the behaviors addressed in the NPRM, existing compliance protocols are sufficient to identify violations, and existing sanctions provide appropriate remedies for investors. The real issue is the ability of the SEC to adequately staff and perform compliance examinations.

By any measure, the percentage of investment advisors who are guilty of violating existing statutes is extremely small. Regardless of this fact, the NPRM would impose significant financial and operational costs on ALL investment advisors.

Despite the assertion included in the NPRM that the “potential impact of the NPRM would not be significant,” (NPRM, page 74) from the perspective of this investment advisor, the financial and operational costs associated with compliance would be substantial. These proposed requirements would result in deferred or foregone investments in business infrastructure and staff. The proposed requirements would also result in the reallocation of existing resources to non-productive, compliance issues despite the fact that our firm’s most recent SEC examination revealed no deficiencies in our internal controls or compliance procedures.

The potential benefits of this NPRM are by staff’s own admission “difficult to quantify.” (NPRM, page 56) From an economic perspective, this NPRM would impose substantial, new compliance examination requirements in hopes of a very nebulous return.

The NPRM requests comments on the impact of the NPRM on costs and competition for consumers or industries. In any economic calculus costs incurred that are not directly related to production reduce the overall efficiency of the system. In the case of this NPRM, the costs of compliance would inevitably be passed on to consumers resulting in reduced investment returns and less efficient markets. Furthermore, the imposition of additional compliance costs to the burdens already borne by small businesses will inevitably reduce the number of new investment advisory firms and limit consumer choice.

Finally, the NPRM will not achieve its stated goal to foster more informed consumers. In fact, the NPRM will likely give the investing public a false sense that the SEC has eliminated the risks associated with investing. Nothing could be further from the truth. Nevertheless, the investing public will assume that the requirements of the NPRM will protect them from these risks and lead many to rely on this implicit assurance instead of becoming the informed consumers they should be.


1. Apply risk assessment techniques to identify the firms most likely to pose hazards to consumers. Do not impose additional compliance requirements on those with clean compliance records, those whose “custody” relationship is limited to fee disbursements, and the vast majority of advisors who are already making a good faith effort to comply with the existing regulatory structure.

2. Determine who will be responsible for conducting compliance examinations, staff the entity appropriately, and train those selected to perform examinations to work in the investment environment. (As a former CPA, I can assure you the designation alone is insufficient to provide fraud detection or prevention as we saw with Enron, WorldCom, and others. Legal, financial, and ethical lapses do not lend themselves to easy detection in the types of sophisticated organizations most likely to perpetrate them. Proper training is imperative!)

3. No system will catch all wrong doers, and it is disingenuous of the SEC or Congress to imply that any regulatory scheme can protect investors from risk. Instead, the SEC should embark on a campaign to educate and inform investors of the risks associated with investing and investment management in order to foster realistic expectations within the investing public and provide consumers with an appropriate framework to use in evaluating their own risk tolerance and return requirements. The more people take ownership and responsibility for their own affairs, the less likely they are to be fooled by unscrupulous business practices.

Thomas Pflug, CFA
Pflug Koory, LLC