July 23, 2009
Ref: S7-09-09 Custody of Funds by Investment Advisors
I am writing to oppose requiring annual surprise audits of advisors who are deemed to have custody of clients' assets solely because they deduct their fees from client accounts held with an independent third-party custodian.
Your proposed rule starts off well, requiring a surprise examination of advisors who have custody of client assets unless the accounts are held with an independent custodian. The Madoff, Stanford, and other cases involved advisors who had insufficient distance from client assets.
But then you veer off in a self-defeating and harmful direction when you include advisors whose client assets are untouchably in the hands of a third-party custodian but who are paid fees from those accounts, even though these advisors are instructed to answer "no" on the Form ADV question about whether they have custody.
At this point you are trying to hit a nail with a mallet, you're aiming at the wrong wall, and you'll leave a gaping hole in that wall that the homeowner won't be in a position to fix.
The rule would be harmful because:
- It would hurt small advisors like myself especially, who simply cannot absorb the cost of an annual surprise audit.
- It would force advisors like me to pass on the cost to investors of the audit (a significant increase in fees) or to return to the inefficient paper invoicing of the past. which would also increase costs and inconvenience clients as well.
- It would hurt investors because they would no longer be able to use the tax-advantaged deduction of fees from IRAs as a tax-free withdrawal, the only permitted such withdrawal.
By all means let's increase regulation and scrutiny of advisors who hold client assets in their hands. But it's crucial for the SEC's own reputation, as well as the well-being of advisors who are trying to do the right thing and of investors themselves, to be able to distinguish between situations that pose real peril to investors and those that are safe.
None of the referenced actions in the proposal involve advisors who have independent custodians deduct fees, so why are these advisors part of this rule next to self-custodying hedge funds and large brokerage firms?
This proposal makes me think that you really do not understand the difference between the business models of brokers and RIAs, particularly fee-only financial planners and investment advisors, and it makes me fear for the future environment for investors.
I recommend the following measures as an alternative policy:
- Require all advisors to hold client assets with an independent third-party custodian with whom they have no influence. Your proposal even states that this would resolve the problem, so why would the surprise audit include the advisors for whom there is the simpler solution? The only constituency that would argue against the independent custodian solution is the large wirehouse firms where serious problems have, in fact, occurred, and where there is real peril for investors. These firms contributed to the current financial crisis. I fervently hope the SEC is not willing to accommodate them at the expense of advisors who every day are doing the right thing for clients.
- Require that investors receive statements from the custodian directly and not through the advisor.
- Require that all fees be disclosed to the client in the statements. My firm also sends each client an annual letter showing the total of all fees they may deduct on their tax return as well as the amount that was deducted from their IRAs.
- Require advisors to document, in an examination, that the reports they issue to clients match the balances and fees in the custodian's statements.
The SEC has some work to do to re-gain the respect and trust of the public and of advisors who have been working as fiduciaries because it's the right thing for investors. How you handle this rule will give key insight into how seriously you take that mandate.
Rozanna Patane, Financial Advisor
CFP, MBA, NAPFA Member
York Harbor, Maine
PS I am supervised not by the SEC but by the State of Maine.