July 28, 2009
To the SEC regarding File Number S7-09-09:
I am employed by a registered investment advisor (RIA), who is also a Financial Planning Association member. Over the past two years we have witnessed a great erosion of investors' confidence in the markets, financial institutions and their regulatory agencies. We, as an adviser firm, have listened to our clients' opinions about financial services, the economy, the markets and the government for the past two years. All during these difficult economic times, our clients have not been displeased with the services we provide them. If they were, clearly they would have terminated our services and found some other firm to care for their investments. Our clients acknowledge and appreciate that this RIA has worked diligently to protect them from the exposure to risks that are beyond an individual investor's control.
The unprecedented scale of Madoff and a few other thieves, in the guise of registered investment advisories, has raised a public clamor for action to prevent a future theft. Yet, the thefts from investors by these RIA fraudsters are quite modest when compared with investors' trillions lost through collateralized securities, undocumented consumer loans, credit default swaps, naked short sales, derivatives and government bailouts, let alone excessive executive compensation. Truly, this worldwide recession and its contributing factors have cost American investors a fantastically greater sum than the scamming RIAs. The outcry for regulation is very loud; however, this outcry is for many reasons, only one of which is thieving RIAs.
Proposing annual surprise audits for all RIAs is a rapid and inchoate response to resolve the problem of illegal activity by a few RIAs. Targeting this proposal to apply only to RIAs who directly debit client accounts for fees will not identify which RIAs are stealing. A greater loss than fees for an RIA client is the theft of the assets of his/her account. One need only remember that Madoff was stealing assets from all clients. May I suggest that surprise annual audits should be directed at RIAs who are also the custodians, or who are affiliated with a custodian? It is obvious that when the custodian and RIA are distinct entities, separately reporting on a regular basis to all clients, that the RIA and the custodian hold each other in check.
Further, fully 85% of RIAs bill clients through direct debit, and have done so for decades. Again, this indicates that the direct debit billing practice does not relate to an RIA being fraudulent. The fact is that the overwhelming majority of RIAs are law abiding fiduciaries. And the majority of RIAs are also small businesses. Requiring by regulation an annual surprise audit increases the operational cost of 85% of all RIAs in this manner: if you directly bill the clients’ accounts, then you will have the cost of the annual surprise audit. Then, if you do not want an annual surprise audit, and you decide to directly bill the client, you must add the expenses of labor and materials for the client billing and account collections, plus the expense for the capital to finance operations while collecting receivables. This requirement of a surprise annual audit for RIAs who directly bill from client accounts will significantly increase the operational costs for nearly every RIA in the United States. And, it is suggested that this annual surprise audit is estimated to cost $8,100 do by completed by an independent public accountant. This estimate is quite low ball park. In our corner of the State of Michigan, a CPA might get your taxes and reviewed statements completed for $8,100. However, a CPA audit for SEC compliance runs $12,000 and up.
I must stress that the majority of RIA firms are small businesses. Adding significant expenses to RIA operations will cause quite a few practitioners to decide not to operate. And this is the crux of the question of regulation, of which our regulators and politicians have not faced in their oversight of all the businesses in the world’s largest economy: fewer participants in an industry means less competition. Granted, from a regulator’s viewpoint, fewer businesses to oversee appears to be an easier scenario to regulate. However, larger firms create larger opportunities for mismanagement and fraud. The lack of competition gives the consumer fewer choices. The lack of competition allows the focus of a business’ culture to move from how best to serve the client to how best to serve itself.
Currently there are other costs for RIAs that are already increasing because of the already increased regulatory oversight. Given the requirements to protect personal information, there are large outlays for the technology, security and human resource management that require constant dollar costs for an RIA. The expense of preparing and securing contingency plans for business continuation and disaster recovery are also expenses that are made to comply with regulation. The annual testing, review and improvement of these systems require increasing expenditure. To actively decrease the number of RIAs in a time when their services are needed more than ever is to hurt the investors the RIAs work to serve. This profession, of being and RIA, a true fiduciary, is needed more now because of the increasing complexity of financial services, the current recession and the fact that the number of investors (baby boomers) retiring is skyrocketing the demand for assistance in securing a solid retirement. Small RIAs provide more personalized service and accountability to their clients when compared with the large financial services institutions.
There are easier ways for the SEC to increase effective oversight of RIAs:
1.) The SEC could require that all custodians send account statements monthly to all account holders. I suspect the great majority of custodians already do this, and in general, the custodians are larger businesses for whom this would not be a significant cost or change in operations.
2.) The SEC could more frequently audit new (and newer) advisers. It is easy to see that requiring an annual audit (with no exceptions) of new advisers for three years, then perhaps every other year until year 9, would assure that an RIA got started on the right path of policies and procedures from the beginning, and that this right path is held until it is ingrained.
3.) The SEC could increase the fines for when its audits determine non-compliance.
2.) The SEC could hire and train additional staff, increasing the size of staff to audit RIAs. What advantage is it for the SEC to bring another party to the table, namely CPA firms? It was not that long ago that the CPA firms were out of step, and encouraging outrageous financial chicanery (Enron, financial reporting standards). What of CPA firms’ recommendations of illegal tax shelters and offshore accounts? It would be better for the SEC to assume the responsibility for all audits, rather than putting a third, for-profit party in the middle, which in the end will only create greater division and litigation for disputes regarding CPAs’ audits results.
Thank you for considering these comments.
Controller & Chief Compliance Officer
JOHN A. WOLFE & ASSOCIATES, INC.