July 28, 2009
File Number S7-09-09
Re: Response to the proposed rule to require a surprise examination by an independent public accountant for firms whose only “custodial function” is deducting advisory fees from client accounts.
Our Firm, Alexander Investment Services Co. (AIS) is a SEC-registered investment adviser and a FINRA broker-dealer. AIS has been registered with the SEC and the NASD (now FINRA) since 1965, and the Firm has a long history of exemplary service to our clients and compliance with securities laws and regulations.
We did expect in light of Madoff, Stanford and other schemes that the regulatory climate would intensify. However, the proposed regulatory reaction that would include our Firm in the same category as firms "that have no qualified third-party custodian" only because we deduct fees from client accounts is simply an over-reaction. We are not aware of a single case of significant loss involving firms who use third-party custodians and only deduct fees. The significant Ponzi scheme losses have occurred involving firms who do not use third-party custodians.
We have already incurred a significant increase in auditing fees due to the required use of a PCAOB registered accounting firm. We had intended to absorb the increase of this cost, but the fees associated with an additional examination will have to be passed on to our customers. Our customers will not only incur higher fees due to the additional auditing fees, but will have to bear some of the administrative expense of dealing with another set of auditors.
What the SEC proposes is a surprise annual examination that will be added to an annual examination by a PCAOB registered independent accounting firm, a bi-annual examination by FINRA, a quad-annual examination by the SEC along with another examination about every seven years, and a quad-annual State examination. The proposed examination requirement would be onerous, costly and burdensome, particularly for small, independent investment advisers and considering the overall low level of risk. What level of protection would this proposal add for clients of firms that are already broker-dealers? How many pairs of eyes does it take?
There are clear alternatives to your proposed examination requirement. It would be feasible to specify a minimum custodial requirement, that if met, a firm would be exempt from the additional examination. For example, if a custodian allows for fees to be deducted from client accounts, reasonable limits or restrictions on the fees (dollars or percentage of assets) could be imposed. In addition, information on fees deducted can be captured and reported to the Advisory firm on an as needed basis. The information could be examined in the PCAOB sanctioned annual audit. These procedures, added to those already in place (especially for broker-dealers), would provide each chief compliance officer with reasonable assurance that client assets are properly protected and accounted for, and would provide a basis for a certification that such assets are reasonably protected.
In our particular case, fees are deducted from client accounts and placed into a sundry account maintained by the custodian. We do not receive deducted funds directly from the client’s account, but receive the funds indirectly from the sundry account. The movement of the funds directly into the sundry account provides another level of auditable information and a level where reportable information can be maintained.
To restate our position, requiring an annual surprise examination of firms that only deduct fees from client accounts is an unnecessary regulatory burden. It is our sincere hope that the SEC pursues alternatives to the examination requirement before applying a cart blanch approach to all firms of all sizes regardless of the use of a qualified third party custodian and regardless of the examination requirements already in place.
Best regards, Leo Andrew Hanlein, President
Alexander Investment Services