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Examining Investment Advisers: The Challenge Continues

Commissioner Elisse B. Walter

U.S. Securities and Exchange Commission

2013 NASAA Public Policy Conference, Washington, D.C.

April 16, 2013

Good morning, it is a pleasure to be back here, among strong allies and good friends at a gathering of securities regulators from across America — men and women who are as committed as I am to investor protection and to safe and stable securities markets.

As you know, for more than 20 years I have worked as a staffer, Commissioner and Chairman at the SEC, and that I also served as General Counsel of the CFTC and a senior officer at FINRA. And, in each of those capacities, I have worked closely with the agencies you represent — building a complex and supportive relationship aimed at making America’s markets work well for all.

Over the years we have established a close relationship, working together to examine financial professionals and enforce securities laws, trying to achieve a seamless regulatory web that keeps markets dynamic and safe. I believe that we have been successful in these efforts, and that our rapport remains strong and our level of effectiveness remains high. The transition of mid-sized advisers from federal to state oversight has underscored the strength of our relationship, with SEC, state and NASAA staff coordinating transition efforts closely and effectively.

Examinations and other oversight of investment advisers is critical. I would like to share my views on that with you today, examining the ways in which we have worked together during the transition, the lessons that we have learned through our advisory examination program, and the important challenges that, in my view, remain. Before I get too far into details, I need to remind you that my remarks are my own.1

The Need to Examine Investment Advisers

As you are aware, the Dodd-Frank Act transferred oversight of mid-sized investment advisers from the SEC to the States. Investment advisers are an area of special concern to regulators because, among other reasons, advisers are fiduciaries charged with handling the investment assets for millions of middle-class Americans, including retirement funds, children’s college funds, and money for down payments on their homes — in a way, these assets are the vehicles to their dreams and hopes. Advisers are a critical part of the American economy, and are in a uniquely intimate position to do tremendous good — or tremendous damage — to clients and their families.

Whether my Aunt Millie trusts her assets to a small adviser with a shingle hung outside a red-brick Main Street office, or to an adviser to a large mutual fund headquartered in a steel and glass Wall Street high rise regulators need to be there. As Millie sits in an office, listening intently to her adviser and trying to understand, she’s relying on us.

But that’s been a challenge for regulators, and particularly for the SEC. The point of Dodd-Frank’s re-allocation of oversight, after all, was to increase examinations of investment advisers. The Commission just wasn’t able to do enough.

So, as it did in 1996 with NSMIA, Congress moved responsibility for many advisers to your agencies, which are now absorbing the additional responsibility. Believe me — I can empathize with the position that you are in. I’ll return to that a bit later, but for now I’d like to focus on how we’ve worked through the transition together.

Supporting NASAA Members Through D-F Transition

I’ve been quite impressed by the way that our teams at the SEC, NASAA, and your agencies have come together throughout the transition. It has been a lesson in regulatory collaboration and investors have benefitted significantly from that effort.

We recognize that small firms present special challenges. For example, many of them don’t have comprehensive compliance programs in place. Many more have off-the-shelf programs that aren’t tailored to their actual businesses.

In small shops, Chief Compliance Officers can wear many different hats. Often, this means they can have too many priorities on their plates to devote adequate time to compliance efforts. CCOs can have conflicting responsibilities — concerns about cost, privacy, investment strategies and so on. And, smaller firms may sometimes inspire too much trust in their clients. Investors who regularly see their investment advisers on the Little League sidelines, at church, or at a monthly business person’s lunch can be inclined to cut clearly incompetent or even fraudulent advisers way too much slack. They can go months or years without reporting obvious and expensive breaches of fiduciary duty, and — perhaps out of denial — even refuse to testify against their advisers despite overwhelming evidence of misconduct.

Given our collective experience and common mission, among other reasons, our staffs felt it important to work together in transitioning investment adviser oversight. I’d just like to mention briefly a few examples:

  • OCIE teamed with our Office of Investor Education and Advocacy in preparing an Investor Bulletin on the transition.
  • As the Dodd-Frank transition deadline approached, you participated in weekly calls with experts from our National Examination Program and Division of Investment Management, working to transfer knowledge acquired through our years of experience with the mid-sized adviser population.
  • And, of course, when appropriate, we have worked jointly with the states on exams.

There have been other important efforts to work together, including:

  • Your invitation to SEC staff to your 2012 Annual conference in preparation for the hand off of mid-sized advisers to the States, and I know that they are looking forward to participating this year as well.
  • You have also arranged our participation in the annual SEC/NASAA 19(d) conference, discussing issues like the volume of advisers making the transition to state supervision, analytics we had performed on transitioning advisers and the provision of deficiency letters.
  • You have also increased your communication with our regional offices, which serve as hubs of communication among the agencies and regulators in their region, using strong ties built over many years to share information back and forth, including background on registrants transferring to the States.

We know that the first years of transition can be the hardest, and as allies and individuals who share your personal commitment to investor protection, we wanted to do everything we could.

Sharing SEC Lessons Learned

We know that you have resource constraints in the face of your new responsibilities. We too have had these challenges — for many years — in the adviser examination area and those challenges have been magnified by our new private fund adviser oversight responsibilities. So, I thought it would be helpful to share with you some of the lessons we have learned.

I must say at the outset that OCIE has been doing a tremendous job under trying circumstances. It’s common for government agencies to be told — especially at budget time: just try to work smarter, not harder, and do more with less. Well, we’ve done a lot on that front.

Most recently, we’ve launched a series of “presence exams” that allow us to meaningfully engage, assess risk, and establish a presence and credibility with a significant percentage of the new private fund advisers now in our jurisdiction. These exams usually consist of a thorough and rigorous review of one or two areas of an adviser’s operation.

This type of examination is obviously not comprehensive — but it does allow us to do some important things. For example, it lets us examine systematically across the industry the areas in the private adviser business model that we believe present the greatest risks to investors and our markets. It also allows us to assess the quality of the adviser’s control environment and key control functions. And, frankly, it is a reminder that we’re out here, keeping an eye on things.

We’ve found presence exams to be very successful and, as your states grapple with a similar influx of new and relatively larger advisers, we’d be pleased to share our experiences and the practices we are employing.

A second strategy has been to enhance the risk-based targeting of adviser examinations. For example, in addition to the qualitative assessments we’ve always done, we now use algorithms to analyze available quantitative data to help us better identify the advisers that pose the greatest risk to investors. Those advisers are then identified for examination. This strategy has helped bring about a significant increase in the number of examinations that discover significant violations or result in referrals to our Division of Enforcement.

And, finally, we’re hiring specialists. Both our regulatory and our examination staff include former industry professionals with experience managing portfolios, sitting at trading desks, investing in derivatives and grappling with valuation issues. These professionals have expanded our understanding of industry activities. And they serve as a tremendous resource to provide a straightforward, “real-world” viewpoint.

All of these strategies have been helpful. I know that incremental improvements are always possible and have confidence that OCIE will continue to make them. They’ve done an extraordinary job these last few years and will continue to do so.

Addressing Remaining Challenges

But, we all must face the reality that, without future action to address our joint resource constraints in the advisory area, there simply are not enough examiners to go around. I think that a periodic re-allocation of oversight from the Commission to the States unfortunately isn’t the final answer.

As things currently stand, OCIE’s examination coverage of investment advisers registered with the SEC is only 8% annually. And as a practical matter for the average adviser that percentage coverage may in fact be too high, as it includes many of the larger and complex advisers that are examined more frequently. Regardless, a single digit percentage coverage is nowhere near enough. By comparison, approximately 50% of broker-dealers are examined each year by the SEC and self-regulatory organizations, with the majority of these examinations being conducted by FINRA.

The transition of mid-sized advisers has not ameliorated the situation. Although on net the number of investment advisers registered with the Commission decreased by just over 8%, from 11,600 to 10,600, the general complexity, and assets under management of the advisers for which we are responsible actually increased by 22%, from $44 trillion to nearly $54 trillion. We now have responsibility for advisers to many of the world’s largest and most complex entities. For example, the staff estimates that, due to the Dodd-Frank Act, the number of advisers to private funds registered with the Commission will increase from 23% of all advisers to 38%.

It’s not just the size of the new registrants that creates challenges. For many of these new advisers, we’re responsible for collecting and analyzing far more information than we have in the past. SEC-registered advisers to hedge funds and other private funds must now submit Form PF, which provides information related to systemic risk. We then provide the data to the Financial Stability Oversight Council, as required by statute, and also use it ourselves for investor protection purposes. Having more data is an excellent development, but it does further strain resources.

Further, examination resources allocated to investment advisers are facing ever-stiffening competition. Adding to pre-existing resource allocation constraints, we have other new registrants that must also be examined, including municipal advisers, security-based swap entities, and others. Needless to say, this increased responsibility without additional resources has stretched our ability to examine investment advisers with any reasonable regularity even more thinly.

It’s great that we’re able to use targeting to zero in on advisers who, because of their size or practices, appear to present greater risk to investors. But targeting “risk” is not enough. There is frankly no substitute for what we learn and can detect through an on-site examination. We should have an ability to conduct on-site exams of even more advisers, even those that seem to present little apparent risk.

An estimated 20% of all advisers that have been registered for more than three years have never been examined. And if you consider relatively recently registered advisers, the number increases to around 40%. Among other concerns this raises, we just can’t leave such a substantial portion of the industry with the impression that they’ll never be examined.

Unless significant changes are made, the SEC cannot fulfill its examination mandate with respect to investment advisers. I said this in 2011, when the SEC released a staff report detailing the problems I’ve just discussed.2 And, I’m saying it again now.

The 2011 report outlined potential solutions, including imposing a user fee on investment advisers or creating a self-regulatory organization. Of course, a substantial increase in the SEC’s budget could address the issue as well. I’m not here today to advocate for one solution or another. I definitely am here to advocate on behalf of our nation’s investors — to say that one of the solutions must to be pursued today.


Aunt Millie needs to know she’s protected.

Thousands of talented and determined individuals devote their careers to this very task, but the current circumstances must in improve in order to enhance their efforts in a rapidly-growing and complex industry. Otherwise, hardworking American families are subjected to unnecessary risk. Congress needs to adequately fund the existing examination program or act to create an effective alternative.

Let’s continue to work together to address this and move forward on this issue — to protect those relying on investment advisers.

Thank you.

1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, other Commissioners, or the staff.

2 See Commissioner Elisse B. Walter, Statement on Study Enhancing Investment Adviser Examinations (Jan. 2011), at

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