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The Case for User Fees

Rick A. Fleming

Investor Advocate

38th Annual Southwest Securities Conference, Dallas, Texas

Aug. 19, 2014

Thank you, David [Woodcock] and Marshall [Gandy] and the other conference hosts, for the invitation to speak today.  It is good to be back in what feels like home turf, as I have attended this conference numerous times over the years while working for the State of Kansas and the North American Securities Administrators Association (NASAA), and I have developed many friendships here.

As you know, the Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any statement by any of its employees.  Therefore, the views I express today are my own and do not necessarily reflect the views of the Commission or my colleagues on the Commission staff.

The Office of the Investor Advocate is a brand new office at the Securities and Exchange Commission.  In February, SEC Chair Mary Jo White appointed me as the first Investor Advocate, and I have been busy building up the office, meeting many investor and industry groups, and preparing the first of my reports to Congress.

The basic purpose of the Investor Advocate is to ensure that the concerns of investors are appropriately considered as decisions are being made and policies are being adopted at the Commission, at self-regulatory organizations, and in Congress.  This sounds simple, but the statutory mandate covers a very broad range of potential issues.  My office must not only analyze the potential impact on investors from proposed rules and regulations that are currently under consideration at the Commission and SROs, but we are also expected to identify areas in which investors would benefit from changes in existing rules and regulations.  Moreover, we are asked to identify “problems” that investors have with investment products and financial service providers, and to propose policies to resolve those problems.

The Office of the Investor Advocate is part of the SEC and I report to the Chair, but my office is designed to remain somewhat independent from the rest of the Commission.  By statute, I file two reports per year directly with Congress.  In some respects, my role is to provide a critique of my own agency, which may explain why the position was not filled for nearly four years after the Dodd-Frank Act mandated its creation.  But, I want to assure you that Chair White has been fully supportive of my office, and we are both working to make sure my staff has a significant and constructive role in the policymaking process.

On June 30, my office filed the first of our reports to Congress.[1]  This report, like the reports we will file every year on June 30, describes the issues that my office will focus upon in the coming federal fiscal year.  Then, by December 31 of each year, we will file a report that describes our activities during the preceding fiscal year, the recommendations I made, and what was done with those recommendations.

As a brand new office that is still in the process of building out a small staff, we will not be able to fully analyze every possible issue impacting investors in the coming year.  So, after seeking advice from knowledgeable people at the Commission and elsewhere, we decided to focus on six core issues during the coming year. 

I don’t have time today to thoroughly cover each of those six areas, but I’ll give you a quick glimpse of what my office has in mind.  First, as the Commission examines issues surrounding equity market structure, we will be focused on whether the equity markets today are fundamentally fair to investors.  We will also look at whether investors have fled from the equity markets in recent years because of fears related to those markets. 

Another important market for investors is the fixed income market, and especially the municipal bond market, where 50 percent of municipal securities are held directly by individual investors and another 25 percent are owned indirectly by retail investors through mutual funds and other pooled vehicles.[2]  My office will work with others at the Commission and relevant SROs to encourage reforms designed to benefit investors in the municipal securities markets, and to the extent that legislation is required to improve disclosures and practices in this market, we will make recommendations to Congress as appropriate.

Because hackers and electronic terrorists present a constant threat to the financial security and privacy of investors, my office will survey the efforts of the Commission, the exchanges, and market participants to prevent market disruptions and safeguard the assets and private information of investors.  In addition, we will work with the SEC’s Division of Corporation Finance as they explore possible ways to make financial disclosures by public corporations more effective for investors.  Finally, we will look at the area of elder abuse.  In particular, we are looking for ways to give financial service professionals better tools to protect clients whenever an adviser or registered representative suspects financial or other abuse of a client with diminished capacity.

In addition to describing these six areas of focus for my office in the upcoming fiscal year, my recent report to Congress included a recommendation to address a substantial risk to investors. Specifically, I recommended that Congress provide sufficient resources to the SEC to conduct an adequate number of investment adviser examinations.

As many of you are aware, the SEC examined only about 9 percent of registered investment advisers in Fiscal Year 2013.[3]  This equates to a frequency of approximately once every 11 years, a rate that many observers find unacceptable. 

There are multiple reasons for the lack of exam coverage, but in my view it primarily boils down to the fact that the SEC has not received sufficient resources to keep up with the burgeoning workload.  The number of SEC-registered advisers has grown by approximately 40 percent over the past decade to nearly 11,500 today.  And, as the number of investment advisers has grown, so too has their complexity.  The amount of assets managed by investment advisers is on a steep ascent, climbing from $20 trillion a decade ago to an estimated $55 trillion by the end of Fiscal Year 2015.[4]  In comparison, staff in the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has grown only about 10 percent in the past decade.[5]

From my own personal experience, I know that investors are exposed to fraud and abuse when regulators cannot maintain an adequate regulatory presence.  While most investment advisers are trustworthy and honest, I have personally prosecuted one who stole more than $7 million from his clients.[6]  In the course of that case, I met with numerous victims who did everything right – they worked hard, saved their money, and entrusted their savings to a licensed person who they thought was investing it in a normal portfolio of legitimate securities – only to have their life savings taken by that licensed “professional.”  For those investors, an ounce of prevention would have been worth far more than the pound of cure.  With their money gone, a maximum prison sentence did little to help those retirees who had to return to work or face a diminished standard of living, or the individual with diminished capacity whose trust fund was stolen, or the church that lost its building fund. 

Not surprisingly, then, as my very first recommendation to Congress, I recommended that Congress appropriate the needed funds this year so that the Commission can hire more examiners without further delay.  In addition, I voiced support for a more long-term, sustainable solution.  I recommended that Congress authorize the SEC to collect an annual “user fee” from registered investment advisers and to limit the use of those funds to expenses associated with investment adviser examinations. 

Admittedly, a shorter examination cycle won’t stop all fraud, but I believe it will allow the SEC to halt these types of activities sooner and will provide a stronger deterrent to advisers who might otherwise succumb to the temptation to steal.  It will also curtail other unethical practices, including excessive fees, excessive trading, and undisclosed conflicts of interest.  Many of you in this room have uncovered these types of practices and can attest to the damage it causes to investors.

To some, the idea of a “user fee” sounds a lot like a tax.  But several industry associations that represent investment advisers have actually endorsed the concept of user fees.  They recognize that a rogue adviser not only harms investors, but also leaves a stain on the advisory industry, so they support an increased regulatory presence and are willing to pay for it.  Let me repeat that – they are willing to pay more money to the SEC so that it can conduct more examinations of advisers. 

Investor advocates have joined with the industry in supporting an increase in SEC resources and the adoption of a user fee.  Among others, the SEC’s Investor Advisory Committee (IAC) has endorsed the user fee model.  On November 22, 2013, the IAC recommended that the SEC seek Congressional authority to impose user fees on SEC-registered investment advisers to fund an enhanced examination program.[7]

So, if investors would be better served by giving the SEC greater resources, and the industry is willing to provide those resources, this should be an easy thing to accomplish, right?  Well…this is where things get tricky in Washington, D.C.

As I have discussed this issue with people, it has become fairly apparent that the main objection to a user fee is a philosophical resistance to growing the government.  And trust me, I get it.  Just last week, it made news that the federal budget deficit for July was “only” $95 billion, a decrease of 3 percent from the deficit in July of 2013.[8]  For a person who has spent most of his career working in Kansas, where the annual budget for the entire state government is approximately $15 billion, the thought of a $95 billion monthly deficit is astounding.  And as a taxpayer, I’m not thrilled, either.

It is important to note, however, that a user fee would not increase the budget deficit, because the increased spending would match the revenue received from advisers.  In fact, even without authorizing user fees, Congress could increase the direct appropriation to the SEC without increasing the deficit because the SEC is already required to collect transaction fees from SROs that offset its appropriation.[9]

To be fair, critics of user fees are not just worried about the deficit.  Some correctly point out that the SEC budget has increased substantially in the wake of the financial crisis,[10] and they wonder why the SEC has failed to bolster its examination rate with these additional resources. 

I have wondered the same thing, especially considering that the OCIE spending has actually increased from about $208 million in FY 2009 to $271 million in FY 2013.[11]  But in studying this issue, I have discovered that the growth in the OCIE budget has been dwarfed by the growth in the number and complexity of registrants (as discussed above), leaving OCIE unable to improve its overall examination coverage rate. 

In addition, a handful of major expenditures have absorbed much of the increase in the overall SEC budget.  For example, the Commission has taken significant strides to upgrade its technological resources and keep pace with an industry that spends enormous amounts on technology.  These initiatives include EDGAR modernization, the creation of tool called MIDAS that facilitates the analysis of trading data, and the development of an electronic system for tracking tips, complaints, and referrals.  Another major cost driver is the payroll, as the Commission has had to pay better to attract a workforce with more technical expertise and to retain experienced employees.  A related cost comes from a heightened focus on economic analysis in our rulemaking, which requires a large team of highly skilled economists and related personnel and led to the establishment of the Division of Economic and Risk Analysis (DERA). 

These major expenditures have been supported by Members of Congress on both sides of the aisle, but in my view what has not been sufficiently increased is the Commission’s ability to do some of its fundamental investor protection work like investment adviser exams – a basic “blocking and tackling” component of the SEC.  I remain hopeful that Congress will see the value of investment adviser exams and that bipartisan support will continue to develop for increasing the SEC’s examination resources, just as it has for other needs at the SEC.

When I talk about bipartisanship, I realize that most people think I must be dreaming.  But, believe it or not, my dreams of bipartisanship have often come true, at least outside of Washington, D.C.  During the majority of my time at the Office of the Kansas Securities Commissioner, we had a Democrat Governor and a legislature controlled by Republicans, but we managed to advance a number of investor protections.  For example, we increased the criminal penalties for securities fraud and obtained authority for the Commissioner to order restitution in administrative proceedings.  In addition, after the disastrous case of the $7 million investment adviser fraud, we were able to get the resources we needed to attain a three year examination cycle.  In working to get these and other reforms passed, I have concluded that investor protection is not by nature a partisan issue.   

I also like to remind people that the very origins of securities law involved both political parties.  Yes, the Securities Act of 1933 and the Securities Exchange Act of 1934 were signed by Franklin Delano Roosevelt as part of his New Deal agenda.  But, more than 20 years earlier, Kansas was the first state to pass a law to regulate the sale of securities in a comprehensive way.  While this became known as the first “blue sky” law, I can assure you that it was not because Kansas was a blue state.  The author of that law, J.N. Dolley, was the Chairman of the Kansas Republican Party and a former Speaker of the Kansas House of Representatives.[12]

Aside from the fact that investor protection should appeal to both parties, I believe the idea of user fees makes sense from a public policy perspective.  As a starting point, most people would probably agree that the status quo is not acceptable.  Investors have a right to expect that their registered investment advisers will be examined more than once every 11 years.  So the question becomes, “What is the best available solution to the problem?”

I've already explained why I think user fees represent a viable solution, but it should also be compared with other possible solutions.  One other solution that has been suggested would be to require advisers to hire third-party consultants to conduct SEC-like examinations.

While third party audits are presumably better than no audits, some observers have noted the inherent conflict of interest when the auditor is selected and paid for by the firm being audited.  In addition, some of the industry associations argue that audits by third parties would actually be more expensive and burdensome than user fees.  Thus, even if a proposal for third party audits could be designed to ameliorate some of these concerns, it seems unlikely that it would gain the type of consensus that surrounds the user fee option.

For my part, I believe third-party audits are the less desirable option than user fees, and I worry that it will be impossible to reverse course if the Commission starts down that road.  But if the Commission isn't given the resources to do the job adequately, and given them soon, it may be left with few options.  I am concerned that we may end up with a solution that ultimately is more expensive for the industry and less effective for investors.  Accordingly, I have urged and will continue to urge Congress to act quickly to provide additional resources to the SEC so that it can examine investment advisers more frequently.   

Thank you. 

[1] SEC, Office of the Investor Advocate, Report on Objectives Fiscal Year 2015 (June 30, 2014),

[2] SEC, Report on the Municipal Securities Market, at 12 (July 31, 2012),

[3] SEC, FY 2015 Congressional Budget Justification, FY 2015 Annual Performance Plan, FY 2013 Annual Performance Report, at 56 (Mar. 2014)

[4] Id. at 55-56.

[5] Id. at 55; SEC, In Brief:  Fiscal 2006 Congressional Budget Request, at 2 (Feb. 2005),

[6] State of Kansas v. James Alvertis Freese, Case No. 07CR00312 (Johnson Cnty. Kan. Dist. Ct. 2007).

[7] SEC, Recommendation of the Investor Advisory Committee:  Legislation to Fund Investment Adviser Examinations (Nov. 22, 2013),

[8] Reuters, U.S. Budget Deficit Falls to $95 Billion in July (Aug.12, 2014),

[9] Dodd-Frank Wall Street Reform and Consumer Protection Act § 991, 15 U.S.C. § 78ee.

[10] In the past three years, the SEC budget has been relatively flat, but it increased from about $943 million in FY 2009 to $1.32 billion in 2012.  Omnibus Appropriations Act, 2009, Public Law 111-8 (Mar. 11, 2009),; Consolidated Appropriations Act, 2012, Public Law 112-74 (Dec. 23, 2011),

[11] SEC, FY 2011 Congressional Budget Justification, at 10 (Feb. 2010),; SEC, FY 2015 Congressional Budget Justification, at 16 (Mar. 2014),

[12] Fleming, 100 Years of Securities Laws: Examining a Foundation Laid in the Kansas Blue Sky, 50 Washburn Law Journal 583, 594-95 (2011).

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