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Responding to a Growing Investment Advisor Industry

3/9/23

taxes; tax; stocks; stock sale; corporation; corporate

By: Andrew Iles

The fields of investment management and financial advising are ever growing. For example, the Securities and Exchange Commission recently stated that the number of Registered Investment Advisors (“RIAs”) has ballooned by 25% since 2016, and now covers more than 15,000 RIA firms. Such growth and constant progress present the Commission with the challenge of keeping up with the growth of the industry as well as the changes within the industry. 

On February 7, 2023, the Securities and Exchange Commission’s Division of Examination announced its 2023 examination priorities. These examination priorities provide insight into the Commission’s prospective risk-based approach to regulating RIAs with particular attention to areas that the Commission believes pose risks to investors1. 

Quickly broken down, the Commission’s 2023 published priorities include: 

  1. Compliance with recently adopted rules under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, specifically the Advisers Act Rule 206(4)-1 (Marketing Rule), Investment Company Act Rule (18f-4 (Derivatives Rule), and the Investment Compan7 Act Fair Valuation Rule 2a-5; 
  1. Registered Investment Advisers to Private Funds which covers approximately 35% of Registered Investment Advisers; 
  1. Standards of Conduct: Regulation of best interest, fiduciary duty, and form CRS particularly as applied to retail clients and working families; 
  1. Environmental, Social, and Governance (“ESG”) Investing and the propriety of the labeling certain investment products and strategies as ESG; 
  1. Information security and operation resilience; 
  1. Crypto assets and emerging financial technology. 

However, the Securities and Exchange Commission realizes that the priorities listed above are broad based and will require added resources. On March 2, 2023, the Commission hosted a panel of key stakeholders to discuss the Commission’s ability to keep up with industry growth and discuss various opportunities for improvement. The panel included representative from the Commission’s Division of Examinations; the Investment Adviser Association; the Corporations, Securities, and Commercial Licensing Bureau for the State of Michigan, Consumer Federation of America.2 

The Commission began by stating that it had examined the regulatory compliance 15% of all RIA firms and represented firms registered with the Commission in 2021. However, stakeholders see the need for increase in those numbers, especially when considering that  between the Commission and FINRA, approximately half of broker dealers had been examined in 2022. Additionally, the Commission conceded that even the 15% figure was aided by the use of remote examinations which became widely employed through the COVID-19 pandemic.  

The panel discussed the need for additional resources to allow the commission to keep up with the growing industry and changing concerns around regulation of the market participants. As with most government entities, the first obvious need stated was an increase in SEC funding, with most of the panelists stating that the best option was increased congressional funding. However, the panelists acknowledged that congressional funding is always accompanied by political back and forth. 

The second option for increased funding discussed by panelists was the implementation of “user fees” to be assessed against RIAs. The implementation of a reasonable “user fee” was preferred by panelists because it would enable the examination function to stay within the purview of the Commission. The only real concern with this particular option centered around the size of such a “user fee” since more than half of all Registered Investment Advisory firms are small offices employee less than 10 employees3.  

Another option discussed to increase the examination of RIAs was the creation of a Self-Regulating Organization (“SRO”) to mirror the function performed by FINRA. However, industry stakeholders disapprove of this option because of the anticipated cost of funding such an organization exclusively through member contributions, particularly when such an SRO would have substantial membership overlap with FINRA. Such a cost is expected to be much greater than simply subsidizing and expanding the Commission’s current programing, particularly for small RIAs. Additionally, panelists voiced concerns over the lack of transparency with such organizations and the precedent of delegating the examination function to a non-governmental agency.  

The panel also discussed the potential of authorizing third-party examinations. However, this option raised the concern of inconsistencies of examination protocol, applied standards, confidentiality, and transparency. Some even propose allowing the most obvious third-party examiner/SRO, FINRA to take on the additional RIA examinations. However, while such an option would likely provide qualified examiners with an established track-record, this option would highlight the problems with dual registration as Investment Advisers and Broker Dealers, by requiring the application of different standards for parties who register as both. Additionally, such an option could lead to the Commission deferring to FINRA and failing to exercise its own oversight over for the largest dual registrants in the market.  

While the expansion of the financial industry, including the increase of Registered Investment Advisers, presents new challenges for an SEC in need of additional funding and technological resources; key stakeholders are continuing to examine potential options for keeping pace with such growth that could affect all Registers Investment Advisers to ensure that investors at all level continue to be protected. 

For more information, please contact Andrew Iles at andrew.iles@fmglaw.com, or your local FMG attorney. 

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