During a House Committee on Financial Services’ hearing yesterday on Congressman Spencer Bachus’ SRO bill , opponents were outnumbered by supporters on the list of witnesses by a margin of two to one.
But those in opposition to the bill dominated the conversation, and managed to raise new questions and concerns from several members of the committee, including some of Bachus' fellow Republicans. One of the main concerns was that smaller investment advisors would be hurt the hardest from the costs of complying with the additional regulation, an issue that wasn’t raised in the hearing related to the bill last fall.
“It wasn’t just a solid wall of support by any means on the Republican side for the SRO, so I guess if you’re trying to keep score, I would say the advantage went to the opposition,” said Duane Thompson, senior policy analyst for fi360.
John Morgan, securities commissioner of Texas and the representative from the North American Securities Administrators Association (NASAA), went so far as to say that a self-regulated organization would be the “last straw” for many investment advisers. There’s regulatory fatigue, he said, and many IAs have told him they would close their doors if an SRO is created.
During his testimony, Morgan suggested that state-regulated IAs be exempt from the Bachus legislation.
As it is now, the bill says IAs who are registered with the states would also have to register with the new SRO. Rick Ketchum, chairman and CEO of FINRA, by some measures the most viable candidate to become the SRO, said that in states that have active examiners, the SRO would not step in. The IAs would, however, still have to register with the SRO and pay the fees.
Ketchum also said he would support a provision to create a de minimis fee for smaller advisors. About 1,700 of FINRA’s members pay less than $1,000 in fees per year, he added.
Small Advisers Get the Shaft?
David Tittsworth, executive director and executive vice president of the Investment Adviser Association, testified against the bill, saying there are several drawbacks, including increased costs to advisers and insufficient transparency and accountability of an SRO such as FINRA.
Because of the exemptions in the bill, smaller advisers are singled out.
The bill provides an exemption to advisers who manage a mutual fund as well as those with 90 percent of their assets in charitable funds, hedge funds, retirement plans, mortgage pools, or qualified purchasers, clients with at least $5 million in investments.
“One result is that the largest advisers, and those with the wealthiest client base, will continue to receive direct SEC oversight at no additional cost, while the smaller advisers with less wealthy clients will be subject to a new added expense for regulatory oversight,” said Barbara Roper, director of investor protection for the Consumer Federation of America, in a letter to Bachus. “Without the ability to spread a portion of those costs to larger, wealthier firms, the costs for small firms could be considerable.”
Last year, Roper had expressed support for the idea of one or more SROs replacing the SEC as the examiner for investment advisers, saying that absent greater will to increase funding for the SEC, having an SRO is better than the status quo. But now her message has changed.
Vocal investor advocate Mercer Bullard recently voiced his opposition to the bill for the very same reason. “It would be like having a national park where the wealthy are allowed to use it for free, but only middle-income and lower-income persons are required to pay a fee,” he told WealthManagement.com.
Smaller firms want to focus on the markets and their clients, and the increased burdens and costs could be a “job killer,” NASAA’s Morgan said.
The impact to small businesses was quite the hot topic during Wednesday’s hearing. “The impact on small businesses is a very important issue for a lot of members of Congress,” one that’s bipartisan, Tittsworth said. Most IAs are small businesses, with more than half of them having fewer than 10 employees.
Some committee members questioned the witnesses about the impact on small advisors. Representatives Stephen Lynch, D-Mass., and Carolyn Maloney, D-N.Y., said they were concerned about the bill’s affect on mom-and-pop investment advisers, especially those under state registration.
One of the common arguments around the need for increased oversight of IAs has been the Bernie Madoff scandal. Randy Neugebauer, R-Texas, said the Madoff scheme was the result of a regulator not doing their job. Rather than creating new regulators and new regulations, the focus should be on holding the regulators accountable for their failures. He doesn’t believe creating a new regulatory body will solve the problems of IA oversight.
User Fees Option
A better alternative would be to build out the SEC’s oversight of IAs, Tittsworth said, as this would cost less than creating a new SRO. He believes user fees should be imposed on SEC-registered IAs to pay for enhanced oversight in lieu of an SRO. Additional government funding for the SEC to oversee brokers seems to be unlikely. These user fees, Tittsworth says, could only be used for the purposes of enhancing IA examinations; the SEC could not divert these funds for other purposes.
Rep. Maxine Waters, D-Calif., the second-highest ranking Democrat on the House Financial Services Committee, said during the hearing that she has drafted her own legislation that would impose user fees on SEC-registered IAs to address the gap in examinations.
There has been much disagreement over how much it would cost to get an SRO for investment advisers up and running. The Boston Consulting Group released estimates of the cost in December, while FINRA issued its own assessment in late April, with vastly lower numbers. BCG then defended its own cost calculations, and FINRA came back with a defense of its numbers.
Of course, the topic also came up during the hearing.
“[BCG] never talked to us once,” FINRA’s Ketchum commented.
According to Ketchum, BCG used a variety of assumptions in coming up with their cost estimates. For one, 87 percent of registered advisory representatives are affiliated with a broker/dealer, and their cost estimates don’t take those synergies into account. BCG also assumed the costs would be the same for broker/dealer compliance and individual investment adviser compliance. FINRA’s cost estimates were less than one-third what BCG suggested.
Sources said Bachus has tentatively scheduled a markup date for the bill on June 27. This is a public meeting of the committee, in which they’ll take a vote on the bill and any amendments that are offered.
Fi360’s Thompson doesn’t expect the bill to be thrown out of the committee just because questions were raised. But he wouldn’t be surprised to see a de minimis fee provision proposed at the markup, since Bachus felt compelled to review the bill.
Thompson believes the bill has a good chance of getting through the House, maybe even before the August recess. But with the exception of another Madoff, he doesn’t believe the Senate will take it up before the end of the year, when the bill would die out. It’s a Democrat-controlled Senate that has bigger things to worry about, and Senate Banking Committee Chairman Tim Johnson, D-S.D., hasn’t expressed interest in reviewing SRO legislation.