The highly politicized industry battle over who will oversee investment advisers—SEC, the government regulator, or FINRA, a privately run group—heated up Thursday as Boston Consulting Group, a global management consulting firm, issued a report on an important piece of the debate that has been missing until now: how much each option will cost.
According to BCG’s report, which was sponsored by firms and groups who support having the SEC oversee investment advisers, including TD Ameritrade, setting up FINRA to oversee investment advisers would be twice as costly as giving the SEC the funding it needs—in part because the SEC would need to oversee FINRA’s new activities. A separate survey conducted by BCG also indicated that more than 80 percent of investment advisers would prefer to pay user fees to fund enhanced SEC oversight rather than have FINRA police them. The majority of investment advisers felt this way even if the user fees they would need to pay the SEC were much higher than what they would have to pay to FINRA.
In a Dodd-Frank-mandated report released early this year, the Securities and Exchange Commission recommended three ways to increase investment-adviser examinations: allow the SEC to charge user fees for exams, establish a number of SROs to regulate advisers, or give a single SRO authority over dually registered investment advisers. Each alternative would require congressional authorization.
Republicans support offering oversight authority to FINRA, now the SRO for broker/dealers. They have not been supportive of giving more funding to the SEC. While the SEC gets all of its funding from user fees today, Congress must approve how much of those fees it can actually allocate to its budget.
After months during which industry participants seemed to think FINRA as the SRO had become almost a given, over the last couple of weeks, the odds have begun swinging in the SEC’s favor. A few days after House Financial Services Committee ranking member Barney Frank (D.-Mass.) said he thinks giving an SRO authority to oversee investment advisers would be a very bad idea, the committee’s chairman Spencer Bacchus (R.-Ala.) announced that he would delay introducing a bill that proposes just that until the Spring. And now this.
The Numbers
The BCG report examined startup costs, ongoing costs and the cost of SEC oversight. Startup costs for the SEC would be $6 million to $million and ongoing costs would total $240 million to $270 million, according to the report. There would be no SEC oversight cost.
In contrast, startup costs for a FINRA SRO would be $200 to $255 million, while ongoing costs, including SEC oversight, would total $550–610 million per year, said the BCG report. Startup costs for an entirely new SRO for investment advisers are projected at $255 million to $310 million, with ongoing costs, including SEC oversight, of $610 million to $670 million per year.
From these numbers, BCG concludes that funding an SRO would likely cost investment advisers twice as much as paying user fees to the SEC. The average annual fee per investment adviser firm is projected to be $27,300 for a full “Enhanced SEC” examination program; $51,700 for a FINRA SRO; and $57,400 for a new SRO.
The cost savings to the SEC of creating an SRO is likely to be minimal because the SEC would need to spend significant resources ($90–105 million) overseeing an SRO, the BCG report adds. The startup costs of an SRO alone ($200–310 million) could fund an enhanced SEC examination program for an entire year ($240–270 million).
Further, the report says that under the Bacchus bill small investment advisers would carry the burden of funding a new SRO disproportionately, since approximately 1,800 larger investment adviser firms would be exempt and would not pay membership fees to the SRO.
Opposition
Not surprisingly, FINRA shot back with a response to the BCG study, claiming that the cost projections were “wildly inflated.”
“The methodology is flawed and not clearly explained,” said Howard M. Schloss, executive vice president, FINRA. “And the fact that the Boston Consulting Group never asked to sit down with FINRA or the SEC to discuss projected costs of IA oversight is evidence this study was never a serious attempt to explore costs. BCG’s own disclaimer language should give anyone pause. It is clear the groups that commissioned the report wanted a public relations and lobbying vehicle rather than a legitimate study.”
“We still believe there’s ample data, publicly available data and research to inform the economic analysis at a level that would support a robust conversation and a robust view of the economics of these three different models,” said BCG Partner Gary Shub, in response to FINRA’s statement. “We are very confident in the analysis and the findings that came out of the analysis. We would expect future dialogue with FINRA and the SEC.”
The Financial Services Institute also voiced its continued support for FINRA as the regulator for investment advisers, without commenting directly on the report's findings. “The simple fact is, FINRA is the only entity with the capacity, funding and know-how to effectively examine retail investment advisers, which is not happening now,” said Dale E. Brown, president and CEO of the FSI. “When the SEC’s own chair and commissioners acknowledge that an SRO is necessary, and that the SEC can’t do the job, then it doesn’t make much sense to keep pushing the improbable. The status quo simply continues to keep investors at risk.”
Adviser Preferences
Part of BCG’s analysis was a survey of adviser firms, asking them about their preferences for an SRO, and panelists at a press conference in New York today said that the SRO debate is about more than cost.
“This is not a debate just about cost,” said David Tittsworth, executive director of the Investment Adviser Association. “We believe that FINRA would be the wrong choice for a lot of other reasons, including their lack of accountability, their lack of transparency, their weak track record and a bias favoring the brokerage industry and that regulatory model.”
BCG’s survey of 424 investment adviser firms found that more than 80 percent of respondents said they would prefer the SEC over a FINRA SRO, based on SEC user fees that were about 24 percent lower than FINRA membership fees. In a scenario where SEC oversight was 50 percent more expensive than FINRA, 68 percent of respondents still preferred the SEC.
The survey also found that 75 percent of advisers would choose a new SRO over FINRA, even if the option would cost 20 percent more. If the new SRO was 50 percent more expensive than FINRA, 70 percent of respondents would prefer the new SRO.
Susan John, chair of the National Association of Personal Financial Advisors, said her membership’s preferences were based on the SEC’s track record of enforcement and examination of investment advisers based on a principles-based fiduciary standard.
“NAPFA has always advocated a fiduciary standard of care and our members are very concerned, given FINRA’s lack of experience overseeing the Advisers Act and the fiduciary standard of care, as well as its rules-based approach to overseeing broker/dealers, is not well-positioned to provide appropriate oversight of investment advisers,” she said.