RIAs Don’t Seem To Care Very Much About The Regulatory Debate; Reaction To Last Week’s FINRA-SRO News Was Muted

Tuesday, May 01, 2012 11:06
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RIAs Don’t Seem To Care Very Much About The Regulatory Debate; Reaction To Last Week’s FINRA-SRO News Was Muted

Tags: Congress | Dodd-Frank | fiduciaries | FINRA | NAPFA | RIA compliance | RIAs | sec | SRO

When news broke last Wednesday about the reintroduction of legislation that would make FINRA the regulator of RIAs, all of the advisor trade publications covered the story. Financial Planning even issued a “breaking news” alert. The reaction since from RIAs has been muted.

 
At Investment News, the article covering the controversial bill garnered 11 comments. The AdvisorOne story evoked just one comment. The Financial Planning breaking news story has attracted no comments. At Financial Advisor magazine, there have been no comments on the April 25 story. Here on A4A, where we did not offer analysis (until now) but instead linked to orginal reporting on other sites, our two-paragraph snippet on April 25 inspired only two comments.

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The issue of FINRA becoming the self-regulatory organization of RIAs is arguably the biggest story of the year for RIAs. Which begs the question: Why has the response to the prospect of FINRA becoming the regulator of RIAs been so muted?
 
The answer partly is that advisors simply don’t care that much — even the RIAs who will be most directly affected.
 
RIAs know something must be done about the current regulatory regime. It’s broken. With RIAs getting inspected by SEC examiners about once every decade, owners of RIAs know that better regulation is needed.
 
Do RIAs want FINRA as their regulator? No, of course not. However, like most business owners, RIAs are pragmatic. While RIAs would much prefer that the Securities and Exchange Commission would continue a their primary regulator, they know there is little chance of that happening.
 
With the obsession to cut government spending sweeping the electorate, it’s political suicide to argue for increasing the budget deficit to expand the SEC bureaucracy. This is the agency that failed to find the $50 billion Madoff fraud after it was provided evidence from an industry expert showing Madoff was likely running a Ponzi scheme. 
 
Frank Armstrong, one of the nation’s most accomplished financial advice professionals, posting a comment on A4A on April 26, said:
 
“FINRA is my worst nightmare. Corrupt and incompetent. Who is going to look out for investors? My preferred solution is to charge investment advisors a fee sufficient to cover SEC regulation.
 
For all their shortcomings, many due to underfunding by Congress, at least they are not total todies for the wire houses and broker-dealers. I thought I had left the stench of NASD behind when I went independent 18 years ago.”
 
Armstrong is smart and practical, and I respect him for all he does. But that does not make him right.
 
FINRA is the devil you know. If the government creates a new inspection and enforcement program, it will be another kind of demonic bureaucracy. And it will cost taxpayers more than if FINRA does it. That’s just the history of government. The additional examiners and support staff that the SEC will have to hire to handle the added workload would create a new bureaucracy that would enrage you in new ways.
 
The other reason why it’s unrealistic to expect the SEC to continue regulate RIAs is because of the power, politics, and money. The financial services industry is organized and, relative to RIAs, vastly more able enough to spread around money to help candidates get elected. It’s a machine.
 
In contrast the behemoth Securities Industry & Financial Markets Association representing Wall Street, the largest industry group in the RIA sphere — investment advisors serving high-net-worth individuals — is the FPA, which is amid a membership slump and seeking ways to reinvent itself.
 
Moreover, the fee-only RIA business —the core group of advisors fighting against FINRA becoming their regulator — represents a tiny fraction of the financial advice industry. With more than 95% of the financial advisors in the country affiliated with securities brokerages and insurance companies, and doing business on a commission-basis, do you really expect to win this fight?
 
The fee-only advisors who say they are the financial advice profession are effectively disowning the financial services industry, ignoring the history of forebears, the place from whence they came. It’s high-minded but unrealistic. It just won’t work when you have an entire industry not doing fee-only business.
 
Advisors know all this. That’s why you don’t see more outrage expressed about the looming prospect of FINRA becoming the SRO for RIAs.
 
Advisors are focused on their businesses. They’re besieged by the rapid pace of change in software, marketing techniques, and productivity tools. The FINRA-as-an-SRO fight is not an issue they seem to care about that much.
 
Then again, I’ve been predicting that FINRA was going to become the regulator of RIAs for five years and I have not been right yet. 
 

 

Comments (24)

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brentb843
Whoa Andy - while the SEC did little in response to Markopolis' letters, FINRA was in fact his regulator, because he was not using a 'qualified custodian.'

A qualified custodian is one in which the RIA firm has no relationship. Madoff owned his custodian. FINRA's primary responsibility is safeguarding client assets and when their is a relationship where the advisor firm shares common ownership with the broker-dealer, they were suppose to take more frequent and harder looks.

While some less sophisticated people may give the SEC a break on Markopolis' high level assessment, the fact that FINRA was unaware that BILLIONS reported as AUM by Madoff Securities was not there, 6 years in a row, is scary.

FINRA was Madoff's primary regulator because he did not use a qualified custodian!

BEB
brentb843 , May 01, 2012
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agluck
Brent: The evidence was presented to the Boston office of the SEC by Markopolos in writing and verbally in May 1999, as you can see at http://www.scribd.com/doc/9189...-Complaint

While FINRA inspections failed to uncover the Madoff fraud, FINRA was not presented a 17-page letter raising 29 red flags by an experienced CFA. The SEC was.
agluck , May 01, 2012
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bramsay
Andy said

"...If the government creates a new inspection and enforcement program, it will be another kind of demonic bureaucracy. And it will cost taxpayers more than if FINRA does it. That’s just the history of government. "

Your reporting is usually much better than this. What you stated is a belief which to my knowledge is not based on evidence. The government does not have a monopoly in demons or bureaucracy.

Evidence indicates that government has a very vital role to play in society. Every large successful society that has ever existed has had a significant government. I know of no examples of large successful societies with tiny governments. (If anyone has an example, I'd like to take a look and reconsider my position- I am a diehard capitalist but I understand capitalism's limitations)

And its also obvious that Grover Norquist and his ilk's strategy is to starve the beast so they can "prove" how bad government is when an underfunded and outgunned government agency does a poor job. If you have been unaware of this, here's an example of the long term strategy to dismantle social security:

http://www.latimes.com/business/la-fi-hiltzik-20120113,0,442443.column

And here's the actual 1983 Cato document

http://www.cato.org/pubs/journal/cj3n2/cj3n2-11.pdf

IMO, the efforts to "prove" government failure by creating a high risk of failure underminds our society. Especially when otherwise reasonable people fall for the BS.

Repeating Libertarian talking points only serves to make it more difficult to have reasoned discussions about where government is the right solution. We should have those discussions and then EXPECT our government to do a good job.
bramsay , May 01, 2012
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bramsay
One more thing Andy, would you consider it "impractical" if Doctors were to fight oversight by the pharmaceutical industry?
bramsay , May 01, 2012
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agluck
BRamsay: Doctors are the world's second oldest profession, and The Royal College of Physicians received its charter from England in 1518. The CFP Board was founded in 1985 and has no status with the government. The medical profession has a history in civilization. The financial advice profession does not. Of course, it would be silly for pharmacists to tell doctors what to do. But for government and institutions to treat financial advisors like doctors, the financial advice profession needs a history.

What you want will happen in time, but not in an era in which hundreds of thousands of financial service jobs are entrenched in business modes developed before the notion of a financial advice professional came into some prominence starting the the 1980s.

Also, you should not lump me in with all anti-regulation libertarians. I like government. Look back at my posts favoring the stimulus and TARP, for example. I argued in favor of stimulus and interview one of the world's best known economists, Martin Wolf, to make the case. I'm just a realist and I'm trying to help promote a broader perspective, one that is informed by a knowledge of the history of the financial planning profession and a concern for its future.

Please know, Bill, I really appreciate your comments here on A4A. You taught me a lot about portfolio management software over many interviews over a decade ago. You are a programmer and an advisor and an all around good guy. So please don't take my comments in the friendliest and most respectful way. I'm just a pragmatic guy.
agluck , May 01, 2012
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bramsay
Andy, I think you meant that I should take your comments in a friendly way :-), and I do- and hopefully vice versa.

But when you say the government is demonic:

"...If the government creates a new inspection and enforcement program, it will be another kind of demonic bureaucracy. And it will cost taxpayers more than if FINRA does it. That’s just the history of government. "

you are pouring more fuel on the anti-regulation libertarian fire that has gotten so extreme that Ronald Reagan probably wouldn't win a primary today.

I think that the move to the RIA business model is happening much more than you realize, and it scares the you know what out of the big broker dealers and FINRA- that's why they changed their name from NASD, and that's why that ridiculous RAND study (which was basically a survey of ignorant happy clients- and whaddya know, they all said they were happy in their ignorance) got commissioned.

Have you ever considered that maybe the BrokerDealer exception that was lobbied for and gotten to prevent brokers from having to comply with the Investment Advisors Act of 1940 prevented the earlier development of the fiduciary financial advice profession? Is this not the same maneuvering 72 years later?
bramsay , May 01, 2012
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agluck
I've read about the history of the '40 IA Act and don't remember seeing any reference of RIAs lobbying against the exception. But I am not sure that would change anything if BDs did lobby for the exception. Fact is, this is our reality.
agluck , May 01, 2012
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brentb843
I agree Andy with the letter, but AT the same time FINRA (NASD) was auditing Madoff Securities who listed the hedge fund and its assets as a part of its business. No one at FINRA, who checks the financial assets ever asked the obvious, 'where is the money that you claim this associated hedge fund manages?' In fact, they never once asked.
brentb843 , May 03, 2012
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brentb843
The medical professional is a great illustration. A smart man (Ron Surz) once drew a comparison to medicine at the turn of the 20th Century to the 'advisory' world today.

In the late 1800s, early 1900s anyone without any education background or experience could call themselves a doctor. They were really pharmacists, or more accurately, drug manufacturers, that would diagnose the patient to be cured from their 'drug.'

This was how Coke was born, and it contained cocaine! However, because the patient (even while dying of cancer) felt better, it was assumed a cure. Palliative medicine.

It is exactly the state of affairs today; however instead of increasing standards as the AMA did, there is a movement to decrease standards.
brentb843 , May 03, 2012
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brentb843
The exemption was in the late 1990s, not in the original act.

It is troubling at the retail level because of the sheer amount of dually registered individuals. While the individual always puts his investment advisor hat first, the investor never knows if the advice is given as a broker, without any duty.

The reason why the standard must be lowered and FINRA must make the rule is because it is the only manner a dually registered individual would make sense.

If a dually registered rep was required to always disclose which capacity he or she were acting, then the investor would never choose the broker. Reps would leave firms.

However, if FINRA would embrace a higher standard, it would actually work out in their benefit. Most RIAs are not acting in a fiduciary capacity, if they realized the sheer amount of hard work it takes, they would run back to the broker dealer and its RIA.
brentb843 , May 03, 2012
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SEBCFP
One of the major reason Dale Brown of FSI states they want FINRA to regulate RIA's is to provide a level playing field with that of registered reps.

In my opinion, FINRA has screwed up the brokerage industry with overbearing rules and regulations, and now FSI wants them to do the same thing with RIA's, so as to level the playing field. Excuse me, really?

Becasue you are unhappy with the rules and regs FINRA has overburdened you with, you claim it's not fair, so let's make it bad for everyone, so we can all be miserable.

While I agree RIA's need to be inspected more than once every 11 years on average, current rules and regualtions have worked fine for years. The SEC should be the regulators and should be doing the exams. The increased cost should be born by the RIA firms.

This is me weighing in, I'm hot.
SEBCFP , May 03, 2012
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brentb843
Dale Brown's rationale is not in the best interest of the investor, it is in FSI's members.

If I were to create a new erectile dysfunction drug, I would be at a huge disadvantage to Pfizer. Should the FDA therefore reduce the approval process to help more garage-based pharmacists sell ED drugs that may ultimately be dangerous to men?
brentb843 , May 03, 2012
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cblackman
Great article Andy! You've hit all the right issues and for the most part have nailed the reasons why advisors don't seem to want to get engaged. However, I believe there are two very strong primary reasons why that you really didn't touch fully explore -

1). There is a sense that there is nothing that can be done and you can't fight city hall. There is a defeatist attitude that is rampant among many professionals. These folks should take heart however. The organizations that represent RIAs and support their fiduciary business models are not taking this lying down. Much is being done behind the scenes and more is being done publicly. Advisors need to believe they can stop this through communicating their dissatisfaction with this bill with their legislators. It is not a done deal. In addition, they need to communicate their support in opposing this bill to their representative organizations, whether that is the IAA, CFP Board of Standards, FPA, AICPA or CFA Institute.

And 2). I don't believe enough advisers understand what it will mean to have the national association of [really big] securities dealers, aka FINRA, in charge of their daily activities. A spate of recent articles on small b/ds going out of business due to regulatory costs and fee increases only begins to tell the tale of the future of the small, independet RIA. Trust me, if FINRA becomes the regulator of RIAs, expect to see a radically different world for RIAs in a few short years.

We all want to have the bad guys behind bars where they belong, but bringing in a flawed regulator owned by those that would prefer we were not even in existence hardly seems the right answer. These are the guys that missed Madoff and Stanford for crying out loud. And a side note, if the guys that now are registered and registering with state regulators believe this will not effect their business operations, they have another think coming.
a guest , May 05, 2012
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williamp707
In my conversations with other IARs and planners at various conferences and events, all are deeply concerned about this fiduciary issue and an SRO. There is a recognition that the B-D trade associations and their lobbyists have essentially purchased our elected officials. Yet, all support the efforts of organizations like the Financial Planning Coalition and AICPA to continue fighting to raise the standards and protect the investing public.

Many advisors who have entered the industry after the dot.com bubble, are unaware of the difference in standards. Like them, when I came into the industry, I affiliated with a national firm and was told I had to earn my 7, 66 and life license. I assumed that these were the requirements everyone had to complete. I had no idea I was dually registered. It was only after 2 or 3 years—and lots of professional curiosity—did I begin to understand the differences. I have since made changes to my business and joined the efforts to raise the standards.

Given the industry has such high turnover, I assume most newer dually registered advisors are focused on survival, which means focusing their energies on business development and the next sale. They have little if any time to get involved with or understand this debate.
williamp707 , May 05, 2012
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Chris Winn
Really good points, but if we try to parallel with other industries, we'll debate indefinitely.

The short story here is that we have a regulatory system that needs upgrades. Instead of developing an action plan to enhance what we have in place, the politicians and those with self-interests are pushing for 180 degree change or shift in responsibilities.

So the SEC can only get to 9% of firms...

That just reinforces that their review methodology is broken. FINRA's is equally broken. Great, they show up more often, but look at the wrong things? There was no need to "switch" the advisors, just as there is no need to pass off responsibility to FINRA.

There are many ways to fix this problem with existing tools and resources. But minor upgrades don't make careers or elections.

Little, if any, value will come from all this nonsense and the investor will be no better off. Oh, remember Mr. and Mrs. Smith? Isn't that why we have these rules in place to protect them? (Also recognize that my firm does benefit from these changes, but we still don't support it.)

IMO, the reason that Advisors are not vocal about this is that they do not feel they have a voice. It would be a colossal waste of time to get excited about this matter.

I personally find it encouraging that advisors have remained focused on clients and growing their businesses and not the political nonsense here.
Chris Winn , May 05, 2012
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agluck
aguest: totally agree with you on the "you can't fight city hall" syndrome muting RIAs' reaction. But do not agree with your second point that costs will soar if FINRA is regulator more than they should.

RIAs have gotten a free ride on regulation. I know RIAs, who are my target readers and clients, do not want to hear this. But it's true.

RIAs pay almost nothing to the government for regulation. It's basically subsidized by taxpayers. The rising costs registered reps and BDs pay are directly connected to market forces. It's much more realistic.

Any RIA regulator that replaces the current regime of government exams will mean RIAs need to pay more for regulation. Even if the SEC does it, the cost will likely be picked up by RIAs in the future because RIAs will be asked to foot the bill for the exam program rather than taxpayers. And that's fair.

I agree with you that RIA membership organizations are getting more organized and maturing. That's part of the evolution of the profession. It's good.

Take note, incidentally, that the CFA Institute, a membership organization that does have status with the government through its history of involvement in the public company arena, has remained on the sidelines RIA regulation issue.
agluck , May 05, 2012
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hilarymartincfp
So you know, I did write to all of my elected representatives protesting the legislation, and I have a blog post scheduled to go out tomorrow to all of my subscribers requesting they do the same. I wouldn't ascribe apathy to the RIA's, rather a feeling of helplessness. It's a terrible situation.
hilarym408 , May 05, 2012
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Chris Winn
I generally don't disagree with your points. I would not call it a "free ride" by any stretch though. While the SEC did not make it out to see ~90% of the firms, I am sure many of those would have survived an audit. There's clearly more work to be done.

I just don't agree with starting over because there was a kink in the chain.

As you mention the industry professional groups, let's also remember the role these organizations have played in helping RIAs to "self-regulate" to some extent. I agree more needs to be done to regulate.

If process changes were initiated at the SEC and we did not waste so much time shifting responsibility, I'm sure the SEC could have increased coverage by at least 100% last year. Not that 18% would have been a number to be proud of achieving!

Simple use of technology could dramatically change the examination process, cost structure and effectiveness.

The ADV2 went from bad to worse without any real planning. We are really going backwards, so I agree that many advisors just feel helpless. Change for the sake of change (or for political gain) is not helping the industry and those they serve.

Everyone can debate the details, but where we are today (still discussing this) is evidence enough.



Chris Winn , May 06, 2012
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agluck
Chris: Saying 90% of RIAs would psss an audit sets the bar too low. Crooks operate on the margins. If 1% if RIAs are crooks instead of the .5% that would be crooked under a real egulator, then that's twice as many investors victimized.

But the real problem is that a weak regulatory system causes sloppiness and excesses. For example, you and I both know that advisors are routinely ignoring privacy rules and emailing personally identifiable information to clients, some are hiring solcitors that make unrealistic claims to investors, and others are just totally unprepared recover from a disaster

So its not just the tiny percentage of crooks doubles, but weak regulation invites other problems.

Just as lack of credible regulation of derivitives caused the debt crisis, lack of regullaton of RIAs is spawning other problems. I'm not in any way equating the two. JUst saying that a lack of credible regulation invites crooks and sloppy practices. To not acknowlege that this is the situation currenlty is folly.
agluck , May 06, 2012
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Chris Winn
Andy.

I must not have conveyed my point clearly enough if you came away thinking I believe nothing is broken. The system is clearly broken, but starting over with a new regulator is not going to fix it. It will make it worse.

Fair point on the crooks - I agree. However, you are mixing my words on the other 90%. I stated "many would pass an audit" (not 90%), just suggesting that many advisors are not taking a free ride, even if it is being offered. Many advisors do take compliance seriously.
There is absolutely work to do. Many do have weak policies. Agreed. The typical audit (of a firm with no intentional wrongdoing) results in a list of these items that the advisor needs to improve. This can be further improved with the current regulators in place. It would be extremely easy to randomly select a topic like the use of solicitors and do sweep exams. Again, no need to start over to fix this.

And make no mistake, many broker-dealer reps (and firms) have the same issues with weak policies, privacy breaches and making unrealistic claims. Having someone "pre-approve" what one might say gets us nowhere. The FINRA system is arguably in a worse state of disrepair. Having a producing rep serve as someone else's supervisor (OSJ) is as riddled with conflict as is multi-million dollar salaries at an SRO that can only exist if they fine its members. FINRA relies on the OSJ structure to limit the scope of their exams. That is why you see similar issues that you describe remain in the B-D space. Having more rules does not mean there is effectiveness.

As you can see, I am not at all suggesting the system is not broken and there are not problems to address. We can all agree that is a fact. I just think that another useless switch of responsibility would a real mistake. I am trying to convey is that it would be much more effective to fix what is already there. I think there is a bigger risk (and window for crooks) in starting over with a new regulator (FINRA or some other SRO) than there would be to immediately start fixing the processes at the SEC.

As we approach 2 years after the signing of Dodd-Frank, I remind everyone that trying to start over takes much longer. How many issues could have been caught in the last 2 years if the exam process at the SEC were just corrected to enable them to increase the coverage (even remote exams)? The SEC likely does not need to park themselves for a week or more at every shop they visit. For some they may need to of course, but for many exams they could execute in a much more effective manner leveraging technology the efficiency of offsite analysis. If the SEC leveraged best practices for audit and assurance that many audit and consulting firms use, they would increase their coverage and effectiveness significantly. And two years later we would not be here debating what they "should do".

So to recap:

1. No folly here. I get it. Change is needed. We just don't need to start over to fix it.
2. No folly with advisors. They get it too. Many are not engaged in the discussion because the notion of changing regulators is the foolish act.
3. Crooks will always be ahead of the system. I agree we need to be enhancing the system and hopefully catching another .5%. My fear is that 2 years and counting of wasted time has given the crooks the "free ride", not the many advisors that have been doing the right thing.
4. It may seem like an overwhelming challenge to get from 9% of advisors to some meaningful number. That's politics and self-interests from every angle. This is such an easy problem to fix. The decision-makers just need to refocus and remember their duty to the investor.


Chris Winn , May 06, 2012
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agluck
Chris: Either way -- FINRA or SEC -- we're starting over. Even if SEC gets the job, it will need to create a new bureaucracy, as would FINRA.

And I'm glad you pointed out the huge weakness in the FINRA OSJ model and the entrenched power held by FINRA's leadership.

Thanks for helping elevate the discussion and add to understanding the issues more clearly. Great stuff!
agluck , May 07, 2012
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chrisp202
THIS IS FROM FSI'S DALE BROWN:

Yes, we need to level the playing field because the status quo is unacceptable. The SEC, consumer groups, even those who don’t support an SRO all acknowledge that the status quo is not good for consumers or the industry. And FSI is keenly aware of problems with FINRA because, as our members’ primary regulator, we are continually engaged with them on issues large and small. The reality is the Dodd-Frank made addressing this regulatory gap a priority when it directed the SEC to study the issue and when it gave the SEC permission to establish a uniform fiduciary standard. The political reality is there is no support in Congress for giving the SEC the money required to close the gap. So an SRO (and FINRA in particular) is the only viable solution practically and politically. Our members, Board and staff leaders have cultivated good, constructive working relationships with FINRA leaders and in the Districts. We have the ability to affect change.
chrisp202 , May 07, 2012
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SEBCFP
I don't think it's the only viable solution. The SEC has the ability to raise fees for inspections on RIA firms and should. I would rather have the SEC perform inspections than FINRA. FINRA does not truly understand the RIA business, neither do the BD's.

SEBCFP , May 08, 2012
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brentb843
Hold on, we are missing a couple of key points here. First, the NASSA (the states) are also a player in this. Second, there is a belief that NO protection is provided a RIA client. Keep in mind, RIAs who use 'qualified custodians' already have their client accounts overseen by FINRA at the broker-dealer level. RIAs who do not use a 'qualified custodian' (Madoff) or commingle investor funds (Madoff) are now required to have a surprise annual audit from a third party CPA firm. These firms cannot renew their registrations without the CPA firm sign-off.

So lets remember, RIA firms already have their client accounts overseen by FINRA. Does anyone truly believe that FINRA does not do annual inspections on Schwab or TD? Or is the assumption made that the accounts of RIAs are ignored during the audit?

Secondly, we have seen immediately after the CPA surprise audit rule (in the wake of Madoff) a shake out of many ponzi schemes. Small RIA firms could no longer hide and small broker dealers pushing Reg D schemes went down as well.

What needs to be address is what, then who taking into consideration that FINRA and CPAs are already looking at the investor accounts or RIA records as appropriate.

Lets have a debate on facts, not rhetoric!!!

BEB

brentb843 , May 09, 2012

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