The push to require
investment advisory firms to use independent custodians gained momentum today after members of the Senate Banking Committee and officials of the SEC endorsed the action at a hearing on the giant Ponzi scheme allegedly perpetrated by Bernard L. Madoff Securities LLC of New York.
Also at the hearing, the Financial Industry Regulatory Authority Inc. of New York and Washington escalated its decades-old call for more oversight of investment advisory firms.
Finra interim chief executive Stephen Luparello blamed the inability to examine the books of the Madoff investment advisory firm for the self regulatory organization’s failure to detect the alleged $50 billion fraud.
Lori Richards, director of the SEC’s office of compliance inspections and examinations, outlined several changes to the Securities and Exchange Commission’s examination process for investment advisory and brokerage firms.
Her proposal included requiring all advisory firms to have independent custodians — which, according to her, about 1,000 of the more than 11,000 advisory firms registered with the SEC do not have.
As it turns out, the Madoff investment advisory business was one of the firms without an independent custodian.
The Banking Committee’s chairman, Sen. Chris Dodd, D-Conn., indicated to Ms. Richards that the SEC should have adopted the independent custodial requirement for investment advisers sooner.
"Any examiner would tell you that's a strong internal control, and that's the most desirable situation, to have an independent entity in charge of customer assets," she replied. "That is one of the changes that I hope the commission will strongly consider," she said.
Additionally, the SEC needs to examine advisory firms more frequently than it is currently able to do, Ms. Richards said.
About 10% of registered investment advisers are examined every three years on average, she said.
The SEC needs independently audited information on the firms, and requiring advisers to file their performance information could be useful as well, Ms. Richards said.
“Among the areas that we will study are the examination frequency for investment advisers, the existence of unregistered funds and advisers [primarily hedge funds], the different regulatory structures surrounding brokers and surrounding investment advisers, the existence of unregulated products, and strengthening of the custody and audit requirements for regulated firms,” she told the committee.
“Investment advisers are not subject to examination or oversight or regulation by a self-regulatory organization. This is different from the oversight model for broker-dealers, who are subject to periodic examinations by an SRO [Finra],” Ms. Richards said.
That theme was stressed by Mr. Luparello.
“Finra has long expressed concerns regarding [an investment advisory] firm’s ability to avoid our jurisdiction by keeping its customers outside the registered broker-dealer,” he said, citing public statements made by the NASD, the predecessor to Finra, as far back as the 1980s.
Investment advisory organizations strongly oppose having Finra regulate advisory firms. They say it is not well suited to overseeing the advisory business.
