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Practice Management

RIAs may be scrutinized more by state regulators than under the SEC.

This Practice Management article is intended for financial advisors only (registered representatives of broker dealers or associated persons of Registered Investment Advisors).

Registered investment advisors are already familiar with the paperwork hassles that accompany SEC oversight. Yet as states take over regulation of RIAs with up to $100 million in assets under management, many firm owners are wondering if the transition will prove difficult.

The change, which will impact roughly 3,200 firms, is part of the Dodd-Frank law enacted more than two years ago. Unlike other parts of Dodd-Frank, which have been challenged and delayed by large financial firms and their advocates, the switch to state regulation for certain financial advisors is continuing apace. By midyear, the regulatory transition should be complete.

The smallest investment advisor firms, with up to $25 million in assets under management, won't notice much—if any—difference, as these firms have always been state-regulated. It's the firms with $25 million to $100 million in assets that will have to adjust.
Expect More Oversight
State regulators have been open about the fact that their inspections of these midsize RIA firms may be more rigorous than those of the SEC. On the website for the North American Securities Administrators Association, a group representing state regulators, the probability of heightened scrutiny is mentioned fairly clearly. "Firms switching to state regulation for the first time can expect thorough inspections generally on e a more frequent basis than they e may have experienced before," the website states.

Since the states will likely have more staff to conduct reviews, compliance may be monitored more frequently than under SEC regulation. "Perhaps the greatest change for the approximately 3,200 RIAs switching from federal to state regulation is that some may undergo an examination for the first time," according to Bob Webster, a spokesman for the state regulators group. "Most advisors should be able to make the switch without interfering with their daily business operations," he says.

Melanie Senter Lubin, the securities regulator for the state of Maryland and an official of the securities administrators association, adds, "The switch will go smoothly if advisors follow the timeline and get their applications in early." (See "Schedules/Rules for RIA Regulator Switching" table, below.)

Chronic Underfunding
Long before Dodd-Frank passed, the SEC was regarded in the advisor industry as perennially understaffed and underfunded when it came to RIA inspections and audits. The agency reported in early 2011 that although advisors' assets under management grew roughly 60% from 2004 through September 30, 2010, the number of RIA exams fell about 30% during that period. The agency has long been under fire by congressional Republicans, who have tried to reduce the SEC's funding and revise many of the rules mandated by Dodd-Frank.

For those advisors who have used the Investment Adviser Registration Depository system used by SEC-registered firms, the filing of the ADV forms should be familiar. States will review those documents and note any deficiencies; they will also be available to take questions and discuss them with advisors, Lubin says.

Ron Pearson, a fee-only advisor at Beach Financial Advisory Service in Virginia Beach, Va., was previously state regulated when his firm was smaller in size. He says he doesn't mind going back to state regulation—in fact, he is actually looking forward to the change.

He estimates that it took him about one hour to complete the ADV and four hours for the remainder of the paperwork. When a question arose on one of his applications, he contacted his regulator directly.

"They always find something to nitpick, but I don't foresee any problem before the deadline" to switch over to state registration, Pearson says. "The nice thing about the state is that I can talk to them. You can work with them in a collegial environment."

As with many financial advisors, Pearson says SEC regulation was less intensive than what he experienced under state regulation. Pearson says he never experienced "a full-fledged audit" in three years under the SEC, for example.

For those unaccustomed to state regulation, the paperwork could be daunting, though. Antolin Du Bois, who started his practice as a CFP in 2011 at RichFaith in Flushing, N.Y., found that to be the case, at least at first. He says he initially received "no real clear direction" on how to file the forms to transition over to state regulation. The extra information required for state registration took him 30 hours to complete, Du Bois says, although the fact that he is new to the business might account for some of the time it took.
Chain of Events
The switch to state regulation is the first step in a chain of events expected to have a significant impact upon advisors in the coming months. The Dodd-Frank law also called for harmonized regulation of investment advisors and brokerage representatives under some form of a fiduciary standard.

After an initial report favoring a uniform fiduciary standard for brokers and advisors, the SEC put aside the idea under pressure from insurers and the brokerage industry. The agency seeks to issue new rules and request comments sometime this year.

Separately, the Department of Labor proposed its own redefinition of the term fiduciary in relation to its oversight of qualified plans and tax-deferred accounts, although again, industry criticism caused the agency to backpedal from its proposal. Agency officials have said they will reissue a proposal this year, but some industry watchers believe it could take longer.

It also remains to be seen whether advisors will be regulated by a new self-regulated entity or if that role will be given to FINRA, the current broker-dealer regulator. The House Financial Services Committee, chaired by Rep. Spencer Bachus (R-Ala.), was slated to propose RIA self-regulatory organization legislation last year, but the introduction of a bill was delayed until later this year. Until it is all sorted out, the $44 trillion industry is watching and waiting.

John F. Wasik, co-author of iMoney, is a columnist for Morningstar and Reuters.



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