Is the SEC up to its $84-trillion RIA challenge?
The SEC is examining more RIAs than it has at any point in the past decade. Even so, the thinned agency is struggling to oversee the more than 13,200 firms managing $84 trillion under its purview.
Agency officials have said as much: The SEC’s latest annual performance review cites the notable rise in the share of RIAs receiving exams but also two missed goals around enforcement. This month, the agency’s inspector general took it to task over those findings.
The average time it takes the SEC to start an enforcement action after opening an investigation is two years and one month. Only 49% of the time was the agency able to file cases within two years of starting its investigation. The figures came nowhere near the SEC’s own targets.
The agency intended to file an enforcement action within two years of opening an investigation at least 65% of the time. It also took five months longer to begin enforcement proceedings, on average, than its goal for fiscal 2018. The SEC lost more than 400 positions to contract cuts and a hiring freeze, and it has only recently started adding staff again. Against this backdrop, the number of SEC-registered RIAs has soared by 13% in the past five years.
“As we reported last year, the timeliness of enforcement investigations remains a concern,” according to the Oct. 7 report by Inspector General Carl Hoecker’s office.
However, the agency’s share-class disclosure program has led to some 100 settlements since it started in February 2018. The cases against brokerage firms’ RIAs are “a perfect example” of how investigations are getting more efficient, not less, according to former SEC enforcement attorney Jacob Frenkel, who now represents firms as a member at Dickinson Wright.
In calling out the regulator’s slipping metrics amid a hiring freeze, the IG also echoed agency officials who have asked Congress for more resources. Concerns have been resounding since the Bernie Madoff case, if not earlier, says Christine Lazaro, president of PIABA and director of the securities arbitration clinic at St. John’s University.
“The SEC has to have the resources to adequately protect investors, and it just doesn't seem like it does right now,” Lazaro says. “As the RIA side of the business expands, it's going to stretch the SEC's resources thinner and thinner if the SEC can't expand as well. This has been a relatively consistent concern of the SEC’s since at least 2008.”
The Division of Enforcement sustained a 10% cut to its staff and contractors between fiscal 2016 and 2018. The SEC’s fiscal 2019 appropriation — which went up by 1.4% to $1.68 billion — has enabled it to begin filling some of the roles it had lost.
“For several years, the SEC’s annual appropriation was essentially flat, requiring a number of difficult operational choices, including cuts to contracts and a hiring freeze,” according to the IG report. The enforcement staffing displays the “challenges created by staffing levels that have fallen or have not kept pace with workload demands.”
Investigation timing may not reflect the current administration or other factors, though. Enforcement involving parallel criminal investigations, international cases and those begun in a prior investigation before Chairman Jay Clayton took over the role are “three areas that are skewing these numbers,” Frenkel says. He also points out that cases vary in complexity.
“Even when the Division of Enforcement was at its most robust staffing levels, there was always a clamoring for more investigative resources,” Frenkel says. “What we're seeing now with the more limited resources is an effort to prioritize and bring cases that are consistent with the Chairman's priorities and the agency's mission.”
In the annual performance review, the SEC pledged it would be taking measures to make each phase of investigations as efficient as possible, using new data analytics technology and training staff to use tools that expedite cases.
“While timeliness in filing actions can be influenced by a number of factors, it is important because it can enhance the action’s deterrent impact,” the document states.
Meanwhile, the number of SEC-registered RIAs keeps expanding. It reached a record 12,993 RIAs managing $83.7 trillion this year, a report by the Investment Adviser Association and National Regulatory Services shows. The report used slightly different criteria for its RIA count.
Even with fewer agency resources, the Office of Compliance Inspections and Examinations is auditing more RIAs. There were 3,150 exams in fiscal 2018, which was 10% higher than the amount in the previous year, according to OCIE’s 2019 examination priorities.
OCIE has more RIAs to examine, with its count up nearly 5% year-over-year. But it’s also reaching a greater share of them: 17% of RIAs received an exam in fiscal 2018, compared to only 9% as recently as five years ago.
The IG has called the rising number of RIAs a challenge for the SEC dating back to 2014, the report states. The continued growth makes it “imperative that management effectively use risk-based processes” and new technology to meet the SEC’s responsibilities, the report states.
SEC officials asked Congress for five more OCIE positions in its fiscal 2020 budgetary request, which would provide enough money to fill in about 130 of the 400 lost positions. The agency expected to add 100 employees in the recently completed fiscal year, according to its request.
The new OCIE positions would help it “further address the disparity between the number of exam staff and the growing number, size, and complexity of registered firms,” according to the budgetary request.
Despite completing the largest number of exams in a decade, the document goes on, OCIE “continues to face a number of challenges and issues that are having a significant impact on its limited resources.”