By ANDREW WYNER
POGO sent a letter today to the House Committee on Financial Services stating opposition to the Investment Oversight Act of 2012 (H.R. 4624), which would, as we argued in the letter, "delegate governmental authority for the oversight of investment advisers to one or more industry-funded self-regulatory organizations (SROs)."
The Committee is scheduled to examine the legislation at a hearing next Wednesday.
POGO’s disapproval of H.R. 4624 stems largely from the high costs associated with shifting governmental authority to SROs—including the Financial Industry Regulatory Authority (FINRA), the largest SRO—to regulate investment advisers. POGO is also concerned by FINRA’s conflicts of interest, lack of transparency and accountability, lobbying expenditures, and its executive compensation packages. Based on FINRA’s flaws, POGO believes Congress should reduce the authority of FINRA and other SROs instead of handing them more authority to oversee investment advisers.
According to a December 2011 analysis conducted by the Boston Consulting Group (BCG), authorizing an SRO to oversee investment advisers will cost taxpayers anywhere from $550 million to $670 million each year.
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That cost not only includes the price of starting up a new investment adviser SRO and funding its ongoing enforcement and examination efforts, but also the cost of equipping the Securities and Exchange Commission (SEC) to oversee that SRO. At a time when the SEC is already struggling to implement various requirements under the Dodd-Frank Act, the agency “would have to set aside significant budgetary and staffing resources to oversee an investment adviser SRO,” according to POGO’s letter. SEC Commissioner Luis Aguilar has said that authorizing an SRO to oversee investment advisers would be an “illusory way of dealing with the problem of resources.”
In contrast, BCG determined that the cost of directly enhancing the SEC’s own oversight of investment advisers would be significantly less—anywhere from $100 million to $270 million.
A recent study by the SEC’s Division of Investment Management outlined one possible solution for enhancing the oversight of investment advisers: giving the SEC the authority to collect user fees from registered investment advisers to support the agency’s oversight. Should Congress authorize these additional user fees, POGO hopes that the SEC, not the SRO, collects the user fees, and that there will be other appropriate measures in place to avoid potential conflicts of interest.
Giving more authority to the SEC makes sense for other reasons: namely, the serious conflicts of interest brought about by industry self-regulation. As POGO notes in its letter, FINRA “collects fees from its member firms and invests in the securities industry, while also assuming responsibility for regulating and disciplining these firms.” While officials at government agencies occasionally enjoy similarly cozy ties to the industries they regulate (such as the SEC), they are all subject to federal conflict of interest statutes and agency regulations. SRO employees, however, must only follow what our letter describes as their organization’s “decidedly anemic ethics policies.”
POGO is not the only group to raise concerns about SRO oversight of investment advisers. The aforementioned SEC study found that an SRO “could possibly have enhanced susceptibility to industry capture” because an SRO is “not only funded by the industry it oversees, but also may include industry representatives in its governance structure.”
The Government Accountability Office (GAO) has also outlined the potential drawbacks of SROs. GAO wrote in a report last year that when “the system of self-regulation was created, Congress, regulators, and market participants recognized that this structure possessed inherent conflicts of interest because of the dual role of SROs as both market operators and regulators.”
POGO also cited in its letter the lack of transparency and accountability at SROs as a major reason to not give them the responsibility to oversee investment advisers. GAO wrote in last year's report that an SRO designed to oversee private funds would “limit transparency and accountability, as the SRO would be accountable primarily to its members rather than to Congress or the public.” Even industry groups, including the Chamber of Commerce, have complained that FINRA’s transparency is “extremely limited and superficial.” Despite the overwhelming lack of accountability, FINRA and similar SROs benefit from a special legal immunity that normally only applies to governmental entities.
FINRA distinguishes itself from government agencies not only through its remarkable lack of transparency, but also through its spending on lobbying and executive compensation. According to the Center for Responsive Politics, FINRA dished out nearly $4 million on lobbying from 2008 to 2011, not including its advertising costs or the campaign contributions of member firms. And as POGO notes in its letter, FINRA’s top 10 executives in 2010 received nearly $13 million in pay and benefits. These huge sums may create additional conflicts of interest. One example POGO cites is SEC Chairman Mary Schapiro, who “received a final distribution of nearly $9 million when she stepped down as the head of FINRA,” and is now in a position to oversee her former employer following a one-year recusal period.
Based on the higher cost of transferring oversight of investment advisers to an SRO paired with the conflict of interest and transparency concerns, POGO hopes that the House Financial Services Committee will not approve H.R. 4624 and instead will give the SEC direct oversight of investment advisers.
Andrew Wyner is a POGO research associate.