Harvey Pitt’s Solution to SEC’s RIA Exam Shortfall

Requiring advisors to get third-party exams is a “creative idea,” but there are “a number of issues that have to be carefully looked at” surrounding such a rulemaking, SEC Chairwoman Mary Jo White told reporters Thursday after her remarks at the Investment Company Institute’s annual conference in Washington.

White, who was addressing SEC Commissioner Daniel Gallagher’s recent suggestion that the commission consider requiring third-party audits to help the agency boost its advisor oversight, said that there was “no question that [the advisor exam] issue is a real challenge for us; we don’t have the resources to do the kind of coverage we need to do.”

Harvey Pitt, who was SEC chairman from 2001 to 2003, told ThinkAdvisor in an email message Thursday that the SEC “definitely” has the authority to write a rule to mandate third-party advisor exams, but the SEC could require advisors to get such audits without rulemaking.

Pitt, who’s now CEO and managing director of Kalorama Partners in Washington, noted that he first floated the idea during his chairmanship, when the agency adopted the requirement that RIAs have dedicated compliance officials and programs.

By requiring third-party audits, Pitt says, “the SEC could ensure that all RIAs are examined at least annually.”

The SEC “could require the examiners to be independent and experienced, and certify those who are and whose audits would be acceptable to it,” Pitt continued. What’s more, the SEC, he said, “would dictate the scope of the audit, points of emphasis, etc.,” with the objective “to get a report to both the entity being examined, the public and the SEC. As the SEC receives all these reports, it would be better able to determine developing trends (and problem areas).”

Says Pitt, the SEC “has the ability to exempt RIAs from various provisions of the two ’40 Acts,” the Investment Advisers Act and the Investment Company Act, ”and could condition such exemptions on the entering into of a binding agreement of the RIA to have an independent third-party audit conducted at least annually.”

He said: “I don’t gainsay the SEC’s ability to compel these audits, but that would require formal rulemaking. If it [the agency] conditions these outside audits on obtaining certain exemptions from provisions of the ’40 Act, it could announce the policy, and allow entities to sign up for it voluntarily, without going through months and months of rulemaking.”

The agreement, he continued, “would permit the SEC to designate which firm would conduct the examination, and at what time, and would also allow the SEC to decide when the audit would be conducted (to make it approximate a ‘surprise’ audit).”

The SEC, he added, “would reserve the right to conduct its own compliance audits ab initio, or as a supplemental audit.”