As questions arise about the SEC’s ability to fulfill its mandate, and a growing chorus of commentators, legislators and professionals calls for appointment of a self-regulatory organization to oversee registered investment advisors, Financial Services Committee Chairman Spencer Baucus is proposing a less radical solution to the agency’s problems.

Chairman Baucus is drafting legislation—the SEC Modernization Act—that would reorganize the Securities and Exchange Commission (SEC), and bring “comprehensive reform” to the agency. “The SEC is structurally flawed and suffers from operational inefficiencies and organizational incoherence,” according to Chairman Bachus. “This legislation will be a comprehensive restructuring of the SEC. It will make the SEC more efficient, consolidate duplicative offices, enable the agency to use better technology, and strengthen ethical safeguards to avoid conflicts of interest.”

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the SEC and its regulatory activities in Advisor’s Journal, see Better Late Than Never: SEC Implements the Switch (CC 11-129), Disarray at the SEC Is Complicating the “Switch” (CC 11-83), & Hedge Funds Must Now Register with the SEC under the New Wall Street Reform Act (CC 10-45).

Investment advisors and broker-dealers may be required to disclose their incentive-based compensation programs under proposed rules approved by the Securities and Exchange Commission (SEC) on March 2. The proposed rule is the latest in a series of advisor and broker-dealer reporting rules issued under the mandate of the Dodd-Frank Wall Street Reform Act. 

The exponentially increasing compliance burden for advisory firms and B-Ds has the potential to radically alter business practices at affected firms. Many will need to overhaul their entire compensation platforms to comply with the new rules.  

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of advisor reporting requirements in Advisor’s Journal, see Advisors Hit with Another Round of SEC Reporting Rules (CC 11-30).

Why is this Topic Important to Wealth Managers? This topic discusses one of the current trends in the financial services industry of adding additional regulation after the events of the financial crisis. The SEC, along with other agencies, is discussing rules that could have an effect on broker-dealers as well as those companies that employ them. Wealth managers associated with firms involved with the prosed rulemaking should take note.

The SEC recently considered a proposal that would prohibit incentive-based compensation practices that may encourage inappropriate risk.

The proposal arises from Section 956 of the Dodd-Frank Act [1], which requires the SEC along with six other financial regulators to jointly adopt regulations or guidelines governing the incentive-based compensation arrangements of certain financial institutions. These institutions include broker-dealers and investment advisers with $1 billion or more of assets.

In particular, the Dodd-Frank Act calls upon the regulators to do two things:

First, it calls upon the regulators to adopt rules or guidelines that require these financial institutions to disclose the structure of their incentive-based compensation practices so that the regulator can determine whether such compensation is excessive or whether it could lead to material financial loss to the firm.

Second, the Act calls upon the regulators to adopt rules or guidelines that prohibit these financial institutions from offering any incentive-based compensation arrangement that the regulators determine encourages inappropriate risks – either because the compensation is excessive or because it could lead to material financial loss.

Among other things, the rules considered by the SEC would:

(1) Require reports related to incentive-based compensation that the financial institutions would file annually with the Commission.

(2) Prohibit incentive-based compensation arrangements at financial institutions that encourage inappropriate risk taking by providing excessive compensation or that could lead to material financial loss to the firm.

(3) Provide additional requirements for financial institutions with $50 billion or more in assets, including the deferral of the incentive-based compensation of executive officers and the approval of the compensation of those persons within a firm whose job functions give them the ability to expose the firm to a substantial amount of risk.

(4) Require the financial institutions to develop policies and procedures to ensure and monitor compliance with the requirements related to incentive-based compensation. [2]

Some in the industry are concerned that the proposal, if adopted, would lead individuals at covered broker-dealers and investment advisers to become unduly conservative and avoid taking even prudent risks. That prospect is troubling; for while it is appropriate to recognize the potential for excessive risk taking, the rule makers also noted that fact that they must recognize that firms can take too few risks. A regulatory regime that places undue emphasis on reducing the likelihood of bad outcomes is costly if it leads to excessive conservatism. Generally speaking, it is usually the case that for an innovative private sector to spurs economic growth depends on the willingness of enterprises to take risks.

What would been a challenging task given the tricky statutory language was reportedly made even more challenging because the joint rulemaking, which has required the agencies to coordinate, deliberate and negotiate with seven total financial regulators. [3]

For more coverage on the Dodd-Frank Act, see Advisorfyi: New Dodd-Frank Study Calls for Stringent Standards

Tomorrow’s blogticle will present discussion on planning tips.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

[2] See Chairman Mary L. Schapiro Opening Statement — SEC Open Meeting: Proposed Rules on Incentive-Based Compensation. U.S. Securities and Exchange Commission. March 2, 2011. http://sec.gov/news/speech/2011/spch030211mls-icomp.htm. Last Accessed March 8, 2011.

[3] See Commissioner Kathleen L. Casey. Commissioner: Statement Regarding Incentive-Based Compensation Rules Pursuant to Section 956 of Dodd-Frank. U.S. Securities and Exchange Commission. March 2, 2011. http://sec.gov/news/speech/2011/spch030211klc-icomp.htm. Last Accessed March 8, 2011.

Do small- to medium-sized advisors represent a threat to the systemic integrity of the worldwide financial system? Probably not, but you’d think so based on the flood of advisor regulations flowing out of Washington.

The Dodd-Frank compliance maze expanded again last week as the SEC commissioners voted unanimously to release proposed reporting requirements that will complicate the compliance landscape for many advisors. Although affected advisors are not among the largest advisors overseen by the SEC, they are nevertheless categorized by the Commission as large enough to represent a systemic threat warranting increased SEC attention.

And while the SEC has assured affected advisors that their proprietary trading strategies won’t become part of the public record, recent events like the Wikileaks private banking releases should spook advisors.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of recent SEC rulemaking activity in Advisor’s Journal, see SEC’s Plain English Requirement Equals Expensive Client Disclosures(CC 10-44) and SEC Approves FINRA Suitability and Know-Your-Customer Rules (CC 11-17).

The SEC recently approved FINRA proposed rules—FINRA Rules 2090 and 2011—that amend and consolidate know-your-customer and suitability obligations for broker-dealers and their authorized representatives. The new rules are based on, and replace in-part, similar NYSE and NASD rules. According to FINRA, the amended know-your-customer and suitability rules are intended to protect investors by “promoting fair dealing with customers and ethical sales practices.”

The new rules are effective as of October 7, 2011.  For previous coverage of the suitability standard and the debate over the proposed fiduciary standard in Advisor’s Journal, see What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10-40) and Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97).

Under the know-your-customer rule, firms are required to use reasonable diligence respecting the opening and maintenance of every account and to know essential facts about every customer. “Essential facts” are facts required to …. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).