WASHINGTON -- The Government Finance Officers Association yesterday said it strongly supports legislation pending in the House that would require the Securities and Exchange Commission to accelerate inspections of higher risk investment advisers.
But SEC Chairman Richard Breeden said that though the agency supports an inspection program that highlights riskier firms, the bill goes too far.
The legislation would mandate that new investment advisers be inspected within a year, that regular inspections are performed, and that follow-up inspections are made when deficiencies are discovered. The bill also would require the SEC to consider various risk factors in determining the need for such inspections, including the frequency of customer complaints and custody of funds.
Linda Sheimo, director of the treasury division for Minneapolis, in testimony before the House Energy and Commerce Committee's subcommittee on telecommunications and finance, said the inspection plan is "one of the major benefits of this legislation." The knowledge that they will receive continued scrutiny should encourage advisers to comply with the law, SEC rules, and ethical practices, she said.
But Mr. Breeden, whose agency supports a number of provisions in House legislation sponsored by subcommittee Chairman Edward J. Markey, D-Mass., said the provisions for first-year and follow-up inspections "unfortunately would compromise the very result this legislation seeks to accomplish -- putting the commission's oversight program on sound economic footing."
He said roughly 2,500 new advisers register with the commission every year. "Even if under some 'risk factor' approach only half of these were examined, the corresponding personnel drain on the rest of the program would be significant," he said.
Ms. Sheimo said more and more municipalities are using external investment advisers to help them manage short-term funds -- at least $34 billion in public funds is placed with advisers. According to Fidelity Investments, firms that oversee local government investment pools currently oversee assets of roughly $7 billion. There is about $7 billion to $10 billion of public assets in money market mutual funds, with about $10 billion in banks using money market mutual funds. Another $5 billion to $7 billion is placed with other firms managing public assets.
In 1981, only two states allowed public investments in money market mutual funds, while 23 states permit it today, she said. In 1986, the investment pools managed assets of $4.5 billion, while 1991 figures show that the pools manage approximately $20 billion.
"GFOA has long advised its members to exercise caution in the investment of public funds and in their selections of investment advisers assisting them in this task," Ms. Sheimo said. "External managers offer an opportunity to diversify investments, increase yield, and reduce internal costs. Expanding state statutes provide greater investment options. Many finance officers, particularly in smaller jurisdictions, turn to investment advisers for assistance in handling their funds."
Mr. Breeden said the commission supports several provisions in the Markey bill that do not appear in a shorter proposal approved recently by the Senate Banking Committee, S. 2266. For instance, the House bill makes it clear that investment advisers must make a determination that the securities they recommend are suitable for buyers.
The House version also would make it clear that employees of advisory firms can be sued by the agency under the antifraud provisions of the federal securities laws. Under the current statute, when officials and employees engage in fraudulent conduct, the SEC has to sue the registered corporate investment adviser and can only pursue individuals under "aiding and abetting" theories.
"We didn't do anything specific to cover" independent public financial advisers, said a Markey aide, touching on an emerging issue in the municipal arena. "Off the cuff, nothing would explicity draw them in. But, it would be our belief that it would be a mistake on the SEC's part if they were giving advice that there would be absolutely no reason why they would have to register. We would disagree with a no action" position, she said.
Agency staff recently issued a pledge not to take enforcement action against a firm that was advising a municipality on how to temporarily invest bond proceeds. Key staff members, however, have said they will think twice before issuing a similar interpretation again.
The House bill also would allow the SEC to deny or withdraw the registration of any person convicted of a felony. In addition, the measure would authorize the SEC to require advisers that have custody of client funds or securities, or have discretionary authority over client assets or advise investment companies, to get a fidelity bond to protect clients against theft or embezzlement of client assets. He said about 3% of advisers have discretionary authority. Most investment advisers use an independent custodian such as a bank or broker-dealer.
Mr. Breeden said the SEC strongly opposes a provision that would require every adviser's recommendation to include the commission or other cash compensation it would receive for a particular sale.
The financial advisers law exempts accountants, lawyers, and brokers from coverage if they give investment advice that is "solely incidental" to the practice of their profession or the conduct of their brokerage business, and in the case of brokers if they receive no special compensation for the advice. The bill would require the SEC to adopt rules outlining the elements of the exclusion, a provision Mr. Breeden said is unnecessary and would lead to highly complex, confusing, and lengthy regulation.