The North American Securities Administrators Association (NASAA) released preliminary numbers this month showing that the number of enforcement cases brought by state regulators doubled during 2011. During that year, states brought about 400 cases compared to 208 cases brought during 2010. This increase is due in large part to an expansion of state examinations as a result of the Dodd-Frank financial reform law. Dodd-Frank gave the states examination authority for some approximately 2,400 “mid-sized” advisers (firms with less than $100 million in assets under management) which are required to switch from SEC to state registration.
As a result of the switch, some former SEC firms that haven’t been examined in many years, if ever, by the SEC now find themselves subject to a state examination and can also look forward to being examined by the state more frequently.
The types of violations seen most often in the state examinations include undercapitalization in those states that have net capital requirements, failure to maintain client and other books and records, and marketing violations, including false performance claims.
The number of state enforcement actions against RIAs is still dwarfed by the 3,000 or so actions against unregistered securities dealers, brokers, and insurance agents in 2011. States have historically focused on unregistered issuer or brokerage activity, but in the run up to Dodd-Frank touted their RIA examination skills and vowed to exercise their new power thoroughly. In anticipation of exercising their new examination powers, states entered into pacts to share information and resources and even in some cases held workshops to explain to mid-sized advisers what they could expect.
According to Liz Skinner’s recent article in Investment News, some in the industry lament the examiners focus on “technicalities,” or complain about having to be bound to a “rule-based” regime rather than examiners who focus on the broader fiduciary standard by which all RIAs are bound. But most RIAs have accepted the new examination regime in stride. Even for those firms that have been found to be deficient, and almost all are deficient in one way or another, most find that state regulators’ approach is generally to try to help correct deficiencies that do not rise to the level of fraud and to help foster better compliance within the organization.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds and issuers of securities, among others. Our regulatory practice group assists financial service providers with the complex issues that arise in the course of their businesses, including compliance with federal and state laws and rules.