Your Investment Adviser Needs an Annual Inspection

In most states, automobiles must be inspected annually to make sure they meet minimum safety standards. This inspection is typically paid by the car owner. And while these inspections may not catch all vehicle problems, they help prevent cars with a range of safety violations from getting back on the road. That provides significant benefits, including peace of mind, to the driving public

Now imagine if cars were inspected on average only once every 11 years and that 40% of cars never get inspected. Would that affect your confidence to drive in your city? How wary would you now be of the car next to you? Would you consider changing to public transportation to avoid other cars on the road? My suspicion is that many of us would change our driving habits to one degree or another. I myself am not sure I’d feel comfortable driving at all.

This, unfortunately, is the situation with investment advisers: They’re inspected or audited on average only once every 11 years, and 40% have never been audited at all.

Do you think that if this information were widely known by the public, consumers would have less confidence in investment advisers? I think they would. Let’s say you’re an investment adviser: Could that impact your own practice, even if you play by all the rules? I think it could.

The management of life savings is a very personal and emotional decision for many investors. An effective investment adviser listens very carefully to a client’s personal situation, crafts a customized investment policy statement for that client, and then abides by this directive to manage the client’s portfolio by executing it and monitoring it to make sure the client is well served. The media has reported widely over the years on egregious cases in which investors have been taken advantage of by investment advisers who clearly were not placing their client’s interest first.

The Securities and Exchange Commission, which is primarily charged with examining investment advisers, has its hands full. Even with the best of intentions, the SEC cannot always perform examinations with the regularity that it wants to. Funding issues are no doubt part of the problem.

To better serve the public, shouldn’t we making sure that checks and balances are adhered to and to monitor this by doing more regular examinations of investment advisory practices?

Is there a better way to ensure that the frequency of an examinations goes up to the point where all investment advisers are audited at least every three or four years?

Perhaps, similar to the requirement that cars be inspected once a year, investment advisers should pay a nominal user fee that is dedicated to regular examinations of those registered by the SEC. It’s difficult for us advisers to argue against this concept, because we’re the ones who benefit from the privilege to be able to work in this profession — just like people benefit from the privilege of driving on a road with a reasonable degree of safety.

There is a bill already before the U.S. House of Representatives (H.R. 1627) that supports this approach and has bipartisan support. This bill has wide industry support, too, from organizations including: AARP, Consumer Federation of America, Certified Financial Planner Board of Standards, Financial Planning Association, Investment Adviser Association, National Association of Personal Financial Advisors, and the North American Securities Administrators Association.

So while it’s true that such an approach should probably have been adopted years ago, we have a notable opportunity to move this trajectory in a positive direction. If we succeed, the public is better protected and served, and we all as investment advisers can benefit from greater confidence in us and in the work we do.

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Stuart Armstrong, CFP, is a member of the Financial Planning Association Board of Directors.