Mandatory Third Party Compliance Examinations for Investment Advisers: An SEC Waterloo?

Authors

Mercer Bullard

Abstract

The Securities and Exchange Commission (SEC or Commission) appears to be on the verge of requiring investment advisers to undergo third party examinations. One justification for the rulemaking is that the Commission lacks sufficient resources to examine advisers frequently enough. Another is to create indirectly a self-regulatory organization (SRO) for investments advisers. Both may leave a rulemaking particularly vulnerable to challenge as arbitrary and capricious under the Administrative Procedures Act. This Article considers three novel grounds on which a rulemaking may be successfully challenged. Congress has repeatedly rejected SEC requests to provide additional funding for examinations or to create an adviser SRO. This Article speculates that the rulemaking could be successfully challenged on the grounds that it usurps Congress’s power of the purse by imposing an unauthorized tax on investment advisers, and/or Congress’s authority to authorize the creation of an adviser SRO. On firmer ground, the Article discusses the risk that Section 206(4) of the Investment Advisers Act of 1940, under which a third party examination rule would likely be adopted, does not authorize such broad rulemaking. Such a challenge could not only defeat the rulemaking, but also undermine the viability of other rules adopted under Section 206(4). This Article also considers some of the numerous examples of third party examiners that could provide useful models for a third party examination rule for advisers. It surveys seven types of third party examiners in order to provide a framework for thinking about how a third party compliance rule might be designed: nationally recognized statistical rating organizations; proxy firm advisors, the CFA Institute, public company auditors, compliance consultants, chief compliance officers, and surprise and internal controls auditors. Each examiner serves a distinctly different third party examination role and their regulation is equally varied, if not always consistent.

Recommended Citation

Mercer Bullard, Mandatory Third Party Compliance Examinations for Investment Advisers: An SEC Waterloo?, 11 Brook. J. Corp. Fin. & Com. L. (2016).
Available at: https://brooklynworks.brooklaw.edu/bjcfcl/vol11/iss1/5