Posted by David Gaffen

Suzanne Barlyn reports:

Testimony about the Bernard Madoff fraud scandal before the Senate Banking Committee on Tuesday and recent inquiries by the Financial Industry Regulatory Authority could signal that investment advisers are one step closer to self-regulatory oversight, say industry observers.
 
"[I]t's possible that Finra should have jurisdiction over investment advisers or alternatively that investment advisers should have to have their own self regulatory organization," said Columbia Law School professor John C. Coffee, in response to a question from Senate Banking Committee Chairman Christopher Dodd, (D-Conn.)

Mr. Coffee also suggested this issue "should be on the table for Congress to at least recognize." The professor testified earlier in the proceeding, in part, about an increasing prevalence of Ponzi schemes among investment advisers and hedge funds.

Stephen Luparello, Finra interim chief executive, was clear about the self regulator's inclination to oversee investment advisers. "The absence of Finra-type oversight of the investment adviser industry leaves their customers without an important layer of protection inherent in a vigorous examination and enforcement program and the imposition of specific rules and requirements," Mr. Luparello said in a prepared statement.

U.S. Securities and Exchange Commissioner Mary Schapiro, Finra's former chief executive, told the Senate Banking Committee during her confirmation hearing Jan. 15 that Finra wasn't able to investigate the investment adviser arm of Bernard L. Madoff Securities, where the alleged fraud was perpetrated, because its jurisdiction extended only to the broker-dealer side.

"The entire industry has been discussing this for years - but the Bernie Madoff case has lit a fire under the issue," said David Thetford, securities compliance principal analyst for Wolters Kluwer Financial Services. "I'd be willing to bet that investment advisers will end up with some sort of self regulatory organizations this time - and I would lay my money on Finra."

Finra was authorized by Congress in 1938, empowered to oversee broker dealers. Expanding Finra's jurisdiction to include investment advisers has been an increasing source of debate as more brokers migrate to the investment adviser model. A decline in commissions for executions, due to the advent of alternative trading systems is one reason for the shift, according to David Tittsworth, executive director of the Investment Adviser Association, an industry group in Washington, D.C.

There are 11,300 investment advisers registered with the U.S. Securities and Exchange Commission, according to Linda Chatman Thomsen, the agency's director of the division of enforcement. "While we appreciate and examine every lead we receive, we simply do not have the resources to fully investigate them all," Ms. Thomsen told the committee, in prepared testimony.
 
Many advisers are expecting changes sooner rather than later.

"More regulation is coming. I don't see how it couldn't be," said Donald Cummings, a registered investment adviser with Blue Haven Capital LLC in Geneva, Ill. "As I tell my kids, 'a few people spoiled it for the group,'" he said.

Mr. Cummings said he suspects that Finra, not a separate self-regulatory organization, will ultimately oversee investment advisers. Another alternative, he said, would be for Finra to operate separate divisions for broker-dealers and investment advisers, but share information between the two.
Recent actions by Finra are also fueling speculation that the possibility of additional oversight of investment advisers is closer.

Monday, Dow Jones Newswires reported that Finra sent a five-page letter to an unknown number of broker-dealers, asking for information about referrals they made to Mr. Madoff's firm and or other investment advisers. Finra's requests in the letter, dated Jan. 15, included copies of supervisory procedures covering such referrals, presentation and marketing materials associated with the investment advisers or the Madoff firm, and written descriptions of due diligence conducted on investment advisers or Madoff.
 
Dow Jones Newswires also reported Thursday that certain broker-dealers received a five-question request from Finra inquiring whether the firm has an investment advisory or hedge fund business within the registered broker-dealer, or whether it's affiliated with an investment adviser.
 
"Obviously, Finra is using the Madoff scandal to support their desire to extend their jurisdiction to investment advisers," said Mr. Tittsworth. Regulation of investment advisers by the SEC is "effective and efficient," he said. Additionally, investment advisers, unlike brokers, are fiduciaries and, therefore, prohibited from activities that are in conflict with their clients.