State to assume oversight of advisers

The burden of regulating mid-size investment advisers will shift from federal to state agencies this year, a time when state budgets have been slashed and resources are limited.

The Dodd-Frank financial reform act mandates this regulatory shift for midsize investment advisers, or those who have between $25 million and $100 million in assets under management. Nationwide, 4,100 investment advisers will be transferred to state oversight this July.

Until now, these advisers have been regulated by the Securities and Exchange Commission.

But the burden will soon fall on the Colorado Department of Regulatory Agencies, or DORA, Division of Securities.

Whether the state securities division will be able to conduct more audits per year than the federal Securities and Exchange Commission remains to be seen.

The number of investment advisers in the nation nearly doubled from 2001 to 2009, placing more of a burden on regulators at the federal and state level.

But many states’ budgets have already been reduced and even cut to the bone, leaving in question their ability to beef up regulatory oversight any time soon. Colorado is no exception. For a couple of years now, the legislature has trimmed education, transportation and health and human services in an effort to balance the budget.

Investment advisers scoffed at the idea that the states can do a better job — especially in light of budget constraints.

That said, plenty of other advisers said they see the switch as a positive and believe DORA will, in fact, provide greater scrutiny because it is closer to the advisers it will oversee.

“There should be more audits, frankly,” said Susan Strasbaugh, president of Strasbaugh Financial Advisory, a registered investment firm. “It remains to be seen if that will be the case.”

The hang-up is the question of how the state will fund its new mandate.

The Securities Division is cash-funded, by fees and licenses, not by tax dollars, said Colorado Securities Commissioner Fred Joseph. Additionally, the state has some of the lowest fees in the nation, about $10 annually per investment adviser, and about $60 per large firm, compared to, say, Texas, which charges about $275 per year.

In Colorado, there are about 700 investment advisers or firms in Colorado with less than $25 million in assets under management.

Joseph expects that 100-plus firms will be above the $25 million threshold, and thus transfer to state oversight.

Most of the time, when the division of securities audits an investment firm, it finds that the firm needs only to improve its record-keeping.

In only about one out of 10 instances, Joseph said, does the division take action against a firm, usually by putting restraints on its license or taking the license away.

“It’s far and few between,” he said.

His goal is examine all the investment advisers in Colorado over the next four or five years. The department has four examiners, in addition to several people who issue licenses.

After the legislature convened this week, his department requested funding for three more examiners, with a July 1 start date. Although he won’t know until about April whether he’ll receive approval for these additional examiners, Joseph said the timing is opportune.

“In this environment, who can argue against more regulators?” Joseph said. “So far, our request has been well-received by our department and the governor’s office, so we think it has a good chance.”

A loss to consumers?

Joseph has a reputation for being aggressive as a watchdog, but some people expressed concerns that state regulators wouldn’t do as good a job as their federal counterparts.

“The SEC is trying to get out of the smaller, nickel-and-dime business and pass it off to the states,” said T. Edward Williams, an attorney with Vaden Law Firm in Denver. “That cannot be good for consumers.”

The reason for his concern is primarily two-fold: The level of sophistication at the federal level vs. the state level, and the level of funding.

States such as New York, Illinois, Massachusetts and California have regulators that are “pretty vibrant,” Williams said.

Other states including Colorado don’t have the financial resources and personnel to go after advisers who are committing fraud or misleading clients.

Investors, as a result, will have to be more vigilant about whom they invest with, he said. As clients realize that regulatory oversight has changed, it’s possible that lawsuits against investment advisers could increase, as well.

“There’s no doubt in my mind that these entities want to be regulated by the state, not the feds,” Williams said. “Overall, it’s a loss to consumers.

“The states will struggle, and so consumers will also struggle,” Williams said.

The securities commissioner disagreed.

“We are well-positioned to do this,” Joseph said. “I feel we can handle it.”

DORA Division of Securities at a glance

Employees: Four regulators, several clerks who process licenses.

Budget: $3.2 million.

Investment advisers/firms it regulates: About 700

Investment advisers/firms it will regulate beginning in July: About 800

Complaints received in 2010: 183

Open investigations: 129

Investor dollars recovered in 2010: $515 million

Source: DORA.