I read an article in the InvestmentNews online publication this past week, “Regulators to crack down on phony AUM” by Dan Jamieson. It was a very good article with some interesting facts. Registered investment advisors (RIAs) are required to report on an annual basis the assets under management (AUM). For obvious reasons, RIAs may be tempted to overstate this number to enhance its marketing efforts. After all, we have grown up in a society where bigger is better. Everyone wants to be investing with those that are handling lots of money, rather than with an advisor who only has a handful of clients.
Under the Dodd-Frank Act, firms with AUM over $100 million must register with the Securities and Exchange Commission (SEC) while firms under that threshold must register with state securities regulators. Now comes the part of the article that I had to re-read several times. According to the article, state securities regulators generally conduct examinations more frequently than the SEC. Ok, let me write that a different way: RIAs with AUM under $100 million may get examined more frequently than larger RIAs with AUM over $100 million. Does anyone else have a problem with this?
As the article goes on further, to explain that in many cases, there are real problems with calculating AUM correctly. Under Dodd-Frank, there is a new method of calculating AUM with the moniker “regulatory assets under management.” These new changes seem to inflate the AUM of an RIA, thus potentially elevating them to the higher $100 million threshold and possibly not being regulated as frequently.
The article did go on to say that the SEC will be monitoring the filing of ADV (the form used to report AUM) much more closely than ever before.
I would rather the SEC spend more time examining the RIAs with AUM over $100 million than determining if they properly added up their AUM. But, that’s just me.
Click here for the article.
Last month, Jay Hanson, a PCAOB (Public Company Accounting Oversight Board) member, stated at an AICPA Conference that implementation of a mandatory audit firm rotation was unlikely. In a written statement presented at a CPAB roundtable in Houston in October, Hanson said that one obstacle to implementing mandatory auditor rotation was the absence of research proving a clear correlation between audit quality and auditor tenure. A second… was a cost benefit analysis.
This is a topic that has been debated and hopefully will only remain as a debate (it would if I had my way.) I am not a proponent of audit firm rotation. I don’t see the benefit to the user of the financial statements. The current system is not broken. If auditing standards are properly followed, the system works fine.
Required firm rotation would be a costly proposition. From a time perspective, the business’ financial team would have to be taken away from their normal daily routine to interview prospective audit firms. They would then have to educate the new audit firm about their business and operations. From an actual dollars and cents prospective, audit fees would increase. Typically, audit firms will not charge for their initial “ramp up” time in learning the new client’s business, instead they write off this time as an expense of doing business and investing in a long-term relationship. Required rotation would cause firms not to write this time off and thus pass it along to the new client.
The chances that firm rotation would find the fraud is not increased by having a new firm perform the audit. In fact, if a study was done, I think you would find just the opposite. Anytime you learn something new there is always the chance of missing something until you become familiar with it.
The financial debacles are not an audit problem at all. If someone wants to commit a crime they will do it and the chances an audit will find it are slim. Unless I am testing 100% of all the transactions, there is a chance I will not select the one or two fraudulent transactions. Even the best controls can be circumvented and not be detected through an audit.
What we really have is the CPA being held out as a scape goat for all the financial debacles. We obviously need better lobbyists.
All I have been hearing over the past month when I turn on the news is how much taxes are increasing, how far down is the drop from the cliff, should we sell our stock, should we pay off expenses – what should a taxpayer do?
I have been getting calls from clients (and my mom) on what this all means to them. Of course the most important person is my mom, because she heard there is an extra tax on her whopping $500 in dividend income which – I explained - will not affect her. I’m not sure she believed me verbally, so maybe if it’s in writing she’ll believe it. After all, if it’s on the internet it must be true.
Check out Tony Nitti’s blog on Forbes.com, “Secrets Of the Fiscal Cliff Deal” to learn about the tax situation affecting all taxpayers.
The cost of the 3.8% tax on dividends and interest to certain taxpayers will come into play for the financial services industry. Investors will surely look at this as an additional “fund expense,” since it reduces their overall return on investment.