SEC proposes new rules over money managers

Curbs would help safeguard client assets, agency says

SEC chairwoman Mary Schapiro is mulling reforms such as increasing the use of professional examiners. SEC chairwoman Mary Schapiro is mulling reforms such as increasing the use of professional examiners.
By Jesse Westbrook
Bloomberg / May 15, 2009
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WASHINGTON - The Securities and Exchange Commission moved to impose new rules on money managers to safeguard client holdings after Bernard Madoff's Ponzi scheme cost investors $65 billion.

SEC commissioners voted 5 to 0 yesterday on a proposal to subject about 9,600 investment advisers to annual surprise inspections by independent auditors. About 370 money managers with direct custody of client holdings would also face yearly compliance exams to ensure they have adequate procedures to protect assets.

"We are taking this action in response to major investment scams such as Madoff," SEC chairwoman Mary Schapiro said at a public meeting in Washington. "Our proposals would greatly enhance the independent checks on client assets."

The SEC is trying to strengthen oversight after lawmakers criticized the agency for missing Madoff's scheme. Schapiro is considering other reforms such as increasing use of professional examiners and overhauling the structure of the SEC enforcement division, which investigates and prosecutes fraud.

About 11,000 money managers are registered with the SEC and most keep client assets with an outside firm to prevent misuse.

Still, almost all investment advisers have custody of customer holdings "in one form or another" through an affiliate or because they have authority to withdraw funds, Schapiro said. Fewer than 200 money managers now undergo surprise audits, SEC staff told reporters after the meeting.

Under current SEC rules, money managers aren't subject to surprise audits if an independent custodian sends account statements to clients detailing their holdings. Under the proposed rule, money managers who hire brokers to send out statements would also undergo unannounced examinations.

Some banks and money managers are permitted direct control over customer assets because they've registered with US regulators as both an investment adviser and a brokerage. The SEC proposal would subject such firms to an "annual custody control examination" performed by an auditor regulated by the Public Company Accounting Oversight Board.

The rule would affect about 370 money managers and force them to hire accountants subject to board inspections. Madoff was audited by Friehling & Horowitz, an unregulated three-person firm in New City, N.Y.

The SEC will seek comments on its proposals for 60 days. The agency's staff will then determine whether to make any changes before the chairman and four commissioners hold a second vote to make the regulations binding.

Madoff, who raised money from new investors to pay off his earlier clients, told customers he "self-custodied" securities on their behalf, the SEC wrote in a March 18 lawsuit against his auditor. Had the auditor checked the claim, Madoff's scheme would have been exposed, the agency said.