Financial planner Thomas J. Lydon Jr. was taken aback last summer when two men carrying briefcases walked into his office on Chicago’s Northwest Side.
The men said they were from the Illinois Department of Securities and were there to check on his operations.
Unbeknownst to Lydon, his firm and thousands of other financial-service companies in the state had become subject to the agency’s inspection as the result of a 1996 federal law.
“I’d never heard of the new program,” Lydon admitted. “They came in unannounced and showed me their credentials. I called their office afterward to verify who they were.”
The legislation encourages states to take over the regulation of financial planners and investment advisers who manage less than $25 million in assets for their clients.
Lydon, who manages about $200,000 in investor assets, is a certified public accountant as well as a certified financial planner, a designation issued by an independent organization in Denver based on education, experience, examinations and ethics requirements.
Under an Illinois law that took effect July 8, such firms and their employees who sell investments or give advice for a fee must register with the state agency.
The move was designed to reduce the burden on the federal Securities and Exchange Commission, which continues to regulate planners and advisers managing more than $25 million.
“We always conduct surprise examinations,” says Robert Newtson, the Illinois agency’s director. “They don’t know when we’re coming. We know it’s disruptive to their business, and we try to be sensitive. But they should always be keeping their books in order.”
The audit teams, he says, generally consist of two or three people carrying laptop computers and sometimes even a portable copying machine.
Illinois has required investment advisers and broker-dealer firms doing business in the state to register since the 1950s, sharing oversight with the SEC. But the state agency hadn’t required the firms’ sales representatives–including those who make unsolicited, or cold, calls to prospective customers–to register until this past summer.
“Few of the exams we’ve conducted so far have turned up any indications of fraud,” Newtson said. “Most of the violations have been procedural.”
For less serious infractions, the department can order suspensions: When one securities firm’s branch office in Downstate Morton failed to correct violations found by a state audit team, the agency suspended the branch manager for 30 days. In more serious cases, it can levy administrative fines of up to $10,000 per violation and refer fraud or criminal cases to law-enforcement authorities for prosecution.
“Only time will tell how effective it will be,” James Cloonan, head of the Chicago-based American Association of Individual Investors, said of the new inspection program. “It’s been tried before and made very little difference. We’ll have to wait and see if it just adds another cost for investors.”
Newtson, who headed the regional Small Business Administration in Chicago before joining the state securities division four years ago, acknowledged that “no one really knows what to expect” from the new responsibilities being put on his relatively small agency, but the number of people it covers is burgeoning.
For example, the state licensed 2,433 broker-dealer firms in the fiscal year ended June 30, up 40 percent from fiscal 1991. During the same period, the number of registered investment advisers jumped 56 percent, to 1,524.
Newtson said he expects 17,000 salespeople and 1,000 to 1,300 planners to register in Illinois next year if they fall under the agency’s purview.
The new law will certainly hit big financial-services firms. For example, American Express Financial Advisors Inc., a Minneapolis-based subsidiary of American Express Co., is registered with the SEC and National Association of Securities Dealers. But because it has 11 large offices with about 350 investment adviser representatives in Illinois, it also must register with the state.
The registration fee amounts to $200 a year for a firm and $75 for each sales representative.
Because all but four states have begun registration programs, a national firm such as American Express may have to meet different standards in different states.
To lessen such a burden, securities regulators are meeting to adopt uniform standardized exam standards, Newtson says.
“We’re also working with the North American Securities Administrators Association”–a regulators group–“to develop a national database for investment adviser registrations and disciplinary actions,” he said.
“We’d also like to see the creation of an umbrella self-regulatory organization for financial planners similar to the National Association of Securities Dealers. There are more than a dozen professional certification groups now.”
A problem is that anyone can call himself or herself a financial planner.
Newtson said the new Illinois registration requirement doesn’t apply to lawyers, accountants, family financial counselors or the like unless “they charge a fee or commission for specifically giving investment advisory services.”
He said his agency hopes to conduct its periodic examinations and investigate fraud and criminal violations without increasing its 56-member staff. Virtually everyone, from clerical workers to Newtson himself, received training in the last few months to perform audits in the field.
“We did 150 examinations in the last fiscal year with a 12-person audit staff,” he said. “We expect to double the number of exams–to 300 plus–this year with the newly trained people. Hopefully, we expect to do close to 1,000 per year ultimately. That would get us to a three-year cycle of exams.”
