Can California Handle Dodd-Frank?

In 1996, Congress apportioned regulation of investment advisers between the Securities and Exchange Commission and the states based on the amount of assets that an adviser had under management.  At that time, Congress drew the line at $25 million in Section 203A of the Investment Advisers Act of 1940 (subsequent rulemaking by the SEC generally did not require SEC registration until the adviser had assets under management of at least $30 million).  Now, Congress has redrawn the line at $100 million in the Dodd-Frank Wall Street Reform and Consumer Protection Act  (n.b. - this is a very simplified explanation of the effect of the legislation; as always, the devil is in the details). 

For the California Department of Corporations, this change means that it will be regulating many more advisers and these new advisers will be substantially bigger than the advisers that it currently regulates.  Currently, the Department registers and regulates just over 3,000 investment advisers and imposes reporting and other requirements with respect to 47,000 investment adviser representatives or associated persons.  While it is difficult to predict how many more investment advisers will come under the Department's sway, my understanding is that the Department is anticipating up to a 50% increase (or about 1,500 advisers). 

While the Department will benefit from increase fee revenues, it still must figure out how to handle this increased workload.  Currently, the Department's investment adviser program is part of the Securities Regulation Division which referred to in the Department as "SRD".  SRD also handles securities and franchise offerings and broker-dealer licensing.  Although California's SRD is large compared to other states, it is small compared to the size of the California economy.  The investment adviser activities within SRD are largely handled by examiners and auditors around the state. 

With this background, here are my thoughts on some steps that the Department should take to meet its new responsibilities:

  • Carefully evaluate the financial requirements of its expanded responsibilities.  While the Department will receive additional filing fees, these funds cannot be spent without legislative appropriation.  The budget process is excessively protracted - today, California is operating without a budget. 
  • Move forward on its existing proposal to amend its investment adviser rules.  The Department issued a comprehensive rulemaking proposal three years ago but no final rules have been adopted.  The Department should re-examine this proposal in light of the changes made by the Dodd-Frank Act.
  • Implement a risk-based methodology to examinations of investment advisers. 
  • Consider whether one or more attorneys should be assigned to the investment adviser unit.  It is my understanding that currently no attorney within SRD has full time responsibility for investment advisers.

The higher dollar thresholds for state regulation under the Dodd-Frank Act mean that exposes the public to greater risk if the Department cannot fulfill its increased responsibilities.  My understanding is that the Department is already considering many of the items that I've listed above.