This article was originally published by Financial-Planning.com
As the SEC charts a new course under Chairman Jay Clayton and his top lieutenants, enforcement actions against advisors serving Main Street investors could be on the rise, officials warn.
The Securities and Exchange Commission headquarters
In September, the SEC launched a new task force focused on abuses against individual investors, and now enforcement officials are training their sights on a broad range of issues in play for advisors working with retail clients, including investment suitability and mutual fund share classes.
While the SEC may be ramping up enforcement, the number of cases filed last year have slowed. The regulator tried to obtain $3.4 billion in fines and disgorgement during the 12 months ended in September. During that time it filed 612 enforcement cases, also the fewest in four years, according to research.
Clayton, as well as recently installed co-chairs of the SEC’s Enforcement Division Stephanie Avakian and Steve Peikin, have led the agency’s new approach.
“What Chairman Clayton and Steph and Steve have spoken about in terms of priorities for enforcement are subject matters that impact and matter to Main Street investors,” Lara Shalov Mehraban, associate regional director for enforcement in the SEC’s New York office, said this week at a conference hosted by the Practising Law Institute in New York and broadcast online.
“So what does that mean? At a high level, it means that we in enforcement are focused on retail investor fraud, investment professional misconduct, financial fraud, cyber and insider trading,” she says,
The Retail Strategy Task Force will cast a wide net, but its core focus will be on ferreting out “egregious conduct by registered entities and individuals,” Mehraban says.
In the RIA world, that translates into increased scrutiny into the appropriateness of the investments advisors are recommending to their clients. Specifically, the SEC is increasingly concerned with conflicts of interest and high-cost mutual fund share classes.
“Some examples of problems we’re continuing to see are investment professionals steering customers to mutual fund class shares with higher fees when lower fee share classes of the same fund are available,” Mehraban says.
Mehraban also cited concerns about wrap fees, micro-cap stocks and alternative investments as areas of focus for the retail investor task force.
In creating the new panel, the SEC drew on enforcement staff throughout the country, as well as officials from the SEC’s Office of Compliance Inspections and Examinations and Office of Market Intelligence.
“This group will look at the many ways that retail investors intersect with the securities market and will look for widespread misconduct,” Mehraban says. “By dedicating additional resources and expertise to developing strategies to address misconduct that victimizes retail investors, we’ll be in a better position to protect our most vulnerable market participants.”
FOCUS ON CYBER
The retail investor task force isn’t the only recent structural addition to the commission. Aligned with that group is a separate unit dedicated to cybersecurity issues, a related field that Mehraban says is also coming into sharper focus at the commission.
“When Steve Peikin first came on board this summer, he said that in his view, cyber-related threats and misconduct are among the greatest risks facing investors and the securities industry,” Mehraban says.
The cyber unit consolidates various commission programs into a single entity dedicated to countering the digital threats to market integrity and sensitive information.
Those threats could take the form of bad actors trying to gain access to material nonpublic information, using social media in an attempt to sway markets, or hacking into brokerage accounts to manipulate trading. Or, for advisors covered under the SEC’s Regulation S-P privacy rules, it could mean a failure to reasonably safeguard clients’ personal information.
Mehraban stresses that the cyber initiative and the retail task force are working toward a common purpose, and are intended as complementary efforts.
“For each of the priorities you can see the connection to the protection of the Main Street investor, and I think you can also see the importance of compliance personnel and strong compliance programs,” she says. Indeed, in many of the cases where the SEC has brought an enforcement action, “a strong compliance program would have prevented the issue from even occurring in the first place.”
AML RULE LOOMS
Mehraban sees additional compliance failures in firms’ anti-money laundering programs, which could become a major issue for advisors down the road. At the moment, the Treasury Department’s Financial Crimes Enforcement Network is drafting a final rule that would require advisors to develop formal AML programs.
A FinCEN spokesman confirms that the agency is committed to advancing the rule but declined to speculate on timing.
“It’s still under development and still moving forward,” Stephen Hudak writes in an email.
Should that rule become the law of the land, the SEC would have responsibility for overseeing advisors’ AML programs.The agency’s recent reviews of how other firms have been working to keep bad actors out of the financial system have found significant compliance failures.
“First, adopting AML policies is not enough,” Mehraban says. “Having adopted AML policies, firms need to implement them. An AML policy that says all the right things yet sits on the bookshelf is not particularly useful.”
Several of the recent cases that the SEC has brought against brokers and other registrants for AML issues have centered on the firms’ failures to adequately implement the policies that they already had on the books, she says. Those included failing to identify and respond to red flags, not filing suspicious activity reports or filing those reports with insufficient information to spot potential abuses of the financial system.
Mehraban argues that an AML program can be a window into the firm’s broader compliance posture. And to get it right, firms need to establish compliance as a core business function, both as a matter of culture and in terms of how the firm runs on an operational level.