Aim­ing at ‘Egre­gious Con­duct’

The SEC is drilling down on in­vestor pro­tec­tions, while warn­ing firms on cy­ber­se­cu­rity and AML com­pli­ance.

Financial Planning - - CONTENT - By Ken­neth Corbin

The SEC is drilling down on in­vestor pro­tec­tions, while warn­ing firms on cy­ber­se­cu­rity and AML com­pli­ance.

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.

In Septem­ber the SEC launched a 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.

Clay­ton — along with the re­cently in­stalled co-chairs of the SEC’S En­force­ment Di­vi­sion, Stephanie Avakian and Steve Peikin — has 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 at a re­cent con­fer­ence hosted by the Prac­tis­ing Law In­sti­tute in New York that was also 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 ... and insider trad­ing,” she said.


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 said.

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 said.

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 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.

The new group “will look at the many ways that re­tail in­vestors in­ter­sect with the se­cu­ri­ties mar­ket, and will look for wide­spread mis­con­duct,” Mehra­ban said.


“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,” she added.

The re­tail in­vestor task force isn’t the only re­cent struc­tural ad­di­tion to the com­mis­sion. Aligned with that group is a sep­a­rate unit that is ded­i­cated to man­ag­ing cy­ber­se­cu­rity is­sues, a re­lated field Mehra­ban says is com­ing into sharper

fo­cus at the com­mis­sion.

“When Steve Peikin first came on board this sum­mer, he said that, in his view, cy­ber­re­lated threats and mis­con­duct are among the great­est risks fac­ing in­vestors and the se­cu­ri­ties in­dus­try,” Mehra­ban said.


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 stressed 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 said.

In­deed, in many of the cases in which the SEC has brought an en­force­ment ac­tion, “a strong com­pli­ance pro­gram would have pre­vented the is­sue from even oc­cur­ring in the first place,” she said.

Mehra­ban said she sees ad­di­tional com­pli­ance fail­ures in firms’ anti-money laun­der­ing pro­grams, which could be­come a ma­jor is­sue for ad­vi­sors.

As of late Novem­ber, the Trea­sury Depart­ment’s Fi­nan­cial Crimes En­force­ment Net­work was draft­ing a rule that would re­quire ad­vi­sors to de­velop for­mal AML pro­grams.

A FINCEN spokesman con­firmed 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 wrote 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 said. “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 re­cent cases that the SEC has brought against bro­kers and other reg­is­trants for AML is­sues have cen­tered on firms’ fail­ures to ad­e­quately im­ple­ment poli­cies al­ready on the books, she said.

Those cases 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 ar­gued that an AML pro­gram can be a win­dow into a firm’s broader com­pli­ance pos­ture. To get it right, she said, firms must es­tab­lish com­pli­ance as a core func­tion, as both a mat­ter of cul­ture and in terms of how the firm runs on an op­er­a­tional level.

“We in en­force­ment are fo­cused on re­tail in­vestor fraud, in­vest­ment pro­fes­sional mis­con­duct, fi­nan­cial fraud, cy­ber and insider trad­ing.” — Lara Shalov Mehra­ban, SEC

SEC Chair­man Jay Clay­ton has pushed en­force­ment ef­forts that fo­cus on re­tail in­vestor fraud, in­vest­ment pro­fes­sional mis­con­duct, fi­nan­cial fraud and insider trad­ing.

Cy­ber­se­cu­rity is­sues are a ma­jor source of risk fac­ing in­vestors, and a key fo­cus of the SEC.

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