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Investors Raise Advisor Fraud Concerns With the SEC

By Rita Raagas De Ramos June 14, 2018

In a town hall meeting with the SEC on Wednesday investors shared their concerns over advisor fraud, the skills and education of financial professionals, and the need for clarity around suitability versus best interest standards.

The town hall meeting in Atlanta, Ga. was conducted by the five SEC commissioners and staff members from across the agency. In attendance were SEC Chairman Jay Clayton and Commissioners Kara Stein, Michael Piwowar, Robert Jackson and Hester Peirce.

The event was billed as an opportunity for all "Main Street" investors – “from those who just started their first job to those approaching retirement” – to share their views and concerns with the SEC on topics that directly affect their personal finances.

The first question raised by an attendee was “Do you think that the SEC has institutional responsibility for the Madoff fraud and the adverse impact on the investors’ lives ruined?”

Clayton said concern about Ponzi schemes – such as Bernie Madoff’s defrauding investors of around $65 billion in assets – “is at the forefront of our minds,” especially when the victims are “old people.”

Without addressing whether the SEC should take institutional responsibility for advisor fraud, Clayton said “more importantly,” the gravity of the Madoff fraud is an “institutional memory” for the SEC.

“It’s with us every day,” Clayton said. “We go through a number of exercises” – referring to inspections and examinations, including asset verification – “to ensure that type of thing can’t happen again.”

Commissioner Piwowar said the SEC went through a “soul-searching process” after the Madoff scandal. “What went wrong? Why did it take so long to find this?” were among the questions the SEC addressed, he said.

The SEC has learned from its mistakes and has done a “number of things … to make sure it doesn’t happen again, in terms of that magnitude.”

Citing an example, Piwowar said the SEC has centralized its fraud “tip” process. “We know that any single tip may not be useful but if you get multiple tips or multiple questions, a pattern of that is very, very useful,” he said.

Piwowar also cited the SEC’s whistleblower program, where a tipster “can get anywhere between 10% and 30%” of any money recovered.

Commissioner Peirce said the SEC is “constantly thinking about how we can better run the agency to avoid things like that from happening and to stop them from happening earlier in the process.”

Peirce added that advisor fraud is unavoidable, so the SEC must be better at catching it before it victimizes more people. “You know people will always try to do bad things. But we have taken a lot of lessons from that event,” she said.

Concerns about the skills and education of financial professionals were also raised by the town hall attendees. Commissioner Stein didn’t directly address that question but said the SEC has tools and resources that investors can use for their research, such as www.investor.gov, and the watchdog is always interested in hearing from investors how it can better serve them.

The need for clarity about the suitability standard broker-dealers are currently held to as opposed to the best interest standard they will be required to comply with under the SEC's proposed Regulation Best Interest was also raised at the town hall meeting.

Clayton chose to reply by giving an example.

“If you come up with two investments that are suitable for your client, this is the standard today, there are people who will argue that you are allowed to look at which investment makes you, the broker, more money and put the client into that investment,” he said.

“Under our new [proposed] standard, you would not be allowed to do that,” he added.

Before the questions began, Clayton gave four tips for investors on how to choose their financial professionals.

First, Clayton said, it’s better for investors to choose financial professionals that are registered with either the SEC or the state. “If not, the risks you are taking in dealing with them go up dramatically” because they don’t have oversight.

Second, Clayton said, investors should ask what type of financial professional they are dealing with – a broker-dealer or an advisor. This distinction is a big part of the SEC’s proposed Regulation Best Interest package, where financial professionals are required to clearly declare their roles and relationship with the client. Clayton said the right relationship for clients will depend on their investment activity levels and what they want from their financial professionals.

Jay Clayton

Third, Clayton said, investors should ask financial professionals how they are paid – if there are any incentives involved in recommendations – and ask more questions to understand the fees involved.

Fourth, Clayton said, investors should ask their financial professionals exactly how much of their money will be put to use in investing.

Following the town hall meeting, attendees joined the SEC commissioners and staff in breakout sessions on the following topics: stopping fraud; the investor experience with mutual funds and ETFs; tips for savers; bitcoins and initial coin offerings (ICOs); and investing in small companies.

Cryptocurrency is among Clayton’s top concerns. At Finra’s annual conference in Washington, D.C., he said he was “surprised” by the level of activity in these digital assets.

“What we are seeing in the ICO space is people not following either the private placement or public rules. Rather, they are taking the most advantageous pieces of a public offering and providing none of the protections you can get in a private placement and somehow saying this was OK because it is a new technology,” Clayton said at the time. “It didn’t take me very long to figure out this was not a good idea.”