by Bill Singer
SEC Commissioner Gallagher Takes A Sledge-O-Matic To Wall Street Regulation
May 16, 2014
Securities and Exchange Commission ("SEC") Commissioner Daniel M. Gallagher is a sharp-elbowed member of the federal regulator: a commissioner who speaks his mind, isn't afraid to say what he means, and, at times, seems to delight in his bad boy status. Although I am not always a fan of his style, I frequently find myself in agreement with his positions. Yet again, Commissioner Gallagher stirred the pot during his May 9, 2014, Remarks at the 46th Annual Rocky Mountain Securities Conference, and I offer you the following verbatim nuggets from his speech:
Despite the onslaught of regulation over the past ten years and the consistency with which extremely costly and often frivolous plaintiff actions are brought, our capital markets continue to be the strongest and most vibrant in the world. As the primary U.S. capital markets regulator, the SEC administers a regulatory framework built upon our threefold mandate to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.
[W]e require market professionals, particularly those who interact with retail investors, to apply for, and prove themselves worthy of, the privilege of working in the industry.
Unfortunately, this privilege is all too often abused by scoundrels, including some that repeatedly engage in egregious misconduct that directly impacts retail "mom and pop" investors, destroying their nest eggs and financial security. These repeat offenders, despite accumulating dozens of customer complaints and disciplinary actions, have been able to remain in the industry by jumping from one disreputable firm to another and hiding behind false and misleading CRD filings and Form BD representations. They are, to be blunt, cockroaches, and it is in all of our interests to purge them from our markets.
Evidencing a chameleon-like quality of a sometime industry defender and a sometime public advocate, Commissioner Gallagher refuses to allow himself to come off as doctrinaire. At times, he seems a Wall Street apologist complaining about regulatory onslaught and frivolous lawsuits; however, he counterbalances those pro-industry comments with equally caustic aspersions about some industry participants as scoundrels and cockroaches.
Bad Boys, Bad Boy, What Ya Gonna Do?
In burnishing his investor advocacy credentials, Gallagher takes direct aim at the bad boys of Wall Street:
[A]n astounding 20% of the 600,000 plus actively licensed registered representatives have between one and five disclosures for items such as customer complaints, regulatory violations, terminations, bankruptcy, judgments, and liens. One active-and currently employed-registered rep has disclosed a whopping 96 customer complaints and disputes. Another individual has made 21 financial disclosures relating to bankruptcies, yet still is licensed and working in the industry. At the firm level, 17% of broker-dealers had more than six total disclosures, and 5% had more than 20 disclosures.
These numbers illustrate a real and growing problem in the securities industry. These repeat offenders are swindling seniors out of their hard-earned retirement funds, looting our kids' custodial accounts, and diverting assets from charities and religious organizations. But despite our best efforts, they manage to stay in the industry and continue to wreak havoc on the investing public.
I would be remiss if I did not point out that a common misconception is that this is exclusively or even primarily a broker-dealer problem rather than an investment adviser problem as well. In reality, there are plenty of repeat offenders at investment advisory firms who are engaging in misconduct. We're just not finding them as quickly because the SEC allocates a disproportionate amount of resources to policing the activities of broker-dealers when compared to those we expend policing investment advisers. There are nearly three times as many investment advisors registered with the SEC than there are broker dealers: approximately 11,100 investment advisors versus about 4,300 broker-dealers. This is due in large part to unfunded mandates imposed upon the SEC by Title IV of Dodd-Frank. Even more importantly in the context of resource allocation, there is no SRO interposed between the adviser industry and the SEC like there is for broker-dealers.
I worry that this has created the unfortunate side effect of underreported investment advisor rule violations, inappropriately skewing our enforcement statistics by revealing a disproportionate amount of problems on the broker-dealer side. Simply put, it is impossible to separate the fact that we find many more broker-dealer violations than investment advisor violations from the fact that thanks to the assistance of the SROs, we examine a greater proportion of broker-dealers than investment advisors.
One way to address this imbalance would be to provide for third party examiners of investment advisors-including, potentially, defining the term "third party" to include SROs in order to allow the SROs currently involved in broker-dealer oversight to conduct examinations of "dual hatted" investment advisors as well.[4] In the past, questions regarding the wisdom of creating an SRO for investment advisors have been addressed in a binary sense: should the Commission push Congress to create an SRO for investment advisors, or keep things as they are? Leveraging the current resources and expertise of broker-dealer SROs to assist in investment advisor examinations could greatly facilitate our ability to examine advisors without undertaking the daunting project, with Congress, of creating a new investment advisor SRO out of whole cloth.
Too Big A Basket?
In my opinion, Commissioner Gallagher unfairly conflates into his basket of recidivists those who are repeat offenders with those who are repeat disclosers. Registered persons are required to report "disclosable events," but the range of such disclosures includes allegations of industry-related misconduct, employment terminations, bankruptcies, liens, judgments, and other civil matters.
Within the employment context, the brass knuckled nature of life on Wall Street frequently invites an angry former employer to "jam up" the record of a departed employee. Such retaliation often involves the allegation of all sorts of crap, much of which is merely calculated to hamstring the former employee's ability to compete against the former firm. Similarly, after the Great Recession, financial difficulties and consumer bankruptcies have generated disclosable matters.
As such, we need to be careful about confusing those with worrisome records suggesting fraudulent sales practices with those who are involved in personal civil matters. Regardless, where there's smoke, there's fire -- and industry participants unable to manage their own financial affairs should not complain when someone questions their competency to manage those of others. Gallagher makes a fair point about repetitive disclosures as a "real and growing problem," and he certainly sounds the proper alarm as to the dangers facing senior citizens and other vulnerable investors.
Oh No, SRO?
Commissioner Gallagher warns that we should not be too quick to trash stockbrokers without equally sanctioning registered investment advisors ("RIA"). The commissioner seemingly suggests that the disparity in enforcement of both the BD and the RIA camps is based, in part, on the SEC's misallocation of resources. That's going to a touchy subject for many folks and competing interests.
Troubling for me is Gallagher's foray into the creation or perpetuation of the whole self-regulatory organization ("SRO") construct for the RIA community. My inference is that he appears to favor an SRO for RIAs, and I fear that he may be leaning towards some role for FINRA as the solution.
BrokeAndBroker Blog readers know that I believe the current form of Wall Street self-regulation is a failure and should be abandoned. Similarly, I do not believe that FINRA has been an effective SRO, and I see no laudatory track record commending FINRA as a candidate to take on an even more expansive regulatory docket pertaining to an industry with which it has virtually no experience. If Commissioner Gallagher is leaning towards expanding FINRA's reach into the RIA community, he is terribly mistaken. Hopefully, he will keep an open mind on this issue.
Still -- I have to compliment Gallagher for not shying away from controversy and having the guts to wield his sledge-o-matic down upon far too many sacred compliance procedures and sacrosanct regulatory policies.
Not Pulling His Punches
Commissioner Gallagher offers thoughtful suggestions and poses a number of credible and overdue challenges to the complacency of Wall Street regulation. If his barbs and jabs engender a meaningful debate, then he has achieved a meritorious goal. Consider these further comments of his:
Most importantly, the agency needs to take aggressive action aimed at permanently expelling the worst offenders from the securities industry. All too often, we see the same individuals and firms featured prominently in examination reports and enforcement actions. As an agency, we need to seek out the repeat offenders and revoke their licenses and registrations rather than repeatedly mete out injunctions that can be violated and penalties that can be paid from the fruits of misconduct. Unless we put these offenders out of the industry for good, they will continue to take advantage of retail investors.
With respect to the most egregious and recidivist violations of our securities laws and regulations, whether by broker-dealers or investment advisors, we need to ask ourselves a fundamental question: should the violating entity retain the privilege of participating in our capital markets? Unbeknownst to many, both the Exchange Act and the Investment Advisers Act authorize the Commission to deregister entities if it finds such action to be in the public interest, although we have rarely done so.[6] This authority, of course, should only be invoked after full due process has been afforded to the entity in question, but it should indeed be invoked when appropriate. I have seen several instances in which I believe it would be appropriate since I've been a Commissioner.
As a federal agency charged with protecting investors, the SEC needs to make such existential threats-and, where appropriate, deliver on them-in the most egregious circumstances. Otherwise, the cockroaches of the industry will continue to abuse the system, shrugging off the well-meaning but all too often ineffective remedial actions taken against them . . .
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