More On Legal & Compliancefrom The Advisor's Professional Library
- Where Are We Headed? The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
Securities and Exchange Commission attorneys are reviewing the stock holdings of about 3,400 employees after some New York staffers were found to own securities prohibited by ethics rules.
The agency’s ethics office has begun an examination of all personal financial disclosures to ensure that employees don’t have a financial interest in companies they regulate or investigate, SEC ethics counsel Shira Pavis Minton said in an interview.
The ethics review raises questions about the effectiveness of SEC programs for ensuring compliance with its trading rules, which bar workers from owning shares of most Wall Street firms, including Bank of America Corp. and BlackRock Inc. (BLK) The agency relies on employees to disclose their investments and doesn’t have a tool to automatically scan employee holdings for violations.
“Given the extensive nature of the SEC’s restrictions on stock ownership that go well beyond government requirements, it only makes sense to help staff comply,” Minton said. “Having an extra set of eyes on these filings is a proactive way to help staff ensure the forms are completed correctly.”
The ethics office’s review isn’t considered an investigation, Minton said. The ethics attorneys advise SEC employees on how to follow internal rules with the goal of preventing conflicts of interest; investigations of violations are handled by the SEC Inspector General.
Minton said previous reviews have identified assets that needed to be divested. She declined to speculate on how widespread the problem might be or discuss whether recent reviews of New York-based employees turned up improper holdings.
The change follows the arrest in November of Steven Gilchrist, a New York-based SEC examiner, charged with misleading investigators about bank stocks he owned. In addition, several other employees in the New York regional office were recently told that their personal holdings violated trading rules, according to a person familiar with the situation, who asked to not be named because the matter is private.
One case was mentioned in a December report by the SEC’s Inspector General, who wrote that a senior employee failed to properly report stock owned by a spouse; U.S. attorneys declined to prosecute the case, according to the report.
Michael Smallberg, an investigator for the nonpartisan Project on Government Oversight, a nonprofit that promotes government accountability, said the SEC has done more than other federal agencies to guard against employees’ abilities to profit from nonpublic information. At the same time, the agency is justified in expanding its compliance effort, he said.
“The recent episodes in the New York office make you wonder how many other employees are failing to comply with the rules,” Smallberg said in a phone interview. “Even if the abuses aren’t systemic or deliberate, conducting a full review would bolster public confidence in the agency’s work.”
About 75% of the SEC’s 4,500 employees, or 3,400 workers, are required to report financial holdings annually on a confidential disclosure form. That includes many of its attorneys, auditors and financial analysts and all of its accountants, economists and examiners. Supervisors are supposed to review the forms to ensure their workers don’t have a financial interest in companies they regulate or contracts they oversee.
Ethics attorneys also review the forms, and in past years have sought to examine 25% of the disclosures each year. This year, they will review all of them, Minton said.
The discovery of prohibited holdings among some New York-based employees may also prompt a separate internal audit of the quality of past compliance reviews, the person said.
Some employees disclosed ownership of certain stocks for years before being informed in 2013 that they are on a list of roughly 220 banned securities. That’s because the SEC’s compliance system is designed to vet new trades and doesn’t flag holdings that became prohibited after an employee acquired them, the person said.
The SEC tightened limits on the stocks employees could own in August 2010, the year after former Inspector General David Kotz investigated allegations of insider trading by three enforcement attorneys. The stricter rules forbid employees from owning shares in any financial company directly regulated by the SEC, such as a broker-dealer or investment advisor, and any firm under an enforcement investigation. The agency also began requiring that all of its employees provide their brokerage statements to the SEC and get approval for any trading.
The SEC sought in 2009 to acquire an automated system for monitoring employees’ trades and hired Financial Tracking Technologies LLC to provide software for the job. The SEC terminated the contract in 2011 after finding the Connecticut-based company shared employees’ data with an unapproved subcontractor.
The SEC then built its own system, known as the Personal Trading Compliance System, to monitor employees’ personal investments. Employees who enter a trade into the system are told whether the transaction is permitted.
The SEC’s system doesn’t automatically detect prohibited holdings that aren’t actively traded. For that reason, some employees have argued they weren’t told that some longtime holdings became prohibited after the company made an acquisition or changed its business model, the person said.
Some of the banned stocks are in bank holding companies that acquired SEC-regulated firms — such as a broker or clearing firm — after the 2008 financial crisis, the person said.