Are regulatory violations by broker-dealers and registered investment advisors on the rise? Certainly the volume of screaming headlines makes it seem like regulators are busier these days.
The Securities and Exchange Commission (SEC) filed 734 enforcement actions last year, one shy of the 2011 record. The North American Securities Administrators Association (NASAA) reported that enforcement actions at the state level against brokers and advisors nearly doubled last year, and they are seeing large increases among those with $25 million to $100 million under management. FINRA, whose focus is on broker-dealers and their affiliated registered reps, reported that for the third quarter of 2012, sales practices complaints against their members were up 280%.
I cringe when I see negative news stories involving a registered rep, trader, investment banker, hedge fund, wealth manager or financial planner. Their actions besmirch the reputation of all of us, regardless of our role in financial services. We know that many consumers and members of the press don’t know the difference between financial services players, so when a scandal sees light we all appear stained by the same bad ink.
As head of a custodian that serves RIA firms and their clients, I suffer even stronger emotions when learning of an indictment or finding against a fiduciary advisor, as that is our milieu. When RIAs commit unethical acts against clients, they are FINOs—Fiduciaries In Name Only. Unfortunately, these FINOs use the cloak of their position to exploit the trust of their clients.
While advisory professionals make up a relatively small sample of the regulatory actions, violations that do occur are real head-scratchers. Take a recent SEC finding against an advisor who sold an ownership stake in his firm to a client. The order stated that the advisor sold a minority interest in his RIA firm “to a client at a fraudulently inflated price,” which he apparently justified by “employing several devices to artificially inflate the value.” The SEC order also identified two other occasions when the advisor placed clients in investments in which he and the firm had “personal and pecuniary interests without first disclosing the facts,” thus giving rise to conflicts of interest.
Regrettably, this is not an isolated scenario, though the fraud charge makes it unusual. Sellers of advisory firms often have an inflated perception of value, but typically negotiate at arm’s length. While I have no special insight into this matter, in cases like this, the client is at a clear disadvantage because his advocate—the advisor—is presenting the deal or investment as truthful and the circumstances as free of conflict.
Who should the client turn to when presented with these “opportunities”? What processes exist inside the advisory firm to protect the client from the advisor, especially if he is a sole proprietor also functioning as his own chief compliance officer, chief financial officer and chief operating officer?