At the Financial Services Institute OneVoice conference in late January, FSI President and CEO Dale Brown set the stage for things to come by commenting on the intentions of SEC Chairwoman Mary Jo White. White is the first to assume the SEC chair with a background as a federal prosecutor and securities lawyer, and her priorities reflect this litigation bent. She intends to usher in a period of rigorous enforcement, with a key component to that enforcement being the application of the “Broken Window Theory.”
The thinking behind “broken windows” is that no crime is too small to garner the attention of the cop on the beat, including acts such as vandals throwing rocks through windows. As the theory goes, when a window is broken and later fixed, it signals that disorder will not be tolerated. When a broken window is not fixed, it sends a signal that breaking windows will bear no consequences and will lead to more serious crimes. White is upfront that one of her primary goals will be enforcement.
Independents Pay the Price
Given White’s broken window approach to regulation, I am hopeful that we will get some relief thanks to the efforts of Dale Brown and FSI, who advocate on behalf of independent broker-dealers and their financial advisors and strives to create a healthier, more balanced regulatory environment. Still, given current circumstances, I have to make mention of former FSI Chairman Joe Russo when he says, “Regulators have a “Put” written on our industry.” (Joe happens to be an options principal.)
Dale Brown’s response to the SEC was spot on when he said, “The current regulatory environment is still far too costly and complex.” Brown also remarks “Not a single independent financial advisor contributed to the financial crisis, and yet they’re paying for it today. What we need is not an enforcement mindset on minor issues but more of a consultative approach.”
There’s the rub. When it comes to financial matters, customer complaints are rarely black-and-white issues like broken windows. Rather there are nuances, shades of grey that need discussion and disclosure from both sides. A good example of this is investment suitability. To police such matters in an enforcement context you’d have to say, “If the client made money on the investment it was suitable. However, if they lost money, it was unsuitable.” Back in the days of the NASD, regulators did operate in more of a consultative role. They gave feedback, guidance and advice on how to better supervise and run a firm. White is moving 180 degrees from this approach, opting for a heavy-handed enforcement policy. Moreover, this is happening at the same time that we face further increases in the number of regulations thanks to Dodd Frank implementation.
Unfortunately the question “What is enough regulation and enforcement?” has the same answer as, “What is the fair share of taxes for the wealthy to pay?” with the answer being “always more!”
Ever-Shrinking Islands of Liberty
Jeff Rose, a constitutional lawyer who fights for small business owners struggling with government regulation, argues that, “government grows in one direction and doesn’t shrink. Bureaucrats love rules and live to enforce them. America was conceived as a sea of liberty with islands of government power. Now we are a sea of government power with ever shrinking islands of liberty.”
Right in line with this thinking, I received an e-mail from a broker-dealer president who was commenting on an article I had published, suggesting, “For your next project, maybe you could look into why FINRA is growing when most of the bad firms are gone, and the number of broker-dealers is down substantially from five years ago.” Like any other government bureaucracy, this is all these little emperors know: grow in size, expense and power.
As a recruiting firm, we have already seen the impact of the broken window enforcement approach, with minor offenses being treated as major offenses and larger offenses treated as potential career enders. A 2013 case we worked on involved a representative with an outside business that encountered a liquidity squeeze when the bank called the business loan during the 2010 bank credit pullback. This rep had a clean compliance record and only this one credit issue. The credit issue resulted in state regulators requiring five years of heightened supervision, which is an extremely long requirement, given the situation.
The Risk of Appearing Friendly to “High Risk” Reps
Heightened supervision requirements, once rare events, are becoming quite commonplace as not only FINRA but many state regulators flex their disciplinary muscles. Obviously, broker-dealers don’t want the burden of additional oversight and reporting required by heightened supervision, so some firms are discharging reps to avoid the extra supervision required of them. Broker-dealers also face additional pressures from errors and omissions insurance carriers. When these carriers ask about the number of reps under heightened supervision, they can exclude those reps from coverage or limit the coverage extended to the firm as a whole.
Having numerous reps under heightened supervision can also jeopardize a firm’s “Rep Expansion Request (1017)” resulting in fewer representatives allowed to join the firm in a given year (I’ve always found it disturbing and dictatorial when regulators decide how many reps a broker-dealer can add on a year-to-year basis. Imagine regulators telling you how many clients you can add to your book in a given year!).