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New SEC Task Force to Use Data to Root Out Advisor Fraud

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The Securities and Exchange Commission’s new Retail Strategy Task Force will use data analytics to root out misconduct “occurring at the intersection of investment professionals and retail investors,” namely mutual fund share class and wrap-fee account abuse, Stephanie Avakian, co-director of the agency’s enforcement division, said Thursday.

Avakian, speaking at the Securities Enforcement Forum in Washington, said that the retail task force will zero in on “the many ways that retail investors intersect with the securities markets and look for widespread misconduct,” drawing on the agency’s “experience in the retail space and elsewhere to identify strategies that have worked well for us across all kinds of cases, particularly those in which we used data analytics and technology.”

The unit, she continued, will “then apply those strategies and investigative techniques more broadly to look for incidents of widespread misconduct targeting retail investors.”

SEC Chairman Jay Clayton announced the creation of the retail unit along with a new Cyber Unit during his Sept. 25 testimony before the Senate Banking Committee.

The SEC, Avakian explained, is “increasingly able to identify threats to retail investors — everything from registrant-based threats to microcap-based threats — through the use of data analytics.”

Technology can be used to “slice and dice data and apply analytics to look for all kinds of problems — by product, by investor type, by location, by sales or trading practice, by fee, you name it,” she said.  

The task force will be charged with identifying “those uses of data analytics that can be scaled more broadly, and that can be used in targeted ways to identify misconduct.”

While the task force will have a dedicated staff and work with the enforcement division’s Office of Market Intelligence and Center for Risk and Quantitative Analytics, along with other agency divisions such as the Division of Economic and Risk Analysis (DERA), and the Office of Compliance, Inspections and Examinations, the group “will not generally be responsible for conducting investigations,” Avakian explained.

“Retail” misconduct issues “are extensive and often involve widespread incidents,” she said, including problems the agency continues to see:

  • Investment professionals steering customers to mutual fund share classes with higher fees, when lower-fee share classes of the same fund are available.
  • Abuses in wrap-fee accounts, including failing to disclose the additional costs of “trading away” or trading through unaffiliated brokers, and purchasing alternative products that generate additional fees.
  • Investors buying and holding products like inverse exchange-traded funds for long-term investment. These can be highly volatile products that are generally intended as a hedge against exposure to downward moving markets, and that face a long-term high risk of losing their principal. Yet the SEC is increasingly seeing retail investors holding these products long term, including in retirement accounts.
  • Problems in the sale of structured products to retail investors, including a failure to fully and clearly disclose fees, markups and other factors that can negatively impact returns. And, abusive practices like churning and excessive trading that generate large commissions at the expense of the investor.

As to the new Cyber Unit, Avakian said the agency views its “potential enforcement interest in cyber-related issues” as falling into three separate types of cases.

  • Cyber-related misconduct is used to gain some sort of unlawful market advantage;
  • Failures by registered entities to take appropriate steps to safeguard information or ensure system integrity; and
  • A cyber-related disclosure failure by a public company.

The enforcement division has brought cases related to the first two areas, but not the third, she said. 

— Check out SEC ‘Working on’ Fiduciary Rule, Concerned About State Laws: Clayton on ThinkAdvisor.