State Securities Regulators -- Stepping Up Enforcement Examinations and Investigations in the Wake of Madoff and Industry Migration Trends
By: David N. Jonson
The North American Securities Administrators Association ("NASAA") started the new year off with an ambitious agenda at its annual Winter Enforcement Conference on January 8-11, in Coronado, California. The conference, which is open only to state, federal and FINRA enforcement attorneys and investigators, featured panels on Enforcement Trends, Enforcement Best Practices, Broker-Dealer Sales Tactics, and Enforcement Implications of the Financial Crisis. The attendees also met to discuss strategy and tactics in six specialized NASAA enforcement groups: Enforcement Technology, Enforcement Trends, Special Project Development and Coordination, Attorney Investigator Training, Litigation Forum, and Enforcement Zones.
State securities regulators, who have regulated the securities industry since before federal securities laws and the SEC were created by Congress during the New Deal, have always been mindful of the erosion of their regulatory power by federal initiatives advocated by both the SEC and the securities industry itself. Although the securities industry's clout in Washington today is arguably at its weakest level in decades, the states are also aware that any new financial services regulatory scheme from Washington could still result in a diminution of state authority. Accordingly, even though recent multi-state regulatory enforcement actions in the areas of research analyst conflict of interests and auction rate securities have been widely viewed as successful by investors, consumer groups and some influential members of Congress, the states clearly do not intend to stray too far from the kitchen while a new regulatory pie is being baked.
To continue demonstrating their value during this time of regulatory change, state securities regulators will continue to focus on local cases with a common national theme (e.g. , auction rate securities and senior citizen issues). However, since the states have also detected an unprecedented number of registered representatives departing broker-dealers to form smaller, state-registered investment advisory firms, the states have also indicated that they will dramatically increase the number of proactive examinations, investigations and enforcement actions against such firms.
There are several reasons for the states' increased interest in these new investment advisers. As an overarching factor, the effects of the Madoff matter cannot be understated. No state securities regulator, many of whom serve at the pleasure of statewide elected officials, wants to have to explain how or why they missed clues or leads that, if properly investigated, would have shut down a would-be Madoff in their jurisdiction. Therefore, future state examinations and investigations — regardless of whether or not a whistleblower provides a roadmap of where to look — will be far more thorough than in the past. As a result, subjects of these inquiries should expect to find that responding to such matters will involve considerably more time and expense than they may have grown accustomed to in prior years.
Second, state regulators are very concerned that since the majority of the new advisers may not be accustomed to handling compliance and other administrative details themselves, and because adequate compliance takes time and money and may be less of a priority than client development, state regulators theorize that these advisers are more likely to be deficient in carrying out such duties. Some states will even be taking the unusual step of conducting introductory examinations of newly registered advisory firms.
Third, some regulators believe that most of the representatives who left broker-dealers to form their own advisory firms may not have been in the upper echelon (or "top producers") at their former firms, and now, under pressure to pay their own way, may be more desperate to generate business through questionable advice or investment opportunities that they would not have attempted to solicit while at their prior firms. (Interestingly, some state regulators — especially those who considered the term "top producer" to be questionable when viewed from the client's perspective — took a more charitable view of the motives of the lower-producing representatives who recently became state-registered advisers.)
State securities regulators have identified new, state-registered investment advisers as the latest "at risk" group who will bear the brunt of their regulatory and investigative scrutiny. Given the deterrent effect and favorable publicity that can be generated from taking strong enforcement actions, the states can also be expected to continue availing themselves of the full array of media outlets on both the local and national level.
