Regulators, in-house lawyers and compliance officers told a serious cautionary tale at the recent Practicing Law Institute Broker-Dealer Regulation and Enforcement seminar. Representatives of the Securities and Exchange Commission, FINRA, the Department of Justice and state securities regulators, as well as corporate counsel and compliance officers, discussed the areas in which regulators were active - and becoming more active - in their examination and enforcement efforts against securities brokers and their firm. Regulators proudly trumpeted their increasing success in locating and prosecuting wrongdoers because of the influx of investigative talent and of industry types and non-lawyers who understand markets and creative investment products. Speakers bandied about phrases such as "keep you up at night" and "shot across the bow." Areas of heightened regulatory enforcement interest included:

  • Anti-money laundering. Proper reporting is the key, particularly regarding rogue brokers who leave one broker-dealer and set up shop at another broker-dealer across the street.
  • Dark markets. Transparency is critical, especially where complex products (including mortgaged-backed and asset-backed securities) are being offered in over-the-counter markets.
  • Administrative proceedings. The SEC's use of administrative forums and administrative law judges is increasing. The SEC typically chooses cases that do not have jury appeal, such as insider trading cases where juries often improperly hold the SEC to a criminal prosecution standard.
  • False statements to the SEC and obstruction of justice. The U.S. Attorney's Office is particularly interested in this subject, with a high degree of emphasis on insider trading, valuation fraud, Ponzi schemes and embezzlement. The Commission also has been making efforts to increase compensation being paid to whistleblowers.
  • Expungement. State regulators are taking a hard look at the increase in requests for expungement, as they are becoming routine, not occasional. Regulators expressed the belief that expungement should be an extraordinary remedy, not a matter-of-fact one that should be left to the regulators, not arbitrators who are determining the rights of the parties.
  • Supervision and Disclosures. Regulators are taking an increasingly hard look at investment advisors and brokers, as to whether their U-4 disclosures and supervision are adequate.
  • Alternative investments. Regulators are applying heightened scrutiny to non-traditional investments, including non-traded REITs, precious metals and mortgage- and asset-backed securities, particularly where liquidity is an issue.
  • Conflicts. Regulators are increasingly investigating firms that recommend to customers that they invest in the firm's own mutual funds.

The in-house attorney roundtable added to the cautionary tale, emphasizing the newly popular "broken window" philosophy of regulator enforcement - a focus not just on the big, bad crimes, but on cleaning up the neighborhood of smaller violations. They also warned that the SEC is increasingly hesitant to include a "without admitting or denying" statement in a settlement agreement, more often than not insisting on admissions as a condition of settlement, which admissions could undermine positions being taken and arguments being made in other litigation in which a broker-dealer is involved.

The following were identified by the SEC as "core matters" on its examination agenda:

  • Branch offices
  • Rogue brokers and problematic registered representatives
  • The protection of senior investors and those planning for retirement
  • The expanded use of data
  • Higher risk products, including fixed income investments
  • Excessive trading ("churn and burn" patterns)
  • Pump and dump transactions in microcap (penny) stocks
  • Migrating clients who switch from traditional broker relationships to investment advisors who are fee based
  • Equity order routings
  • The quality of fixed income executions with an emphasis on municipal bonds
  • Cybersecurity
  • The flow and misuse of information, including confidential and non-public information
  • Anti-money laundering, with an emphasis on clearing firms that do international business