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The sorry truth about the SEC's plan to crack down on bad stockbrokers by putting RIAs in a vise

The move is a clear diversionary tactic on the SEC's part to avoid flexing its muscles and withhold licenses

Friday, September 16, 2016 – 5:06 PM by Columnist Irwin Stein
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Irwin Stein: These brokers get fired not because they lied to their customers but because they lied to their firms.

Brooke's Note: We talk plenty about the fiduciary duty of advisors. But what about the duty of regulators to advisors? Fairly or not, a profession gets judged as much by its handful of quacks as by its thousands of dutiful practitioers. So if the regulator of that profession isn't weeding out the quacks, it does a diservice to those it polices. Irwin Stein, long an attorney in this field and now an RIABiz writer, called my attention to this matter and wrote this compelling column on the topic.

With its lastest directive, the SEC has proferred a fake solution to a real problem.

The Office of Compliance Inspections and Examinations at the Securities and Exchange Commission will now give the hairy eyeball to RIA firms that hire stockbrokers with a history of disciplinary events. See: How much should RIAs shake in their boots after the SEC punished three firms then put out a detailed press release? 

According to the risk alert issued by the SEC Monday: "OCIE staff intends to conduct examinations of registered investment advisors that employ or contract with supervised persons that have a history of disciplinary events." 

At first blush, It sounds like a long-awaited response to an ugly problem.

It's not. It's like saying, 'look, you hired a pedophile as a nanny' rather than saying 'we don't allow pedophiles to work as nannies.'

The regulator has chosen to examine rather than enforce. The Financial Industry Regulatory Authority Inc. did the same thing a couple of years ago and it didn't solve the problem of bad seed brokers. I doubt that the SEC thinks this will effectively weed out shady advisors, either.

Rather, this announcement is merely an acknowledgement that those brokers who have been identified as serious compliance problems continue to work as brokers, albeit with the regulatory equivilent of a low-tech beeper monitor on their ankles. See: RIA advocates cry foul after international media pick up on U. of Chicago study labeling shady stock brokers as 'investment advisors'

Second chances club

FINRA and the SEC have the power to simply tell these brokers to find another line of work -- a broker who is terminated for cause can be denied a license to join another firm by these agencies. Instead, they choose to let the brokers continue to interact with customers and let examiners have a once-a-year look.

Why are these regulators so bent on giving brokers who have demonstrated that they can’t be trusted a second chance? Sadly, it is a question that no one seems to ask. It's certainly not helpful to honest brokers, RIAs or investors to let muddied brokers self-rehabilitate. No one hates the sight of a miscreant stockbroker being led away from his office in handcuffs more than the honest brokers working across the street. It serves to affirm the common knowledge that Wall Street rips off just about anyone with impunity.  See: Why Wall Street's DOL killer threat -- that 'millions' of IRA investors will go unadvised under new rules -- is hogwash.

FINRA has been on a similar mission to review the adequacy of supervision of firms that hire these high risk brokers since early 2014. The program was introduced with some fanfare. The results are unreported but no one is suggesting a parade because FINRA has finally done its job and taken out the trash. See: FINRA shifts an unwelcome spotlight away from itself -- by training it on the brokers it oversees

FINRA knows whenever a registered representative gets sued, terminated or gets a DUI or hit with a tax lien. Each of those events is reportable. When a report of one of these events is made what does FINRA do? Not much. 

Recidivist brokers

In heightening scrutiny of RIAs who hire dinged brokers, the SEC cites a recent academic study finding that prior offenders are five times as likely to engage in new misconduct as the average financial advisor.

Let that statistic sink in for a minute. Stockbrokers who break the rules once often do it again.

Notable is that Wall Street firms don’t see much upside in leniency. Approximately half of financial advisors lose their job after serious misconduct. 

Unfortunately, the free market system falters in its weeding process because in a market with a constrained supply of trained brokers, not every firm cares. The labor market partially undoes firm-level discipline; 44% of brokers who are fired are reemployed in the financial services industry within a year. See: FINRA's scandalous litany of failures and its efforts to redefine the true fiduciary standard out of existence

Some brokers who are terminated for cause and not rehired by brokerage firms hang out a shingle as an RIA or join an established RIA firm. They pooh-pooh the problems that led to their termination as “the manager was out to get me” or “FINRA is biased against little guys like me.”  See: Why advisors see FINRA as the devil.

Rather than deal with this problem directly, FINRA and the SEC have decided to let the examiners handle it. An examination by FINRA or the SEC starts with a form questionnaire. Every firm examined by either FINRA or OCIE will be asked if they have procedures in place to provide heightened supervision for these individuals. Every firm that is questioned will answer in the affirmative. See: SEC launches elite unit with unspoken promise of technological parity with Wall Street

The worst case for RIAs is that the examiner will tell its compliance managers to work harder and to be a better supervisor. See: SEC launches elite unit with unspoken promise of technological parity with Wall Street

The real deal

Sure, we can all trip up when negotiating a blizzard of regulations but let’s be clear: A stockbroker does not get fired “for cause” because they recommended investments that did not perform. They get terminated for forging documents, doing unauthorized trades and selling investments away from the firm's supervision. Each of these actions involves some amount of intentional dishonesty and deceit. No amount of supervision will deter a broker intent on scamming customers.

The bottom line is that these brokers get fired not because they lied to their customers but because they lied to their firms. A good producer can retain their job with a dozen customer complaints. Brokers get fired when the compliance department does not trust them anymore or sees them as a significant liability. See: City National sells off salvaged remains of Convergent Wealth Advisors, but not before Convergent sheds nearly $7 billion of AUM

No one has a constitutional right to have a license to sell securities. The regulators can simply refuse to permit serious offenders to stay in the business by refusing to accept their application to switch firms -- if not for the first offense, then certainly for the second. The regulators can use their licensing authority rather than examinations to stop these brokers in their tracks. See: The unbelievable series of missteps that sent Aequitas, its RIA clients and their investors, reeling

Instead, the regulators opt for the path of least resistance. Rather than cleaning up the sandbox they tell the worst offenders to clean up their act knowing that the odds are it's not going to happen.

Whenever one of these dishonest brokers scanarios acts out, the rest of the industry gets painted with a broad brush of ill repute. Pundits write articles vilifying the entire industry; politicians scream for reform; and customers look to robos because they believe that human advisors can’t be trusted. Compliance GPS: It may be a mistake to project too successful an image, especially in a post-Bernie Madoff world

No quick fix is coming. Honest brokers are not about to launch a petition drive asking for the regulators to step up their enforcement game. The best they can do is to mind their own business, follow the rules and try to do right by their customers.

In the meantime, chronic distrust of the people put in charge of managing our wealth will continue.



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