May 9, 2014 / 5:05 PM / in 4 years

SEC's Gallagher fears violations at advisers are going undetected

WASHINGTON, May 9 (Reuters) - A top U.S. regulator said on Friday he is worried that investment advisers may be getting away with securities violations that are going undetected, and he called for action to improve how advisers are policed.

In a speech in Colorado, Securities and Exchange Commission member Daniel Gallagher unveiled the results of a new SEC review that showed an “eye-popping” percentage of licensed brokers have checkered histories, even though they are routinely inspected by regulators.

The results of the review, he said, raise concerns about whether many investment advisers may also be bilking mom-and-pop investors and not getting caught as often because they are not inspected as frequently as brokers.

“I worry that this has created the unfortunate side effect of underreported investment adviser rule violations, inappropriately skewing our enforcement statistics,” said Gallagher, a Republican, in prepared remarks.

In a recent statistical analysis, Gallagher said the SEC found that 20 percent of all 600,000 licensed brokers list regulatory violations, customer complaints and bankruptcy on the disclosure forms they submit to regulators.

One currently licensed person, he said, has 96 complaints and disputes, raising concerns about repeat offenders who migrate from firm to firm like “cockroaches” where they destroy peoples’ nest eggs.

These results are particularly troubling, he added, because brokerages face strict regulatory oversight, both by the SEC and by the Financial Industry Regulatory Authority (FINRA), the self-funded industry watchdog.

But investment advisers, which outnumber registered brokers by roughly 3 to 1, face far less oversight because they are not inspected by a self-regulatory organization and the SEC lacks the resources to police them all on a regular basis.

Only about 9 percent of registered advisers typically get examined by the SEC per year.

FINRA has come under withering criticism in recent months for the quality of its database, known as BrokerCheck. The database is meant to be used as a tool for investors to find a trustworthy broker.

Recent analyses by media outlets and legal groups uncovered scores of problems with the disclosures that brokerages submit, including numerous failures to report critical information.

FINRA is taking steps to correct the problem, including weighing new rules requiring mandatory background checks for brokers.

However, FINRA’s authority to inspect and police for misconduct only extends to brokerages, and not investment advisers.

During the crafting of the 2010 Dodd-Frank Wall Street reform law, lawmakers considered whether to give FINRA the powers to inspect advisers, or to create a new self-regulatory organization.

Congress ultimately punted, and asked the SEC to suggest a workable solution.

The SEC in 2011 released a study that explored three possible solutions.

One option, which is the preferred avenue by the advisory industry, was to ask Congress to impose user fees on advisers to help bolster the SEC’s funding.

The other two proposals involved asking Congress to either authorize the creation of an SRO or to permit FINRA to exam firms dually registered as brokers and advisers. Gallagher said the latter option might be the easiest to enact, saying the SEC should consider supporting efforts to let FINRA examine “dual hatted” advisers.

Gallagher also raised concerns about another Dodd-Frank-provision concerning investment advisers and broker-dealers.

Dodd-Frank gives the SEC discretion to harmonize disparate regulations over retail brokerages and advisers. Today, advisers are held to a higher fiduciary duty to put clients’ interests first, while brokers are only required to recommend “suitable” products.

Critics say these differences may confuse investors. The SEC has been weighing whether to adopt one new uniform standard, but has not reached a decision. Gallagher cautioned against rushing to adopt a rule, saying the SEC should “get all the facts” first. (Editing by David Gregorio)

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