President, North American Securities Administrators Association
2014 SIFMA Compliance and Legal Society
April 1, 2014
Good morning distinguished guests and colleagues. I would like to begin today by thanking Howard Plotkin, President of SIFMA’s C&L Society, David Prince, the Conference Chair, and Ken Bentsen, Kim Chamberlain, and Marin Gibson from SIFMA for inviting me to speak to you all this morning.
As mentioned in my bio and the brief introduction, I am Ohio’s Securities Commissioner and am current President of NASAA, the North American Securities Administrators Association. It is my pleasure to share with you the state perspective on issues facing the broker-dealer community in the area of state securities regulation. This is my first time attending the SIFMA Compliance and Legal Society Seminar. I spoke on a state regulatory panel yesterday with my fellow state securities regulator from Florida, Pam Epting, and am very grateful for the strong interest in what Pam and I do as state securities regulators.
While my day job is serving the securities industry and investors located in my home state of Ohio, I speak to you this morning wearing my NASAA hat. I was elected NASAA President this past fall right around my fifth anniversary as Ohio Securities Commissioner and, as it were, the fifth year anniversary of the most recent financial crisis. Those were some tough days back then. I’m sure it was a particularly challenging time for many of you, having to contend with firm closures, consolidations, mass transfers, and what probably seemed like altogether constant motion in the broker workforce.
Many of you probably moved from one firm to another, from one position to another, but thankfully five years later, you all are the survivors, still dedicated to the job of helping every day investors preserve and grow their nest eggs. On behalf of NASAA and state and provincial securities regulators across North America, I want to thank you all for the important work you do serving our investors.
While things today are unquestionably better than they were five years ago and heaven knows we have all taken many valuable lessons away from that experience, there are still many challenges that we face in the securities industry. Investors are still trying to rebuild their portfolios and remain wary of the stock market. According to a recent Reuters report, cash balances are at all-time highs in some of the largest brokerage firms. In a recent Wells Fargo survey, a full third of brokerage firm clients indicated they are still skeptical about investing in the stock market. A third of the Wells Fargo survey respondents also said that the 2008-2009 financial crisis, five years later, is still a factor in how much stock they are willing to own. Of those that remain wary and suffer from that “hangover” effect, 21% don’t plan to invest in stocks at all.
On the flip side, investors who are more willing to bear risk are increasingly turning away from Wall Street to the private capital markets to make up their losses. According to a July 2013 SEC Report, entitled Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 2009‐2012, authored by Vladimir Ivanov And Scott Bauguess, the private market now outpaces the public markets in capital raises in terms of numbers and dollar volume, with $1.7 trillion raised through private offerings in 2012, compared to $1.2 trillion raised through registered offerings that same year.
As the SEC report recognizes, the gap is likely much greater as private offering amounts are understated due to the SEC’s inability to observe all private capital activity. That fact may not come as much of a surprise to many people, especially those of you working at firms who are constantly and carefully monitoring the markets for dynamics like that.
What may surprise some of you, I must say it surprised me a little bit, is just how infrequently brokerage firms and other intermediaries are used in the private market. Are you aware that only 13% of all new private offerings sold since 2009 have used a registered intermediary such as a finder or broker-dealer? That is what the SEC report says and the figure would be even lower if you excluded real estate deals that are more likely to use intermediaries. Most of these offerings have taken place in the Regulation D market where, by design, the terms of the deals receive no substantive regulatory review.
Looking ahead, I anticipate the gap between the public and private markets to only widen further, at least in the short term due to expansion of federal offering registration exemptions instituted as part of the JOBS Act. Regulation D deals are expected to increase under new Rule 506(c) with the SEC’s recent removal of general advertising and general solicitation restrictions. Additional unregistered deals will be sold through crowdfunding and possibly under new Regulation A+. While crowdfunding deals will require the use of a registered intermediary, there is no such requirement for the other offering exemptions where significantly greater sums of money can and likely will be raised. While some of the firms represented in the audience may plan on participating in these exempt offering types, I have heard from many firms who have serious reservations about dabbling in these new untested markets. If last year’s SEC report reflects what we should expect to see in this area, the broker-dealer community will be handling a decreasing minority of the deals sold to American investors.
So what does all of this mean for the securities markets – for you in the industry, for us regulators, and for the investors we all work so hard to serve? I am sure it means many things that none of us will completely realize for a few years to come, but in the meantime, I do have a few takeaways as they pertain to our role, our partnership to serve as effective gatekeepers in the securities markets. For purposes of this discussion, I am using the word “gatekeeper” in the generic practical policy sense and not the gatekeeper liability sense that many of you in the CCO framework sometimes frame the discussion.
1. The Need For Good Professional Financial Advice Has Never Been Greater.
My first takeaway is good news for all of you – there has never been a greater need for professional financial advice than there is right now. Investors, including our large retiring Baby Boomer population, are working hard to recoup their losses from the financial crisis. They are being bombarded with investment opportunities from every direction – in the papers, on the TV, radio, telephone, internet, social media, you name it – and many do not know what to make of it. More often than not, it is our aging, senior population who is targeted in these marketing efforts because that is where most individual American wealth resides.
While it used to be that investors as a whole could take comfort in the fact that most investment opportunities were vetted in some fashion by a regulator before being shopped to the public, that is decreasingly the case. The SEC report I mentioned a minute ago is direct proof that regulatory screening and review is slowly becoming the exception rather than the rule. That report, in fact, may have marked the turning point where private deals have become the norm. Investors will need brokerage and investment advisory services to guide them to good, safe opportunities considering their age, liquidity needs and risk tolerance, amongst other things.
In Ohio, unregistered products sold by unlicensed individuals are a constant source of investor loss and, consequently, state enforcement action. In 2012, the Division saw eight (8) securities fraud cases result in a criminal indictment or conviction. Seven (7) of those cases involved the sale of unregistered securities. In 2013, there were six (6) cases resulting in criminal, indictment, or sentencing; five (5) of those cases involved unregistered securities.
Of course, Ohio is not unique in this regard, as statistics from NASAA’s annual enforcement reports bear out the same trend nationally. 580 out of the 690 fraud cases prosecuted by state securities regulators (or 84%) in the last reporting year involved unregistered products. Almost the same number and percentage of cases, 576 cases or 83%, involved an unlicensed promoter. For the past four consecutive years, unregistered Regulation D deals have topped the state’s list as the single most common investment product or scheme involved in state enforcement actions.
Some of the more notable recent SEC actions involving fraud actions against seniors also involved unregistered securities. There was a $3 million Ponzi real estate scheme that targeted seniors (Brown – Lit. Rels. 22642), a $1.8 million promissory note scheme directed to seniors on Medicaid (Hicks – AP 3-15413), and another $2.8 million scam focused on retirees seeking to invest in a Colorado hedge fund promising to invest in safe government bonds.
FINRA has also experienced a steep increase in the number of enforcement actions it has taken against broker-dealers engaging in private placement sales gone awry – from approximately 20 cases per year, on average, in the 2005-2010 timeframe to 70 cases in 2011 and approximately 90 cases in 2012.
Brokerage firms have also found themselves victimized by Ponzi schemes and other scams orchestrated through unregistered securities. In the recent billion dollar MedCap private placement fraud, for example, dozens of independent broker dealer firms went out of business following investor lawsuits seeking to regain money lost in the fraud. When the money is gone, investors quickly move past the defunct issuer to the intermediary middle man for relief. It is critical that firms do as much due diligence on these deals as possible to protect both themselves and their clients from fraud and financial loss.
2. Investors Need To Understand The Benefit Of Advice And Know They Can Trust The Professionals Giving Them Advice.
My second take-away this morning is: investors need to understand the benefit of professional financial advice and know they can trust the professionals giving them advice. For whatever reason, more and more deals are being done without a licensed, professional intermediary, nearly 9 out of 10 private deals as noted above. Some of these investors are sophisticated entities or individuals who can “fend for themselves” and do not need or see a benefit to those services. Others simply may not have a relationship with an advisor they feel they can trust. In that sense, investor trust and confidence in the industry remains critically important.
There is a lot we can do to bolster investor trust and confidence in the securities industry and the folks sitting in this room often are one of the first lines of defense. Firm registration managers, for example, directly control the flow of brokers from firm to firm. I spoke a month ago at the Association of Registration Managers Conference here in Florida on this topic. As I urged them, I urge all of you to keep careful watch – talk to each other and ask tough questions when you are faced with a questionable firm-hopping broker, especially where the broker has numerous customer complaints or an employment history that includes more than one expelled firm. And please don’t get too testy when your friendly state securities regulator has a few questions for you on a broker like that at the registration or examination stage, we are just trying to fulfill our gatekeeping function, too.
For its part, FINRA has announced that it will be focusing on high-risk brokers this year in order to cut down on “cockroaching” practices. State regulators understand that this practice refers to a very small percentage of brokers, but the bad acts of a few can really take a hit on the reputation of the industry as a whole. Investors will not seek professional financial advice if they do not trust industry professionals to protect their hard-earned money.
Another easy way to boost investor trust is for the SEC to raise all securities professionals’ standard of care to a single fiduciary duty standard in which the client’s best interests comes first. NASAA has long been a proponent of the fiduciary duty standard and, while some of the details still need ironed out, industry stakeholders like SIFMA have also come on board.
SEC Chair Mary Jo White, who is making short work of remaining Dodd-Frank and JOBS Act related rulemakings, recently announced that the fiduciary duty issue is one of the Commission’s top regulatory priorities for 2014. It is great to see growing consensus on this issue. Retail mom and pop investors will respond favorably to the change knowing their interests will come first no matter what hat their financial advisor is wearing at the moment the advice is rendered.
3. Our Markets Function Most Effectively When Industry And Regulators Work Together To Protect And Serve Investors.
The final thought and takeaway I have for all of you this morning is to continue the strong partnership you have with regulators at the SEC, FINRA, and the states through NASAA. Our markets function most effectively when industry and regulators work together to protect and serve investors. You all are quite fortunate to have Sifma leadership – veterans like Ken Bentsen and Ira Hammerman – guiding the ship and representing your interests. I have had many occasions to watch these two particular gentlemen and other Sifma leaders in action and am always impressed with their deep understanding of the markets, the issues, and their professionalism in interacting with NASAA and the states.
For better or worse, we are all in this together. The best way for us to restore integrity to our markets is to restore investor confidence in us (as regulators) and you (as industry). We need to be seen as part of the solution to what ails our markets, not the cause. This requires constructive, sometime difficult, discussions on how we can bring back trust and certainty to the markets without suffocating investment opportunity.
I really wish investors could see us working together as we do here at Conferences like this. All too often they see or hear commentary on the issues that divide us. By showing a united front where we can, on issues like those you have heard about here at this Conference, investors will know that we are all working hard to protect their money and build their wealth.
If there is ever anything that I can do to assist you all with your work in the great state of Ohio or that you would like for me to take back to my fellow state regulators and the NASAA team in Washington, please let me know. Enjoy the rest of the Conference. Thank you.
April 1, 2014