Appearing on Capitol Hill on Dec. 11, the U.S. Securities and Exchange Commission Chairman hinted that the agency’s final rule on investment advice for retail customers may harmonize the wording for advisor and broker standards.
Under questioning from Sen. Elizabeth Warren (D-MA) during the Senate Banking Committee hearing on oversight of the SEC, Chairman Jay Clayton offered that the Commission may ultimately settle on a uniform “best interest” standard between investment advisors and brokers.
Echoing concerns she raised in August, Warren pressed Clayton on why the SEC did not define a best interest standard in the agency’s proposed rule, suggesting that different rules for investment advisors and brokers leave investors confused. “You could have made brokers subject to the same fiduciary standard that investment advisors are subject to, but you didn’t do that. Instead, the SEC’s proposals says that brokers have to act in best interest of the client, but you never define what best interest actually means,” Warren argued.
Warren maintained that investors first need to figure out whether they are working with a broker or investment advisor, and then need to figure out the difference between the fiduciary rule and the best interest test. “We could have fixed this by giving everyone the same rule,” Warren suggested.
Warrenr pointed to a recent SEC study showing that an investor was not able to identify the difference between an advisor and broker, based on the proposed disclosures by the SEC. “When your own study shows that disclosure don’t work to help regular investors make informed decisions, will you move away from a disclosure-based approach in your final rule and just adopt a uniform fiduciary standard for both advisors and brokers as Congress instructed in Section 913 of Dodd-Frank?” she asked Clayton.
Clayton responded by explaining that the “baseline advisor standard” in the proposal says that the advisor cannot put their interest ahead of the clients. “That’s not well understood and this is something we want people to understand; but they are able to say ‘I’m going to do these things’ and, with informed consent, they can cut back on that standard,” he noted. Clayton further explained that on the broker side, the fundamental duty is that they cannot put their interests ahead of the clients, adding that the two are the same, but it’s a different type of relationship.
Warren persisted, suggesting that if the meanings are the same, “then just use the same words,” to which Clayton responded, “We may do that.”
In later questioning by Sen. Catherine Cortez Masto (D-NV) about broker sales incentives and having a uniform standard, Clayton emphasized that the “bedrock principle” of the SEC’s proposal is that brokers can’t put their interests ahead of their clients. At the same time, however, he noted that investors understand that brokers have to get paid, but investors don’t want hidden incentives or incentives that are inconsistent with the best interest of the client.
Disgorgement Remedy
In his wide-ranging testimony, Clayton also reviewed findings from the agency’s annual enforcement report and highlighted the work of four investor-oriented enforcement initiatives over the past year:
- the Retail Strategy Task Force;
- the Cyber Unit;
- the Share Class Selection Disclosure Initiative; and
- Enforcement’s work in returning funds to harmed investors.
Notably, Clayton suggested that he intends to work with Congress to address a recent Supreme Court decision that limits ability of defrauded retail investors to get their money back when they are harmed by violations of the federal securities laws.
While in FY 2018, the Commission returned $794 million to harmed investors, Clayton explained that the unanimous Supreme Court decision in Kokesh v. SEC, however, has impacted the agency’s ability to return funds fraudulently taken from investors. He explained that in Kokesh, the Supreme Court found the SEC’s use of the disgorgement remedy operated as a penalty, which time-limited the ability of the Commission to seek disgorgement of ill-gotten gains beyond a five-year statute of limitations applicable to penalties.
While agreeing that statutes of limitation serve many important functions in the legal system, Clayton said he was troubled by the substantial amount of losses from Ponzi schemes and affinity frauds that the agency may not be able to recover for retail investors. “Said simply, if the fraud is well-concealed and stretches beyond the five-year limitations period applicable to penalties, it is likely that we will not have the ability to recover funds invested by our retail investors more than five years ago,” Clayton stated.
Clayton suggested that he believes that any such authority should be narrowly tailored to recover funds for defrauded investors, while being true to the principles embedded in statutes of limitations.
SEC Enforcement Activity Up
The number of SEC enforcement actions against public companies and subsidiaries jumped substantially in the second half of FY 2018, according to a new report.
Analyzing data from the Securities Enforcement Empirical Database (SEED), the report by the NYU Pollack Center for Law & Business and Cornerstone Research shows that the SEC filed 55 new actions against public companies and subsidiaries in the second half of FY 2018, reversing a decline in filings that began in the second half of FY 2017 and continued into the first half of FY 2018.
“While we often see end-of-year upticks, the number of actions filed in the second half of fiscal year 2018 was more than triple the number filed in the first half of the year,” noted Stephen Choi, the Murray and Kathleen Bring Professor of Law at the NYU School of Law and director of the Pollack Center for Law & Business.
For all of FY 2018, which ended Sept. 30, the SEC filed a total of 71 new enforcement actions against public companies and subsidiaries, compared to 65 in FY 2017. Monetary settlements in public company and subsidiary actions totaled over $2.4 billion in FY 2018 — more than the total in any fiscal year since at least FY 2010 and an 87% increase from FY 2017, according to the report.
The SEC continued to bring the substantial majority (85%) of actions against public companies and subsidiaries as administrative proceedings in FY 2018. In contrast, 55% of actions without public companies or subsidiaries were filed as civil actions in FY 2018.
Moreover, nearly half (45%) of public company and subsidiary actions involved broker dealer or investment advisor/investment company allegations, consistent with the SEC’s launch of its Retail Strategy Task Force at the end of FY 2017, the report notes.
