Looking Back: July 1982, Part Three: The States Come to Denver

Written By: Phil Feigin

In the last two segments, I discussed the beginning of NASAA’s modern era, and in particular, its Enforcement Committee and my first dealing with group. I turn now to what brought me to Denver for the first time, opening new doors I could not have anticipated.

As memory serves, we in Wisconsin and several other jurisdictions were investigating a rather significant and sophisticated national tax shelter scam called “Gold for Tax Dollars” run by a guy named Gerald Rodgers. I was frustrated by the case, because it cried out for a coordinated national effort yet the SEC was not particularly interested in exotic scams (sound familiar?) and individual state efforts were ineffective when crucial records were strewn across the country. I prepared a long letter to Rick Tucker urging him to revisit the idea of joint state investigations with travel, room and board to be funded by NASAA. Unbeknownst to me, Royce Griffin had also petitioned Tucker for help in dealing with his big problem, the penny stock industry in Denver. Colorado had adopted (in my view) the weakest state securities law in the country in 1981, for one thing, stripping the Commissioner of the authority to require licensing of, or regulate, brokerage firms and reps that were registered with the NASD. In Royce’s view, penny stock brokerage firms and their reps in Denver were doing business in states where they weren’t licensed, and committing securities fraud to boot.

It was April or so of 1982. We were at the annual spring meeting at the Hyatt Regency in Washington, D.C. The Enforcement Committee was meeting in one of the lower level conference rooms, and I remember that Ed Greene, then of the SEC, was giving a presentation on the new Regulation D that the SEC was in the process of adopting.

I was pulled out of the meeting by forensic accountant Nancy Jones of the Arkansas staff. My letter and Royce’s entreaty to Tucker had prevailed. Nancy had been recruited by Tucker and Royce to put together what would be NASAA’s first “special project.” She sought my help, along with that of several other enforcement types. We would put together a team of examiners from states where selected/suspected Denver penny stock firms were registered/licensed, thus giving them inspection authority, and these examiners would gather evidence the firms and reps were conducting business in states where they were not licensed. The evidence gathered would then be distributed it to the offended states. To be honest, at the time, I really didn’t know what a “penny stock” was. I had to ask one of my Wisconsin mentors, Ron Burtch, when I got back to Madison.

Back then, it was pretty unusual for state securities agencies to conduct onsite examinations of the headquarters of firms licensed/registered in their states but located elsewhere, particularly out west. It was one thing for a Boston-based Massachusetts examiner to inspect a Providence-based, Rhode Island firm just down the road; it was quite another matter for a Boise-based Idaho examiner to check out a Salt Lake City firm. They simply didn’t have the budget, even though they had unquestioned authority, to do so.

NASAA funding made it possible, particularly if an issue of regional or national concern presented itself. That was the case with Denver’s penny stock firms. The team of 16 or so staffers, including me, flew into Denver the first week of July 1982. (Among team members was Ralph Lambiase, at the time, an examiner from Connecticut, who would later become the state’s long time administrator and a NASAA President, and Lee Polson from Texas, who would become NASAA’s General Counsel a few years later.)

We had arranged for our own rented copying machines to be delivered to each firm that Tuesday morning. Back then, some firms would complain about examiners using their xerox machines, and insisted on having their own people make copies of requested documents. That of course allowed the firms to identify which documents were of interest. Bringing in our own machines obviated that problem.

As I recall, the team conducted exams of about 12 firms. Virtually all of them would go out of business over the next few years. Some I recall were Blinder, Robinson & Co., N. Donald & Co., E.J. Pittock & Co., Vantage Securities, Wall Street West, First Financial, Rocky Mountain Securities & Investments, Hanifen Imhoff (probably shouldn’t have been on our list), S.W. Devanney & Co. and R.B. Marich. The team left for a week and then returned for a second week of exams later that July.

Collectively, the exams collected evidence that the firms and their reps had hundreds of accounts in dozens of states where they and their reps were neither registered nor exempt from the requirement. For some reason, the Vantage numbers stick in my mind. Per NASD records, they were only authorized to do business in Colorado, but our team examiners found they had something like 693 accounts in 39 other states. (Paul Hurtado, who ran Vantage, was murdered years later here in Denver. I don’t think the crime was ever solved.)

Even more glaring than the 693 accounts in states where Vantage wasn’t licensed was the fact that team examiners noted the NASD Denver District office had inspected Vantage twice in the last few years, and had noted the fact in their reports. Even so, the NASD had not done anything on its own to make Vantage correct the problem, and had not notified any of the state securities agencies in the offended jurisdictions. When we brought that to the attention of Georgia securities director H. Wayne Howell, now NASAA’s President, sparks flew. I wish I had copies and recordings of the communications between Wayne and Gordon Macklin, the head of the NASD back then. This issue and other similar bones of contention helped forge the attitudes of a generation of state securities regulators toward the NASD and SROs in general. Things got a bit better in later years, but my sense is the distrust is pretty hard-wired and genetically imprinted in state securities regulators.

A wave of enforcement actions followed in the wake of the distribution of the evidence the team gathered in the two weeks of examinations. I think the count was about 110 cease and desist orders and the like. As I recall, Wisconsin was the first state to enter into a consent order with Blinder. A dozen or so other states took action against Blinder based on the project evidence as well, a statistic that was later cited by a federal judge in granting injunctive relief against the contentious firm in a hard fought SEC action. Colorado had been the jurisdiction to examine S.W. Devanney & Co., and they took Colorado to court in an attempt to preclude the Division from distributing the evidence of violative conduct to other jurisdictions. Eventually, Devanney would lose the case,* and ironically, strengthen the Commissioner’s powers under the Colorado act in doing so.

During my two weeks in Denver, I spent most of the time in “headquarters,” the Colorado Securities Division office, and got to interact with Royce Griffin. It was not long afterwards that he offered me the job of Assistant Commissioner. I was ready for a change, and took on the challenge, moving to Colorado in November 1982.

I had no idea what lay ahead for me. My state regulatory career gave me the opportunity to testify in Congress on many occasions, I would represent Colorado and NASAA traveling to almost every state and Canadian province, Cambridge and Oxford Universities, London, Tokyo, Paris, São Paulo and Montevideo. I would be named to a federal advisory committee, work on the drafting of two Uniform Securities Acts, the Model State Commodity Code, a bunch of federal legislation, and NASAA model statutes, rules and policies. I would go on to be named and serve as Colorado’s Commissioner for ten years, chair NASAA committees and sections, serve on NASAA’s Board, as its President and later, Executive Director, speak at more conferences than I can remember, work on national cases against Salomon Brothers and Lloyd’s of London, and forge friendships for the ages. It all traces back to Nancy Jones plucking me out of that Enforcement meeting about Regulation D that Spring day in 1982.

State awareness of the penny stock problem was certainly raised by the Denver effort. Soon, the NASD would, grudgingly, begin advising states of firm problems with state registration they uncovered in their exams. National publications started covering firms like Blinder, with the famous Forbes story entitled, “Blind ‘em and Rob ‘em.” While I have always held that New York, New Jersey and Florida had far more of a penny stock problem than Denver, at least by number of firms, they had lots of legitimate firms as well. With the predominance of Denver’s penny firms in this market, they stood out like a sore thumb.

Over the next decade or so, the combination of bad publicity, NASD efforts (particularly those of Frank Birgfeld and his staff here in Denver), the SEC’s dogged pursuits, U.S. Attorney actions, Colorado efforts, national, Colorado and Utah legislation and combined enforcement efforts and private litigation combined to end the bulk of penny stock abuses in Denver. I like to think what became known as the “Denver Project” was the beginning of the end for the worst of the Denver penny stock market. It also laid the groundwork for the dozens, if not hundreds, of “special projects” that NASAA has funded in the cause of investor protection.

* Griffin v. Devanney, 775 P.2d 555 (Colo. 1989)

Looking Back: July 1982 Part Two: Origins of NASAA’s Enforcement Committee

Written by: Phil Feigin

One of the side effects of the system was the creation of Series 63, the Uniform State Agent Securities Law Examination (“USASLE”). The states were required to drop their own exams in favor of the national exam, to the great relief of firms and reps across the country. Most states weren’t all that keen on keeping their own exams up to date and administering them anyway, so it was of benefit to them as well as the industry. Series 63 was to be administered by the NASD along with all the other NASD exams at its testing centers, at the NASD’s expense. That was another saving for the states. Finally, and perhaps most importantly, Series 63 was to be drafted and owned by NASAA. For the first time in its existence, NASAA would have an independent, and significant, funding source producing revenue and a budget far exceeding the experience of the past dependent on member jurisdiction dues. NASAA would only get a small fraction of the test fees, but it was still a substantial figure.

That meant that for the first time, NASAA could afford to fund staff members from NASAA member jurisdictions to attend face-to-face meetings at national conferences and otherwise during the year. This gave projects an enormous boost. Certainly, there had been meetings before, and staff members from jurisdictions with ample budgets had attended conferences in the past, but it was nothing like what the new era of Series 63 revenue provided.

I began my securities regulatory career in April 1979 as the Chief Attorney of the Enforcement Division of the Office of the Wisconsin Commissioner of Securities. The first annual conference I attended was that fall, in Little Rock, Arkansas (Anchorage had been selected site, but as it turned out, could not accommodate the meeting, so Little Rock filled in at the last minute). I attended on Wisconsin’s dime because NASAA funding had yet to kick in.

In 1979, I knew nothing of securities law, regulation or practice. Over the next three and half years, the excellent staff at the Wisconsin office had the patience to share with me their estimable and comprehensive knowledge and experience, on which I still rely every day of my practice, and for which I am forever grateful. I thrived in my new career, and being able to attend conferences and meetings, I began to participate in issues of national significance, initially, precious metals fraud.

With NASAA funding, the first winter enforcement meeting was held in January 1980, at the Big Mountain Ski Resort outside Whitefish, Montana, with R.G. “Rick” Tucker as our host. There were about 20 of us. Tom Krebs, the legendary director of the Alabama Securities Commission, was NASAA’s new president, and the Enforcement Committee chair was Wayne Howell of Georgia. There was no conference room—we sat wherever we could in the bedroom, with Krebs and Howell running the meeting from the bed. I remember discussing the idea of multistate investigations to be funded by NASAA, but worries about potentially adverse insurance ramifications quashed the idea.

We tromped along for the next few years, and enforcement types across the country got to know each other better from the face-to-face meeting opportunities. The first winter meeting in Whitefish had grown into a significant annual enforcement conference taking place in various venues. The January 1982 meeting was held again in Montana. Rick Tucker was the Chair of the Enforcement Committee for 1981-82. It was at this Montana meeting that I first met Royce Griffin. I had seen his name in the NASAA directory for prior years as a member of the Arkansas staff, but in February of 1981, he had been named Colorado Securities Commissioner. It would turn out to be an important meeting for both of us.

Looking Back: July 1982 Part One

Written by: Phil Feigin

My life and career changed dramatically and forever in July 1982. I have been encouraged to do some reflecting on times past every once in a while. I couldn’t help but think back to 30 years ago this summer. It was one of those pivotal periods in my life—which is not particularly important to anyone but me, my family and friends—but also in securities regulation and the maturation of the North American Securities Administrators Association (“NASAA”).

Let me set the stage, first on NASAA. Until the late 1970s, NASAA was an organization where the “blue sky” administrators, the bosses, met twice a year, in Washington, D.C. in the spring and a host state venue in the fall. The administrators were usually outnumbered by a large multiple by industry professionals from brokerage firms, investment companies, law firms and the like. It was a good opportunity to discuss events, issues and projects blue sky staffs had been working on back home. NASAA was funded by the dues paid by the blue sky agencies and their jurisdictions. Therefore, it was usually the bosses alone who got to attend the meetings, and only those administrators able to obtain state funding for the trips.

Investing was becoming a middle class/consumer fact of life to an ever increasing degree, inflation was rampant, and brokers across the country were reaching out to investors everywhere, not just where the brokers had their offices. That meant that both firms and agents had to fill out forms, take qualification examinations and meet other requirements of each state jurisdiction where they sought investors, on top of what they had to do for the SEC and the NASD. That was becoming an unholy mess.

The late 1970s and early 80s saw an unusual spasm of uniformity and cooperation that must be marveled at and commended. The SEC, the states and NASAA, and the NASD worked together to come up with uniform forms, entry requirements and tests, and a computerized system for administering all of it. The most recognizable feature of the new system was the Central Registration Depository, or CRD. There were bumps in the road to be sure, and it wasn’t perfect, but the CRD and coordinated registration/licensing process for firms and reps remains a model and paragon for every multistate/federal regulatory registration/licensing structure.

Bachus Bunkum

Written by: Phil Feigin

It’s August, and that means football is back! We have had but one pre-season game to date, the Hall of Fame game, but it was from the halls of Congress, not the gridiron, that we saw the launch of the first “Hail Mary” pass of the year. The op-ed piece written by Chairman Spencer Bachus (R-Al) in yesterday’s Wall Street Journal, “Financial Advisers, Police Yourselves” made this loyal Broncos fan yearn for the days of Tim Tebow. Even Tebow’s passes were more accurate than the good Congressman’s desperation heave to revive his moribund investment adviser SRO bill.

I could hardly believe what I was reading. Rather than lift his voice and assert his Chairman’s authority to support enhanced, targeted funding for more SEC investment adviser inspections, at no expense to taxpayers, Bachus urges the profession to cough up millions more in fees to “police itself,” to create its own self-regulatory organization, or, more plainly stated, line FINRA’s shrinking pockets with a newfound membership base.

Bachus and his ilk would rather we rely on a private club of overpaid mercenaries than fulfill the government’s responsibility to provide basic protections for its citizens. On that logic, let’s cut funding to the EPA. After all, the Gulf spill happened on their watch, didn’t it? We should let the petroleum industry police itself. And the FDA and phen-fen, and the FBI and 9-11. His argument is simply ridiculous.

In support of his misguided proposal, he and his supporters wave the “bloody shirts” of Bernie Madoff and Alan Stanford. Bit it was the NASD/FINRA that last inspected Madoff. And don’t give me that tripe about FINRA lacking the authority to look at the adviser side of Madoff’s operation. Ask any broker with his own IA in a FINRA exam how much information he is required to provide to them about his RIA business. (Think colonoscopy.)

And as for Stanford, yes, the SEC could have acted sooner, but it wasn’t all out of lethargy and not caring. The Congressionally mandated barrier to the SEC getting involved in the activities of banks (at the urging of the banking lobby) must account for at least some of the SEC’s reluctance to pursue the matter earlier and more aggressively. And oh, didn’t Stanford operate a FINRA member brokerage firm?

And let us not forget the stellar work of the National Futures Association, another broker-dominated SRO, in uncovering MF Global and Peregrine before any harm could befall their customers.

Further, Chairman Bachus cites to the Madoff and Stanford disasters rather than the thousands of scams-in-the-making uncovered by state and SEC adviser inspections over the last 72 plus years, and without an SRO.

It may be a dirty little regulatory secret, but inspections are not the be-all and end-all of regulation. They help detect problems, but they are not foolproof. Brokerage firms are required to inspect branch locations regularly, with searching for evidence brokers are selling away from the firm high on the priority list. Protection of the firm’s own checkbooks are on the line. Even so, dozens if not hundreds of selling away cases come to light every year.

Inspections are regulatory tools with an enforcement side effect. Inspections, exit meetings and follow-up deficiency letters are designed to help industry professionals better comply with statutes and rules. Sometimes you get lucky and uncover a fraud, but that’s not common. Crooks are crooks, and are very good at doing what they do, at least for a time. Once in a rare while, they can pull it off for years. A crook’s success is often due in greater part to weakness in the statutory and regulatory system, not the lassitude of regulators.

Instead of adding another SRO, the debate ought to be whether we need any SROs in today’s market. FINRA has evolved into nothing more than a private police force. Give the same authority and even half its resources and personnel to the SEC and state securities regulators, and brokerage and advisor misconduct would be pulverized.

If the lake is flooding over the dam into the valley, you don’t tell the villagers to hold a bake sale and buy their own bricks. The town council finds the funds to build up the dam for the benefit of all. I don’t want some private security service trying to protect me and my loved ones, I want real police, well staffed, trained and funded. So should everyone. So should Spencer Bachus.

So What Was I Supposed To Do?

Written by: Phil Feigin

A precious metals dealer client of mine called me late Monday afternoon, July 9, 2012, all in a tizzy. He had just received word that all accounts at PFGBest, the futures broker his company uses, had been frozen, and he needed advice on what to do. He added that he had just gone through a similar experience with their last broker, MF Global. I got as much of a handle on things as I could and advised him there wasn’t much for him to do at this point but wait for word from someone in charge, along with all the other PFGBest account holders.

Another fraud and scandal.

This week’s version is the PFG story, as we witness the previously microscopic Cedar Falls, Iowa, life of Russell Wasendorf Sr. being blown up exponentially on the financial world’s big screen. Along with it, we see the typical frustration inherent in the hunger for instantaneous information and clarity where there is none to be found. There are far more questions than answers, a scrambling for hard facts, and in their absence, innuendo, suspicions, and potential conspiracy and intrigue, and inevitably, but in this case a bit ahead of schedule, the recriminations, finger pointing, and harangues of regulatory failure.

What we know as of this morning is that a relatively prominent veteran of the futures industry lies in a coma in a University of Iowa hospital after what appears to be an attempted suicide. PFG’s accounts at U.S. Bank, the custodian for his firm’s client funds, are about $215 million south of what they are supposed to be holding. It is pretty clear Mr. Wasendorf Sr. fiddled with financial holdings reports and U.S. Bank account statements sent to the National Futures Association (NFA). Fueling contempt for regulators, there is some tantalizing indication that in early 2011 the NFA received word that PFG accounts at U.S. Bank held around $10 million—hundreds of millions less than was supposed to be there. However, when the NFA asked for clarification, they received a fax purported to be from the bank verifying the higher holdings. There is now suspicion the fax came from Mr. Wasendorf, not the bank. A bank employee is under investigation for potential complicity.

My client may well ask me, “So, what was I supposed to do?” He was not dealing with some unregistered outfit in Fort Lauderdale or Newport Beach he found on Yahoo. MF Global, and now PFG, were fully registered, regulated, long-established companies run by pillars of the industry. The law decrees that client funds must be segregated from firm money, held in trust, supposedly at independent, third-party custodian financial institutions. Everything was supposed to be overseen and audited by self-regulatory organizations (either the exchanges or the NFA) and the Commodity Futures Trading Commission. What more can you do or ask for?

From my client’s standpoint, my answer has to be, “Not much.” It’s tragic and appalling when time-tested, systemic protections collapse. Reactions are predictable. The regulators and those who believe in and support strong regulation will assert the regulators did all they could. The guy was a clever crook, it was a conspiracy, and there was no reasonable way to discover it earlier than they did. The system did work, in that the fraud was uncovered before he could do more harm than he had already done. Perhaps if they had stronger laws and more resources, they could have discovered the fraud sooner.

The detractors of regulation will assert the laws are fine as they are and the regulators have plenty of resources; they were just incompetent and dropped the ball. At the same time the fraud at PFG was being perpetrated, there were hundreds of thousands of transactions conducted at thousands of commodity brokerage firms across the country in a perfectly lawful manner. Those firms and all the honest professionals who work at them should not be tarnished and made to suffer more unnecessary regulations because of one crook in Iowa and regulatory shortcomings in detecting his fraud.

There will be the hearings, reports will be demanded, some sordid details will come out, the trustee in bankruptcy, trustee’s counsel and forensic accountants will make lots of money, anyone who received back more than they deposited will face clawback suits, account holders will get back X on the dollar, and we will eventually move on when the next catastrophic financial scam surfaces.

As I see it, there is some validity to all of these reactions. My client did his homework and did business with the kind of firm with which he was supposed to trade. Fraud and conspiracy to commit it are pernicious, underhanded crimes. You can only do so much to protect yourself from some things, like having your home burglarized, being hit by a drunk driver, being mugged on a busy street, or losing money to a criminal at a respected institution. Crooks are crooks, and they are the reason we have crimes, prosecutors and prisons.

On the other hand, I was surprised to see how easy it appears to have been to convince the NFA there was money in the bank. In this day and age of instantaneous electronic communication, how hard could it be to require each futures commission merchant (FCM) to report to some regulatory computer their custodial balances electronically, along with the clearing house settlement process after each market close? Wouldn’t it simply be another encoded transmission? Further, FCMs already identify their custodians to regulators. How hard could it be for the regulators to provide confidential codes to custodian banks, and have an electronic report on custodial balances, marked to market, sent to an NFA computer at the close of every business day? The computer would match balances and kick out any discrepancies. A discrepancy north of $100,000 would generate an official inquiry.

I’m not a back office guy, so perhaps what I suggest is already in place, or harder to institute than discovering the Higgs boson. Maybe the NFA proposed doing it, but the industry fought back because it would be too expensive. Maybe some clever computer guy at the bank could figure out a way to game the reporting system.

Maybe pieces of all of that.

I remain firm in my conviction that the surest way of preventing and detecting financial fraud is a two-pronged device. First, an independent, third-party custodian must be positioned between those who are supposed to be investing your money and those who are supposed to be holding it. Second, the custodian must provide reliable reports directly to those with an interest in protecting the sanctity of those custodial assets—either the client, regulators, or both—and those reports must be diligently reviewed, with discrepancies acted upon promptly and effectively, in direct communication with the custodian.

From initial reports, it appears the NFA was in the process of implementing some form of electronic reporting directly with the bank. That triggered the ultimate discovery of fraud at PFG. That’s a good thing, but apparently too late to help my client and his fellow account holders. What seems very, very bad for the NFA is that even when their earlier reporting system succeeded in detecting the gross shortfall at PFG more than a year earlier, in early 2011, the “fire alarm” could be turned off with nothing more than a fax—a form of communication that in this age of so many more forms of direct communication, seems about as reliable as a smoke signal or a whisper around a campfire. How did they know the fax even came from the bank? It could have come from anyone with a sample of U.S. Bank letterhead, word processing, an Internet connection, and a telephone number. Sadly, it appears it did. Someone at the NFA bought it. Perhaps the story will change as more as learned. But if it doesn’t, not good.

INVESTMENT ADVISER SRO – The “Colorado Experiment.” Part Four

Written by: Phil Feigin

They say if you stick around long enough, everything will happen again. So it is for the IA SRO concept for me. It was many years (and pounds) ago, when I served as Colorado Securities Commissioner. I had succeeded in winning adoption of the Colorado Securities Act in 1990, replacing what I felt was the worst state securities law in the country. It had been adopted in a deregulatory wave of 1981. In late 1993, I undertook to amend the 1990 Act in the 1994 legislative session by adding investment adviser regulation. Colorado was one of the handful of states that had never regulated investment advisers or their advisory personnel.

Colorado’s General Assembly was always hostile to providing new authority, funding or staff to its regulatory agencies. The state was in what seemed to be an eternal fiscal crisis. Any new regulation with licensing and inspection authority, if adopted at all, could have no fiscal impact. That appeared to pose an irreconcilable problem unless we changed the parameters of the problem.

In desperation, I came up with what I thought would be a novel solution only available in Colorado. What I knew as the International Board of Standards and Practices for Certified Financial Planners (“CFP Board”) was headquartered here in Denver, and already had in place a form of testing, application screening, licensing, continuing education and an oversight program for certified financial planners. I approached the CFP Board director to see if naming the CFP Board some sort of self-regulatory organization (“SRO”) for Colorado investment advisers was even theoretically possible. When he didn’t say “absolutely not,” I at least floated the idea publicly.

At this point, I harken back to my classification a blog or two ago in which I divided the investment advisory profession into three general groups:  (i) money managers; (ii) retail advisors; and (iii) fee-only planners. Suffice it to say for these purposes that these three general groups are loosely bound together by the facts they deal in securities, they are generally subject to either federal or state investment adviser registration and regulation, they charge fees based on AUM, and they reside on Earth. Oh, and members of each group hold themselves in higher esteem than the other two groups.

Now, back to my Colorado story. My 1994 IA legislative proposal was plain vanilla, standard state investment adviser regulation, i.e., a bill I thought had a chance of passing. As I recall it now, a local, activist fee-only planner (and mind you, I have great respect for fee-only planners generally) with no regulatory or legislative experience decided that Colorado was uniquely situated to be the first state to outlaw anything but fee-only advice. He fashioned a rival bill that, as I recall it, would have given Colorado expansive and unprecedented authority over advisers. Thus, in my view, given Colorado’s tendencies, the bill was DOA.

Nonetheless, this planner apparently won the support of Gretchen Morgenson [now a New York Times (self-professed) Wall Street critic, but at the time, executive editor of Worth magazine]. Ms. Morgenson absolutely skewered me in her November 1993 Worth article (“Investor Watchdog or Industry Pussycat”), accusing me of betraying investors by lending regulatory credibility to the CFP Board and its accreditation program by suggesting it could serve as a state SRO. (It should be noted that, although CFPs are held to relatively high ethical standards by their Board, they are permitted to sell products as well as provide investment advice and financial planning services.) As I recall, Ms. Morgenson and this fee-only planner were critical that CFP qualification tests were flawed, and that advisers with the CFP certification were permitted to sell products as licensed securities and insurance agents as well as advise for fees. My 1994 IA bill was likely going to die in any event, with or without the “help” from my planner and Worth fan. And it eventually did.

To that point in time in my government career, one defense lawyer had called me a heartless, cut-throat regulator, and a Colorado state senator had assailed me and my staff in a public hearing, accusing us of using what he termed “Gestapo tactics” in our investigations (being of Jewish decent, that one was particularly sweet to me). However, until the Worth article, I had never been accused of being some sort of investment industry lap dog. (I still remember Gretchen’s article to this day, not that I would hold a grudge for almost 20 years.)

Anyhow, a few more years, one National Securities Markets Enhancement Act (1995), one Democratic Senate, and one or two major advisory frauds later, I finally succeeded in ramming a new, relatively standardized IA bill through, and Colorado at last had an investment advisor law, effective January 1999, sans SRO.

Now, almost 20 years after my desperation Colorado IA SRO trial balloon was “Hindenberged,” Rep. Spencer Bachus has (R-Ala.), Chair of the House Financial Services Committee, has proposed the “Investment Adviser Oversight Act of 2012.” If it passes, the measure will give the SEC the authority (read “order them”) to create and oversee one or more SROs for federal and state registered investment advisers and investment adviser representatives.

Where’s Gretchen when we need her?

INVESTMENT ADVISER SRO – What makes sense. Part Three

Written by: Phil Feigin

We don’t need a new SRO for investment advisers. On top of that, a new SRO would be a marked detriment to the advisory profession, American investors and the economy. The essential reasons SROs arose in the first place are absent in the IA sector. What is needed is funding.

We’re already there where it counts most. FINRA already polices the advisory activities of those of its members who are dually registered as brokers and advisers. If FINRA is somehow limited in its oversight of dually functioning firms and reps, whatever those weaknesses are can be addressed easily in narrowly targeted legislation or rules.

In my view, it was a mistake way back whenever for the SEC, the states and the SROs to allow the Jekyll/Hyde arrangement of broker-IAs anyway. If you want to sell, be a broker; if you want to advise, be an IA, but they should not have allowed the two to be mixed. However, that cat’s long out of the bag. I think FINRA is well positioned to deal, i.e., to continue to deal, with the inherent and inescapable conflicts of interest that arise from the dual roles.

That said, I am pretty tired of the seemingly endless studies commissioned to find out if the investing public is confused about the differences between and the responsibilities of brokers and IAs. I am already on record as to my belief that the only real difference a uniform fiduciary duty would make is in customer arbitrations. There’s more persuasive state case law on fiduciary duty than there is on suitability.

Of course, people are confused. They are confused about all sorts of things. We have a Federal Trade Commission, Food and Drug Administration and state consumer protection laws, so those laser comb and other hair restoration technique and weight loss commercials rammed down my throat every night on TV and in newspaper ads (yes, I still read newspapers) must be legitimate, right? Certainly, if they weren’t legitimate, “they”—federal and state authorities—wouldn’t let them advertise. And then there are all the debt relief services that will help people under water keep all seven credit cards, their iPhones, premium cable, Lexus, gym memberships and Starbuck’s habits without sacrificing a thing, and for free; the companies that helped reduce that guy’s $5,000,000 tax liability from not filing returns since high school to $1,300; and the schools that teach people how to become real estate moguls, buying and selling houses risk free and without any money down; or pay off your mortgage in four months; or to day trade your way to millions. (Rant over.)

Are consumers really confused when they deal with an Ameriprise agent? Does the consumer really believe he will be offered a Merrill Lynch-sponsored mutual fund when he visits his Morgan Stanley rep? If you go to a Ford dealership, is anyone out there surprised when they are offered a Ford and not a new Audi? That they are confused by the differences between dealing with a broker and an IA is overly well-documented. But they are not confused about proprietary products.

For all the years I was Securities Commissioner, it was well-known that one of the NASD’s greatest fears, concerns and frustrations was that large producers at firms the NASD regulated were resigning, registering as investment advisers and placing their clients’ trades through accounts at Schwab or the like. It was apparently the NASD’s view that these reps turned advisers were then able to engage in violative conduct they could not engage in under the purview of the NASD.

We never quite knew what that wrongdoing was. Both NASD and IA regulation prohibited unsuitable recommendations. Neither the broker rep before nor the IA rep now could take custody of customer funds or securities. Both the broker rep and the IA rep could devise ways to steal from his customers. That was illegal under both regimes, yet, unfortunately, it still happened.

To us in the states, the IA model, particularly the fee-only model, freed the rep from having to sell stuff. Thus, the only (lawful) way for the IA to make money was if the client made money. The NASD feared losing control over the rep, but to us, a paramount basis for that control had been eliminated. Regulators, even self-regulators, always look over the river at the folks outside their regulatory grasp and seek more jurisdiction. It’s just the nature of the beast.

Show me the money. To me, FINRA has become nothing more than the securities regulatory version of private prisons. The perception is that hiring the private firm to build and run the private prison costs the government less than building and running its own facility. Maybe, maybe not. The functions FINRA now performs are all but indistinguishable from what OCIE, Trading and Markets, Enforcement and the states do, except they do more of it with their expanded resources. FINRA assesses/taxes its membership, which in turn “taxes” its clientele for the cost of that regulation. It is an off-book enterprise and off-book accounting that would make Enron’s Andrew Fastow proud. As for comparative cost to the investing public, one need only compare Mary Schapiro’s FINRA retirement package with whatever Arthur Levitt got as SEC Chair to get an idea as to how FINRA compensation compares to that of the SEC.

The SEC has tried, unsuccessfully, for years to become self-funded, i.e., to keep and spend what it takes in as fees. Under the plan, its fee levels would still be subject to Congressional control to prevent excesses. Relatively speaking, the amount the SEC estimates is needed to fully staff its inspection effort is miniscule in the grand scheme of the federal budget, and negligible when even the fees that would be required to pay for the increase are considered. Not a single additional tax dollar.

Yet, I am told, more money for the SEC is “off the table” in Congress. If that is the case, I say we should then get a new table. The costs of establishing an IA SRO will be astronomical in terms of what it will mean to day-to-day financial planners and their clients, to mutual fund advisors, their investors and their marginal returns since 2008. And for what? It is the SEC and the states that have been licensing and regulating advisers for more than 70 years. There is no legacy SRO as there was with the exchanges for brokers in 1934. And what will this new SRO, or heaven forbid, new SROs, be charged with doing? More inspections!

The SEC and states already have the granular body of IA “does and don’ts” rules and regulations. The belief is that more inspections will mean better oversight, catching the bad actors and improving the operations of the good ones. The regulators in place simply need more people. We do not need an industry/client-supported infrastructure, where the taxation and processes are hidden and largely uncontrolled.

Such a funding burden would all but surely take a punishing toll on a host of localized financial planners. Unlike the brokerage industry, fee-only financial planner practices are often one-person shops, managing $20 or $30 million with maybe 30 to 40 clients. The burdens posed in their having to support an IA SRO would be staggering. It may be more than they can withstand. The very people who are least likely to cause any IA-related problems would be the ones most hurt by the proposal. Per a survey in Massachusetts, 41% of its registered IAs would be driven from business.

Bait and switch? Surely, after winning jurisdiction in Dodd-Frank, the provision of the Bachus bill most offensive to state securities regulators is proposed section 203B(h). Under this unprecedented provision, state securities agencies—political arms of sovereign states—would, in essence, have to petition the IA SRO—a private company—and the SEC on an annual basis, in a report made at some sort of mandated (and no doubt unfunded) regulatory confab, for the power to regulate IAs within their jurisdictions. The petition would be based on the proposed “methodology of their examinations” for the coming year and how they did in meeting their goals the last year. NASAA, or something like NASAA—another private enterprise—is supposed to produce this report and itself make recommendations to the IA SRO and the SEC based on its vetting of how well the state agencies did and on state plans for the next year—another completely unfunded federal mandate. Based on the report and the confab, the IA SRO is to report to Congress each year. It is unclear in the bill, but I infer that, in this report, the IA SRO, with the advise and consent of the SEC, would determine conclusively which state either did not perform as planned last year, or whose plan is insufficient for the coming year, so that its state regulated investment advisers will be subject to IA SRO rather than state jurisdiction for the coming year. Not surprisingly, there is no provision for the states to submit their views as to how well or poorly the IA SRO performed last year or as to its methodologies for the coming year.

I can’t even begin to describe the constitutional problems the proposal entails, let alone the statutory and budgetary confusion and problems at all levels, for both regulators and regulated, it would cause were it to become law. It is just plain crazy.


First, leave state IAs to the states. Under Dodd-Frank, the states were given the responsibility of overseeing advisers with less than $100 million AUM. The states have been gearing up to fulfill that responsibility ever since, and commencement of the grand design is all but upon us. They should be given the chance to succeed. No matter what Congress does about the advisers under post-Dodd-Frank SEC jurisdiction, Congress should leave regulation of these state registered IAs alone. Revisit the system five years from now and see how they did.

Second, if necessary enhance FINRA’s existing jurisdiction. As I said before, do whatever might be necessary to enhance FINRA jurisdiction so it is fully empowered to regulate those entities dually registered as BDs and IAs as well as their people and the unique problems they all may present. The involvement of the states in regulating this sector likewise should be their business to prioritize and to coordinate with FINRA, as they do today. How much or little the SEC involves itself in overseeing this sector should be a matter of coordination and prioritization with FINRA and the states as well, again, as it is today.

Third, impose user fees to fund SEC oversight of SEC IA-only registrants. Finally, fund the SEC to inspect what is left is the third sector, the IAs that are not affiliated with any retail broker-dealer, that are registered with the SEC that do not sell securities, i.e., essentially, the money management sector, the managers of our mutual funds, hedge funds and institutional portfolios. I would include in this group those mutual funds that have brokerage affiliates. The potential risks posed to the economy by problems in this sector mandate direct SEC oversight.

The SEC must be given the authority to impose on these IAs the user fees necessary to fund their regular and efficient inspections and regulation. It is simply nonsensical for Congress to deny the SEC this funding mechanism in favor of establishing, staffing and inventing a new self-regulatory bureaucracy. How can anyone rationally compare the costs of establishing an entirely new and separate self-regulatory regime with those of simply adding additional staff to an already functioning system, and without spending an additional tax dollar?

In my last part in this series, I’ll share an anecdote about my own dabbling with the IA SRO concept as Securities Commissioner.