Regulators Tighten Focus On Retail Investors

This will be the year of the retail investor for financial regulatory enforcement, with a special emphasis on the Security and Exchange Commission’s Regulation Best Interest standard.

When Reg BI went into effect on June 30, regulators were looking for “good faith compliance” for several months. It’s safe to say that we are past the good intentions phase and now firms must practices and documentation locked down, said Brian L. Rubin, head of Eversheds Sutherland’s securities enforcement and litigation team.

Eversheds Sutherland’s latest study of disciplinary actions showed that regulators increased their focus on retail investors last year. Cases relating to retail-type products, such as variable annuities, mutual funds and 529 plans; suitability; and providing misleading information to the public, totaled 60 cases, $8.5 million in fines and $25.9 million in restitution.

Overall fines reported by FINRA in 2020 increased 43% over 2019, up from $40 million to $57 million. The increase was the first since 2016, Eversheds Sutherland reported.

Firms can expect more of the same this year, Rubin said, emphasizing the importance of documentation for each transaction.

“You need to document it, so that when the regulators come and look at it six months, a year later, you have a contemporaneous record explaining why we made the selection,” Rubin said.

That means not just the seller but also the principals who reviewed the transaction, Rubin said. People involved in the transaction might have checked the boxes in the past, but now they literally have to check the boxes.

Expect more scrutiny on variable annuity sales, Rubin said. Enforcement action for VA sales climbed into the top five in the firm’s Top Enforcement Issues report for the first time since 2018.

Big Increase In Fines

That increase in fines for VA sales was substantial even though FINRA filed fewer cases in 2020 as compared with the year before.

FINRA reported six VA cases and lodged $6.1 million in fines in 2020, a tenfold increase over 2019, which yielded $525,000. FINRA also ordered $5.8 million in restitution in VA cases.

In last year’s largest VA annuity case, FINRA fined a firm $4.4 million and ordered it to pay more than $4.3 million in restitution for failing to supervise its registered representatives’ recommendations of VAs for more than six years, among other violations.

“My guess is that both FINRA and the SEC are going to be somewhat more aggressive,” Rubin said. “With that comes both more cases and increased fines assessed.”

Given that investigations take at least a year to complete, it is likely those probes have already started.

With new SEC Chairman Gary Gensler, Rubin expects the agency will be focused on Main Street investors, seniors in particular.

How can firms protect themselves? Watch the directives.

“It's a growing process for firms and for the regulators,” Rubin said. “Last year, both the SEC and FINRA had conferences on the issues. As they were seeing issues develop and seeing firms have questions or act in different ways, they were trying to put out guidance or thoughts about how it all should be working. So, it's important for firms to keep up with the regulatory pronouncements on these issues.”

The Pandemic That Keeps Taking

Just because the pandemic appears to be on a downslope, that does not mean it’s over for firms. In other words, what happened in the pandemic just might not stay in the pandemic.

“It's possible that there will be some enforcement actions stemming from the pandemic and how firms reacted or didn't react to that market volatility,” Rubin said.

That does not mean just how firms reacted to panicky investors and clients early last year when stocks took a loop de loop. But regulators might also be looking at how prepared firms were set up to serve investors when people started working from home.

With so many personnel working from home, did the firms have policies, procedures and systems adequately in place?

“Given the unique situation, I think that even if firms weren't 100% on top of everything, the regulators were being reasonable in their approaches,” Rubin said. “But it's possible that there are some outlier examples where firms didn't, for example, provide adequate resources or adequately train personnel given what was happening. So there may be enforcement actions stemming from that.”

Another 2020 phenomenon likely to pop up involves “meme stocks.” That was when stock prices for companies such as GameStop were pumped by investors through social media, inspiring a rush on shares -- squeezing some firms’ capital positions, especially involving margin calls.

Other regulatory enforcement trends Eversheds Sutherland saw last year were:

Anti-money laundering cases resulted in the most fines assessed by FINRA in 2020, the fifth year in which those cases have been at the top of the Top Enforcement Issues list.

FINRA reported 14 cases in 2020, resulting in $16.2 million in fines. Anti-money laundering kept the top position in part because of a $15 million fine, the largest single fine FINRA assessed in any case in 2020.

In that case, FINRA found that a firm over five years failed to reasonably surveil hundreds of millions of dollars of wire transfers, including millions of dollars of third-party deposits from high-risk jurisdictions. FINRA also found the firm failed to devote sufficient resources, both personnel and technological, to its anti-money laundering program, and failed to file suspicious activity reports for identified suspicious conduct.

Books and records cases resulted in the second most fines for FINRA in 2020, catapulting it into the Top Enforcement Issues list for the first time since 2017.

FINRA reported 29 books and records cases, with $14.5 million in fines in 2020. The number of cases decreased 45% from the 53 cases brought in 2019, while fines increased by 663% from $1.9 million reported in 2019. Books and records cases were driven largely by one case where FINRA fined a firm $6.5 million.

Steven A. Morelli is a contributing editor for InsuranceNewsNet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected].

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