SEC accused of ‘regulation by enforcement’ as critics on both sides circle

The Financial Services Institute says the SEC is leaning too far into regulation by enforcement.

By John Hilton

The Securities and Exchange Commission (SEC) is getting heat from both investor and advisor groups this week over its regulatory strategies.

Representing advisors and their firms, the Financial Services Institute said the SEC is doing too much "regulation by enforcement." In other words, the agency is finding violations from advisors and firms who are trying to comply in good faith.

"We're going to continue to make the case that they ultimately undermine their own important mission and role when they use those enforcement powers and if it's not transparent and not fair, it makes it harder for financial advisors and the firms to comply," said Dale Brown, FSI president and CEO. "It ultimately has a negative impact on the mainstream clients."

FSI released a white paper titled Recommendations to the SEC to Modify its Procedural Framework to Prevent Regulation by Enforcement. The SEC press office pointed to Chairman Gary Gensler's October remarks before the Securities Enforcement Forum.

During that event, Gensler emphasized the need to protect investors from fraud and highlighted some SEC success stories. From December 2021 to Oct. 25, the SEC brought cases against 40 firms, required significant undertakings, and ordered more than $1.5 billion in penalties.

"In the last fiscal year alone," Gensler said, "we settled recordkeeping-related charges with 23 firms." The SEC also brought three cases against both public and private companies that used employee exit agreements to impede an employee’s ability to file whistleblower complaints with the agency.

"Some may call high-impact cases regulation by enforcement," Gensler concluded. "I call it enforcing the laws and the regulations that are on the books."

Under Gensler's leadership, the SEC stepped up enforcement is selected areas and drawn withering criticism of initiatives such as its technology proposal.

In the dark

The FSI paper defines regulation by enforcement as “when an enforcement action involves certain conduct that market participants did not previously understand to be a violation of the federal securities laws despite these market participants’ reasonable efforts to interpret existing laws, regulations, policies, and guidance from the SEC and other agencies.”

FSI recommends the SEC adopt concrete procedures to "detect and prevent certain unfair enforcement practices" by the commission and its staff. The report cited several harmful effects of current SEC practices, including "the circumvention of agency rulemaking requirements, violation of the rights of the regulated by not allowing the opportunity for notice and comment, and the undermining of the agency’s authority by generating a perception of unfairness."

FSI leadership held a media briefing Tuesday from its OneVoice conference in Orlando, Fla. Brown and other executives were pressed for specific examples of problematic SEC rules.

Share class disclosure rules have been a priority for the SEC for several years, and a problematic area for advisor firms. The SEC announced a fee disclosure initiative in 2018, when it gave advisers a four-month grace period to self-report violations regarding 12b-1 fees and the selection of mutual fund share classes without risk of being assessed a monetary penalty aside from compensating affected clients.

Still, many advisors used "industry standard language" in their disclosures and went through SEC examinations assuming they were fine, explained David Bellaire, executive vice president and general counsel for FSI.

"Instead the SEC used a pro-forma formula to calculate damages, which didn't have any real-world connection to investor experience," Bellaire said.

'Forced' arbitration?

Meanwhile, investor advocates are not happy with the SEC either. A coalition of investor advocacy groups will announce a new campaign Thursday aimed at "reforming SEC rules" for registered investment advisers.

The group is emboldened by a December report from the SEC’s Office of the Investor Advocate, which found that many RIA-forced arbitration agreements may be in “violation of the [advisers’] fiduciary duty.”

The report also found that approximately 61% of SEC-registered advisers serving retail investor clients incorporated forced arbitration clauses into their investment advisory agreements.

"The OIA report echoed what [the Public Investors Advocate Bar Association] previously had described as an 'untenable' system for aggrieved investors who seek restitution for improper investment practices by their RIA, which can often dissuade wronged investors from seeking compensatory damages for losses they’ve suffered," the groups said in a news release.

Other groups participating include the American Association for Justice, Americans for Financial Reform, Better Markets, Consumer Federation of America, the National Association of Consumer Advocates, and Public Citizen.

InsuranceNewsNet Senior Editor John Hilton covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.