If you have an issue with an unhappy client, would you rather sort it out within the firm, or bring in a regulator to investigate?
That might sound like an obvious choice: Of course, you’d prefer to avoid an external probe. But state regulators say that they routinely receive complaints from disgruntled investors about advisors and brokers, and many of those comments opens a formal investigation.
"We pursue and open a case on every complaint," Tanya Solov, director of the Illinois Securities Department, said this week at a conference hosted by the Practising Law Institute and broadcast online.
Solov divides the complaints her department receives into two broad categories: allegations that could potentially trigger violations of securities laws, versus calls from dissatisfied clients who might simply misunderstand a fee or some changes to their account.
When it comes to those customer service complaints, Solov recommends firms settle those issues directly with customers before they escalate to the state securities department.
"You don't want to have your name in our database too many times,” she says.
The view is similar in Maryland, where Securities Commissioner Melanie Senter Lubin advises firms to get ahead of the issues that clients raise. Too often, she says, firms instinctively defend their reps and branches. They’ll dismiss a client's complaint as an isolated issue to be addressed through the arbitration process rather than conduct a thorough internal review.
The regulators' comments come on the heels of an active year in state enforcement. Penalties against firms and individuals soared nearly 200% in 2016 over the previous year.
Officials suggest that aggressive state enforcement is likely to continue, especially if the Trump administration’s SEC opts for a laxer approach at the federal level.
"Maybe we're due for some big enforcement actions," Solov says. "Sometimes if there's a gap on the federal regulatory side, the state will pick up on it."
For firms with multiple branches, supervision needs to extend beyond the home office. Lubin says that she is "appalled" at how infrequently some compliance officers get on the road and visit their firms' branches.
Solov cautions that the smaller branches, which might be one-person shops run by dual registrants who are also insurance agents, warrant particular scrutiny.
In contrast to the SEC and FINRA, which have massive market surveillance programs to identify risks, Solov says that her state's investigations of brokers and advisors are very much "complaint-driven." Still, certain issues repeatedly turn up, such as complaints about variable annuities and questions about management fees.
And many of the investigations by state regulators unearth problems with firms' supervisory practices, officials say.
In many of the cases that Solov has overseen, a firm's compliance team was reluctant to probe too deeply into an issue flagged by the firm's supervisory system.
"I've seen this where the supervisor doesn't really want to get into a fight with the reps," she says. "And so something comes up on an exception report, and there's kind of this tendency often by the supervisor to go ahead and approve it. That's what kind of gets the firms in trouble. If you're going to have supervisors, you really have to have them examine what's going on."
In some cases, compliance personnel need to take a closer look at the technology in use at their firm. Solov recalls one case where an investor found that he had been charged a 2% fee for years, when his account had been set up with a promised 1.5% fee. It appeared that the lower rate had applied for the first year, but then the firm's system reverted to the default rate of 2%.
The issue of how well a firm's technical systems aligns with its business activities — and the extent to which supervisors are ensuring those systems are accurate — is one that "our state expects to be looking at in the future," Solov says.
"The people who are doing your programming for you may not understand what you really want, and maybe the default is okay, but you have to make sure then that the rep understands that every year they have to pay attention and override that default," she says. "You have these programs to calculate certain things — are they working properly?"
Lubin sympathizes with the difficulties that in-house compliance team can face, but ultimately sees their supervisory role as fundamentally similar to that of outside regulators.
"A regulator's going to get a complaint and say, 'Okay there's smoke. Is there any fire?'" Lubin says. "I always think that's a really good way for a compliance person to look at something and say, 'We need to dig a little deeper and see if something's going on here.'"
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