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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks Before the SIA Compliance and Legal Division Fall Compliance Seminar


Commissioner Annette L. Nazareth

U.S. Securities and Exchange Commission

New York, N.Y.
November 13, 2006


Thank you for inviting me to share my thoughts on current compliance issues. I will discuss today an important area of the SEC's compliance focus — that is, our program to combat fraud against senior citizens. I will also attempt to offer some suggestions for you to consider when you review your compliance and supervisory procedures. Sales of complex products to retail investors, particularly seniors, require heightened compliance scrutiny. Both supervisory authorities and industry participants have a vested interest in ensuring that these investments are thoroughly vetted before being offered by firms and then targeted only to those investors for whom the products are appropriate. Before I speak further, I must remind you that my remarks represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or the staff.1

Fraud on Seniors

This year, the first of the millions of individuals who are part of the Baby Boomer generation turns 60. For the next 20 years, the Baby Boomers will continue to reach this milestone at a rapid clip, with more than 10,000 of them becoming sexagenarians every day, or roughly 416 per hour. That means that by the time that I have completed my remarks today, we can add another 208 or so to the total.

I think it is fair to say that the Baby Boomers have always been different — always pushing the envelope — always making their voices heard. Quite frankly, I suspect this will remain true as they approach their Golden Years. For one thing, their members will live much longer than previous generations thanks to modern science, and as a result will need to fund longer retirements. This probably means that they will need to stay invested in equities and not switch to fixed income products to the degree that people over 60 have in the past.

Also, it is no secret that many Baby Boomers have amassed a significant amount of wealth, and I expect that they will take it with them well into retirement. Unfortunately, though, where there is a lot of money, there is also an inviting environment for financial fraud. This has been particularly true in the case of senior investors, who have been the victims of countless types of investment frauds. To illustrate the heartbreaking details that accompany frauds on seniors, I'd like to relate to you a brief story, which I heard this summer at the Commission's Seniors Summit.2

Henry was a successful businessman who was married for 30 years. He raised a family and generally had a good life. After his wife's death, he received an overnight package of materials — with all kinds of reports — that was offering an oil and gas investment. Henry had not requested the materials and simply ignored them at first. But the next day a salesman called and used high-pressure sales tactics to eventually persuade him to invest $40,000. Here are some examples of what the salesman said to Henry: "These gas wells are guaranteed to produce $6,800 a month in income;" "Some of the most successful investors in the country are interested in these wells;" "There are only two units left in this project;" and, "We drilled a well in Texas that had these same early gas readings, and the investors all made millions." Over a three-year period, Henry was contacted 12 times and invested what was essentially his life savings in 4 different gas wells. Each time, he was led to believe that he had to invest more or lose his original investment. You already know the ending to Henry's story: he ultimately lost more than $500,000 to an oil and gas scam.

Although this story is particularly compelling, what makes fraud against seniors egregious generally is that the victims are in their later years, having worked a lifetime to build their nest eggs through sacrifice and dedication. Also, they are usually beyond their earning years and have little or no ability to rebuild lost retirement funds. Some of the frauds even use seniors' best intentions against them. For example, a fraudster may pose as a charitable organization offering monthly annuity payments in exchange for a purported charitable contribution. The contribution supposedly will be invested in something described as a charitable annuity, which provides an annuity to the investor and a remainder benefit to the charity. Much or all of the money that investors put into these scams, however, goes straight into the fraudster's pockets — certainly not to any charity.

In addition to these "charitable annuities," there are a number of investment products that have been commonly used to defraud older investors, including "high-return" or "risk-free" investments, illegitimate certificates of deposit and promissory notes, and high-risk investments that do not meet the investing objectives and means of senior investors. Other types of frauds committed against seniors include churning and the use of high-pressure sales seminars. In a sales seminar scheme, an investment adviser may lure investors to attend seminars with promises of a free lunch. When investors arrive, however, they may find it difficult to digest their free meals in the midst of high-pressure sales tactics that are designed to compel them to purchase unsuitable investments.

Commission Action to Protect Seniors

The Commission is very aware of the changing demographic trends and increasing victimization of seniors through investment scams such as high-pressure sales seminars. We have taken significant steps to protect senior investors against fraud, and have recently announced a comprehensive national strategy that includes three main components: enforcement of the federal securities laws, examinations to prevent fraud, and education of senior investors.

First, the Commission has been vigilant in pursuing allegations of fraud, including that targeting seniors. As you well can imagine, the SEC receives many calls from people who have been defrauded, or have been sold securities they neither understand nor should be invested in. Enforcement cannot nor should be the first line of defense, but is an important tool in combating fraud. I'd like to draw your attention to some of the more recent cases brought by the SEC's Division of Enforcement, which, I think, are instructive and illustrate how some recent frauds against seniors were effected.

In July of this year, the SEC brought an emergency enforcement action against Pittsford Capital Income Partners and others,3 seeking, among other things, an asset freeze and the return of the defendants' ill-gotten gains. Over the course of 8 years, the defendants in this matter allegedly raised some $15 million from several hundred investors, many senior citizens, by issuing unregistered promissory notes in various real estate investment companies. As in many frauds, the defendants made material misrepresentations about the financial condition of their investments and misappropriated customer funds.

In a second matter, announced this past August, the SEC took emergency action to halt an ongoing securities fraud that raised over $22 million by targeting investors' retirement funds.4 The defendants allegedly solicited investors by direct mailings that pitched free dinner and retirement planning seminars. The mail invitations included statements such as "Retirement Secrets of the Rich: What your Accountant and Stockbroker don't want you to know." Both the invitations and seminars claimed the defendants would help investors retire "in just seven short years" by investing their IRA funds "to take advantage of the booming real estate market" and "to produce double-digit returns." The defendants promised unrealistically high rates of return, as high as 24%, in order to entice investors to transfer their IRA savings to the defendants for investment in purported businesses — which many did.

Not surprisingly, these businesses for the most part were non-existent. The defendants did not purchase any real estate or real estate related assets in order to pay investment returns. This directly contradicted the representations that were made to investors that their investments would be secured by real property or by funds owed from other real estate transactions. Defendants were in reality running a Ponzi scheme, a fact which they also failed to share with new investors.

Also in August, the SEC filed an emergency enforcement action to halt an ongoing fraudulent offering of stock in a company called "One Wall Street, Inc." The injunctive order stated that defendants had obtained over $1.6 million from at least 64 investors, most of them senior citizens.5 Beginning in 2003 until the present, defendants, to induce sales, made numerous false and misleading statements, including statements that One Wall Street would soon conduct an initial public offering, that E*TRADE Financial Corporation was negotiating to merge with One Wall Street, and that One Wall Street would use the investment proceeds only for business purposes. Of course, none of these representations was true. In fact, rather than apply the proceeds towards legitimate business expenses, the defendants used investor funds to pay for personal expenses.

Next, in addition to the enforcement of the federal securities laws, the Commission is focusing a significant amount of effort on examinations to prevent fraud from occurring in the first place, and to detect it early when it does. As the saying goes, "an ounce of prevention is worth a pound of cure." Our Office of Compliance Inspections and Examinations is focusing on the suitability of recommendations made to seniors, with particular emphasis on recommendations of securities that are more risky or include higher fees and commissions. Examiners are also focusing on the manner in which seniors may be drawn to sales pitches, such as through the "free lunch" seminars. In fact, along with the NASD, NYSE, and state securities regulators, we have been examining firms that sponsor these seminars, particularly in states with a concentration of seniors, to determine whether they have used high-pressure tactics to sell unsuitable products.

The Commission is also coordinating with these regulators through "summit meetings" during which regulators share information and observations about the conduct of firms that specialize in recommending securities or providing advice to seniors. In particular, regulators will share customer complaints and other information that may indicate when firms are targeting seniors for inappropriate sales of securities, and will conduct targeted on-site examinations of these firms.

Finally, the Commission is educating seniors to protect themselves against investment fraud. Indeed, investor education and outreach are critical parts of the Commission's efforts. In this regard, the Commission has sought to arm senior investors with information that they can use to identify and avoid potential fraudulent investment schemes, to deal with aggressive sales tactics, and to assess many of the financial products available to them. Quite significantly, this summer we held our first Seniors Summit at SEC headquarters in Washington. We discussed how regulators and others can coordinate their efforts to protect older Americans from investment fraud and abusive sales practices.

The Summit was also significant in that it unveiled a study on investment fraud funded by the NASD Investor Education Foundation. The study explored the reasons why the elderly are victimized by fraud crimes, and made some very interesting findings. For example, fraudsters use hundreds of sophisticated social influence tactics to get their victims to sign on, such as guaranteeing exorbitant returns or income, and making statements designed to demonstrate their authority. Fraudsters often bombard their victims using a combination of these tactics. Henry's story that I related earlier was a good example of this.

The study also found that investment victims tend to be more financially literate than non-victims. Thus, part of the Commission's educational efforts for seniors will include not just additional financial information, but also information helping them to identify the social influence tactics employed against them.

It was also interesting to learn that seniors drastically underreport investment fraud. This apparently occurs partly because seniors, like all of us, find it difficult to face the reality that they have been betrayed by people they once trusted. Frankly, they are also embarrassed. Others may not realize that they may have lost their life savings. Also, some may not report fraud out of fear that others would view them as incompetent to manage their own finances.

In addition to the Seniors Summit, the Commission's Office of Investor Education and Assistance reaches out to senior investors in many other fora. Our headquarters and regional offices are involved in events across the country, including a Safe Investing Seminar later this month in New Hampshire. The Commission distributes materials at these events and makes presentations that are designed to inform seniors and help them to protect themselves against investment fraud. Also, as many seniors and their children or caregivers use the Internet to search for information on investing, the Commission has dedicated a portion of its Web site specifically to seniors. The site includes links to critical information on investments that are commonly marketed to seniors, such as variable and equity-indexed annuities. It also warns against the dangers of listening to the sales pitches of cold-callers and alerts seniors to the very real threat of affinity fraud.

Broker-Dealer Compliance

As compliance and legal officers, it may be helpful for you to reflect on the SEC's multi-pronged approach toward fraud targeted at seniors. Again, our focus on this area combines the disciplines of enforcement, examinations, and investor education. In many of the enforcement actions that the SEC has brought over the years, the problem invariably comes down to fundamental practices having gone awry — whether it's unsuitable sales practices, inadequate compliance policies and procedures, or a failure to supervise. Although it may be difficult to thwart persons who are wholly devoted to defrauding investors, nevertheless, well-crafted policies and procedures, vigilance with respect to oversight of sales practices, and focused and effective supervision would have identified much of the conduct I've just described and may have stopped these frauds even sooner.

These basic compliance concerns are as important today as ever. You are well aware that broker-dealers must develop a supervisory system and written policies that are effective in preventing violations of the securities laws. Supervision must be specifically tailored to the broker's business and address the activities of all of its personnel. An important component of effective supervision is that it gets updated and modified as necessary to reflect changes in the firm's business lines, products offered, and practices, as well as changes in the securities laws. It is also important that supervision keep up with the latest interpretive guidance issued by regulators, such as guidance issued concerning the sales practices with respect to novel or complex products. Also essential to a supervisory system's effectiveness is that supervisory staff have the knowledge, skills, and tools to carry out their supervisory obligations. Without proper training and support, supervisors will not be able to identify issues or concerns nor follow up on them.

As you know, every broker is required to have policies and procedures to ensure compliance with the applicable securities laws and regulations. One of many areas that must be addressed specifically in a firm's procedures is suitability. You are quite familiar with SRO suitability rules — rules that are grounded in concepts of professionalism, fair dealing, and just and equitable principles of trade. NASD Rule 2310 squarely addresses suitability determinations and requires that the recommendations a broker dealer makes to a customer must have a basis in the customer's particular financial situation and investment objectives. This includes obtaining information about the customer's financial and tax status and investment objectives. But, equally important, and critical before any policy is drafted or security is recommended, is that firms evaluate new and complex products and ensure compliance, supervisory, and sales staff understand the structure, fees, and unique features of the securities products they offer.

Frauds targeted at seniors can take many forms and can involve a variety of securities products, from the plain vanilla to complex products. I've discussed some frequent vehicles for fraud, like free lunch seminars, and I've described some common characteristics, such as high-pressure sales tactics, and unsuitable recommendations. Unsuitable recommendations very often involve products that are complex, involve hidden fees, are high risk, or implicitly are illiquid.

As you work daily to keep up with the developments in the securities markets and the frequently changing terms of complex products, I'd like to direct your attention to the availability of guidance on best practices for reviewing new products that was published last year by the NASD in its notice to members (NTM 5-26, April 2005). The NASD, I believe, timely addressed the fact that the industry is introducing increasingly complex products to the market in response to the demand for higher returns or yield and that some of these products have unusual features, or a combination of features, that are not well understood by investors or registered persons. Further, these products can raise suitability and conflicts of interest concerns. In the Notice to Members, the NASD urges firms to take a proactive approach to reviewing and improving their procedures for developing and vetting new products. I couldn't agree more.

At a minimum, the Notice states that procedures should include clear, specific, and practical guidelines for determining what constitutes a new product, ensure that the right questions are asked and answered before a new product is offered for sale, and provide for post-approval follow-up and review, particularly for products that are complex or are approved only for limited distribution.

I think the Notice provides helpful questions to consider when determining what is a new product. Namely, you should consider: is the firm proposing to sell a product to a different group of investors, for instance, retail? Will the product be offered by representatives who have not previously sold the product? Are there material changes to an existing product sold by the firm, raising increased risk to the customer, new fees or costs, or having different tax implications? Will these changes require internal operational or systems adjustments?

Once products are identified as new or materially different, the Notice stresses that the vetting process explore the right questions, so that the firm may: (i) determine whether to offer it and to which investors, (ii) assess whether the products presents significant conflicts for the firm, and (iii) identify important features of the product that should be highlighted for sales and marketing staff and incorporated into appropriate training and supervision.

To assist firms in assessing their own procedures and implementing improvements that work best in their firm's structure and operations, the Notice also provides some recommended best practices, based on the NASD's survey of certain industry participants. The NASD found that robust new product vetting usually involved several stages: first, a standardized process for a new product proposal that assigns "responsibility" for the product to a specific business group within the firm, and communicates about the product in a high profile manner within the firms; second, a preliminary assessment by legal or compliance as to its status as a new product; third, a detailed review for new or modified products by committees or groups composed of persons from all relevant sectors, such as compliance, legal, finance, marketing, and sales; and finally, once approved by a new product committee composed of senior management, a systematic follow-up and review, particularly of new products that are complex.

Of course, continuous review and follow up concerning the implementation and effectiveness of these procedures is important. While they require a commitment of time and money, both are well spent in this instance, in order to ensure that investors are protected and the firm's reputation is preserved.


I've raised quite a bit today for you to consider. As you certainly know by now, a significant portion of the population in the United States is preparing to enter into retirement, with some of its members taking substantial assets with them. The Wall Street Journal has estimated that by 2010, almost half a trillion additional dollars will be rolled into IRAs each year by aging investors — and seniors will be looking for more options to fund their retirements. In anticipation, the financial services industry has gone to great lengths to anticipate the demands and opportunities created as a result of this retiring generation.

This past year, the Commission has announced initiatives that go straight to the heart of investor protection for seniors, which I have briefly described to you today. Ensuring that seniors are informed of the protections the law provides and vigorously pursuing frauds targeting seniors is a priority at the Commission. I hope you will reflect on your firm's policies and procedures with this in mind. To assist you in improving your firm's compliance program, I recommend that you review the practical guidance offered by regulators, such as the NASD. Finally, I urge you to treat sales of complex financial products to seniors with particular care.

Thank you.



Modified: 11/20/2006