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Remarks at the 46th Annual Rocky Mountain Securities Conference

Commissioner Daniel M. Gallagher

Denver, CO

May 9, 2014

Thank you, Julie [Lutz], for that kind introduction. I’m very pleased to be here today, and I’m proud to say that this will be my fourth time addressing this conference, the last three as a Commissioner. I am always happy to visit Denver, in large part given the presence of a key SEC regional office here. I am a big supporter of our regional offices, and I am very pleased to report that yesterday I made good on my oath to visit all of our offices when I made it to Fort Worth. Now I will try to pull off second visits before the end of my term.

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Despite the onslaught of regulation over the past ten years and the consistency with which extremely costly and often frivolous plaintiff actions are brought, our capital markets continue to be the strongest and most vibrant in the world. As the primary U.S. capital markets regulator, the SEC administers a regulatory framework built upon our threefold mandate to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.

Consistent with that framework, industry professionals such as registered representatives of broker-dealers and investment advisors are required by law to be licensed or registered and to subject themselves to the regulatory oversight, examination, and reporting requirements of the federal securities laws. In other words, we require market professionals, particularly those who interact with retail investors, to apply for, and prove themselves worthy of, the privilege of working in the industry.

Unfortunately, this privilege is all too often abused by scoundrels, including some that repeatedly engage in egregious misconduct that directly impacts retail “mom and pop” investors, destroying their nest eggs and financial security. These repeat offenders, despite accumulating dozens of customer complaints and disciplinary actions, have been able to remain in the industry by jumping from one disreputable firm to another and hiding behind false and misleading CRD filings and Form BD representations. They are, to be blunt, cockroaches, and it is in all of our interests to purge them from our markets.

This is, of course, not a new problem. After all, capital markets are risk-taking markets, and unfortunately a risk as old and as certain as time is that where there is opportunity, there will be unscrupulous characters trying to take advantage of the unwary. The SEC has been struggling for decades to find the best approach to rooting out recidivist misconduct by the worst of the bad apples, but unfortunately, there are no easy answers.

Illustrating this point, exactly 20 years ago this month, the SEC released a report in conjunction with the NASD and NYSE called the “Large Firm Project” that reviewed the hiring, retention, and supervisory practices of nine of the country’s largest broker dealers, which at the time were responsible for handling approximately 50% of all public customer securities accounts in the United States.[1] The report’s findings were grim, reflecting a number of significant concerns about the business activities and conduct of broker-dealers and their registered representatives. Some of the more noteworthy findings may sound depressingly familiar to you.

For example, the study found high turnover rates: over a third of the registered representatives selected as a sample set for the study had left the industry within the two-year examination period, including many who left involuntarily or were barred from the industry altogether.

It also reflected a high incidence of potential enforcement violations, with fully 25% of exams leading to enforcement referrals. The study showed that bad actors are concentrated in select firms: three of the nine firms examined accounted for 88% of the study group’s enforcement referrals. The study also revealed numerous findings of inadequate supervision. Perhaps most concerning is the fact that these bad actors were able to move between firms freely after customers registered complaints.

Do these findings—now two decades old—sound familiar to you? The sad truth is that these are exactly the same types of behavioral red flags we still see today. Only two months ago, for example, the Wall Street Journal reported the results of a study finding that more than 1,500 broker-dealer registered representatives had failed to report bankruptcy filings in their CRD disclosures, while over 150 had failed to report criminal charges or convictions.[2] In response, FINRA announced that it would perform a comprehensive vetting of public disclosures for the more than 600,000 investment professionals it oversees—brokers, not investment advisors—against public court records. FINRA will also propose rules requiring employee background checks.[3]

I recently asked staff in the Office of Compliance, Inspections, and Examinations to put together some statistics based on disclosure information submitted by broker-dealer registered representatives on FINRA’s BrokerCheck system. The results are eye-opening.

An astounding 20% of the 600,000 plus actively licensed registered representatives have between one and five disclosures for items such as customer complaints, regulatory violations, terminations, bankruptcy, judgments, and liens. One active—and currently employed—registered rep has disclosed a whopping 96 customer complaints and disputes. Another individual has made 21 financial disclosures relating to bankruptcies, yet still is licensed and working in the industry. At the firm level, 17% of broker-dealers had more than six total disclosures, and 5% had more than 20 disclosures.

These numbers illustrate a real and growing problem in the securities industry. These repeat offenders are swindling seniors out of their hard-earned retirement funds, looting our kids’ custodial accounts, and diverting assets from charities and religious organizations. But despite our best efforts, they manage to stay in the industry and continue to wreak havoc on the investing public.

I would be remiss if I did not point out that a common misconception is that this is exclusively or even primarily a broker-dealer problem rather than an investment adviser problem as well. In reality, there are plenty of repeat offenders at investment advisory firms who are engaging in misconduct. We’re just not finding them as quickly because the SEC allocates a disproportionate amount of resources to policing the activities of broker-dealers when compared to those we expend policing investment advisers. There are nearly three times as many investment advisors registered with the SEC than there are broker dealers: approximately 11,100 investment advisors versus about 4,300 broker-dealers. This is due in large part to unfunded mandates imposed upon the SEC by Title IV of Dodd-Frank. Even more importantly in the context of resource allocation, there is no SRO interposed between the adviser industry and the SEC like there is for broker-dealers.

I worry that this has created the unfortunate side effect of underreported investment advisor rule violations, inappropriately skewing our enforcement statistics by revealing a disproportionate amount of problems on the broker-dealer side. Simply put, it is impossible to separate the fact that we find many more broker-dealer violations than investment advisor violations from the fact that thanks to the assistance of the SROs, we examine a greater proportion of broker-dealers than investment advisors.

One way to address this imbalance would be to provide for third party examiners of investment advisors—including, potentially, defining the term “third party” to include SROs in order to allow the SROs currently involved in broker-dealer oversight to conduct examinations of “dual hatted” investment advisors as well.[4] In the past, questions regarding the wisdom of creating an SRO for investment advisors have been addressed in a binary sense: should the Commission push Congress to create an SRO for investment advisors, or keep things as they are? Leveraging the current resources and expertise of broker-dealer SROs to assist in investment advisor examinations could greatly facilitate our ability to examine advisors without undertaking the daunting project, with Congress, of creating a new investment advisor SRO out of whole cloth.

Regardless of how we do so, enhancing our ability to examine investment advisors would also serve the critical purpose of allowing us to have informed deliberations on Section 913 of Dodd-Frank Act. Section 913, as you may know, authorized, but did not require, the Commission to adopt rules establishing a duty of care for brokers-dealers that is no less stringent than that which applies to investment advisors and to undertake further efforts to harmonize the two regulatory regimes.[5]

Mind you, as with so many Dodd-Frank requirements, Section 913 has absolutely nothing to do with the financial crisis, but as we proved in the case of conflict mineral disclosure, that may not dissuade the Commission from pursuing a rulemaking. Indeed, it is becoming painfully obvious that many special interest groups and members of the Administration believe this is a terrific election year issue to pursue. As an independent agency, the SEC should never be persuaded by such political forces.

And, although many in Washington seem to have concluded after the high profile issuance of the Volcker Rule that Dodd-Frank rulemaking is “done,” the Commission still needs to complete almost 60 mandated Dodd-Frank rulemakings. In addition to these rulemakings, which include key elements of Title VII derivatives regulation and the removal of references to credit ratings from Commission rules, the Commission still has significant—and well overdue—work to do on implementing the JOBS Act. And, by the way, we still have eight decades worth of securities laws to administer on a daily basis and critical projects on the horizon such as a much needed holistic equity market structure review, and critical reforms in the fixed income markets, such as the disclosure of riskless principal markups.

In light of this agenda, I question the wisdom of rushing into purely discretionary Section 913 rulemaking, especially when the purported substantive impetus is the potentially false narrative that broker-dealers represent a greater potential threat to retail investors than investment advisors. The truth is that we simply don’t know whether or not that is the case. There have been far too many laws and regulations that stemmed directly from false narratives of the financial crisis and its causes. The Commission should slow down and get all of the facts before adding to the long list of rules resulting from these false narratives.

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So what is the SEC doing to curb the abuses perpetrated by the recidivist bad actors I mentioned, whether on the broker-dealer or investment advisor side? I am pleased to report that in recent years, the agency has made great strides in developing programmatic and technological tools aimed at efficiently ferreting out the most egregious misconduct and identifying those individuals and firms most likely to be recidivists.

Some of the most exciting developments are coming out of OCIE under the able leadership of Drew Bowden. Drew’s dedicated and talented staff has developed a number of innovative tools that have moved the examination program into the 21st Century and enabled the staff to surgically and efficiently zero in on potential abuses.

For example, OCIE’s Risk Assessment and Surveillance group, which is responsible for identifying candidates for examination among registered entities, has developed new analytics to track the migratory patterns of registered representatives. Using public disclosures—including U4 and U5 filings and other data from the SROs—the team can track industry professionals who are hopping from firm to firm and single out firms that appear to be havens for individuals with long rap sheets of customer complaints and disciplinary actions. This targeted approach to risk assessment enables our examiners to immediately identify the statistical outliers who are most likely to engage in misconduct.

OCIE’s boots-on-the-ground examiners also have been deploying a new analytics tool, the National Exam Analytics Program, that allows them to review massive amounts of registrant data in a matter of minutes. Rather than relying on a small sample of activity for a few dozen accounts over a compressed time period, OCIE examiners can import a registrant’s entire trade blotter for multiple years and immediately generate over 50 types of customized reports identifying potential red flags for account churning, excessive commissions, P&L irregularities, suspect asset allocation, front running, and even insider trading.

Complementing these efforts is OCIE’s Risk Analysis Examination initiative, which uses advanced analytics to examine data from the largest clearing firms and broker-dealers to identify potentially problematic trends industry-wide. In 2013 alone, this group reviewed hundreds of millions of transactions by more than 500 firms, including trading data that enables OCIE to target for examination broker-dealer firms that appear to be systematically engaged in high pressure sales tactics and excessive trading. With this data, we are able to zero in on firms that are, in essence, nothing more than a criminal enterprise designed to separate investors from their money.

The best part of the story is that all of these tools were developed in-house by the SEC staff. They have revolutionized the way our teams conduct examinations and have done much to level the playing field in terms of our ability to root out potential misconduct by recidivists.

And, OCIE isn’t the only arm of the agency making progress in this area. Under the strong leadership of Director Andrew Ceresney, the Division of Enforcement has made several programmatic changes that have greatly enhanced the SEC’s efforts in identifying and combatting the worst recidivists.

Perhaps most noteworthy is the creation of a task force late last year, a group near and dear to me, to focus on broker-dealer enforcement issues. Among other initiatives, this new task force will coordinate with OCIE and FINRA to target misconduct by “rogue” registered representatives with prior disciplinary histories or customer complaints.

My hope and expectation is that the task force will complement the work of the two specialty units created by the Division of Enforcement in 2010: the Asset Management Unit, which investigates misconduct by investment advisors, investment companies, and private funds, and the Market Abuse Unit, which focuses on difficult-to-detect frauds in which honest investors are bilked without ever knowing anything is amiss. Working collaboratively both inside and outside of the agency, these groups are making substantial progress in identifying and rooting out misconduct by the worst of the bad actors.

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There is no question that we are making real progress on these issues, but more needs to be done to send a forceful message to the bottom dwellers of the securities industry that their behavior will not be tolerated. As I’ve illustrated today, the SEC has a number of tools to combat abuses by recidivists, but we need to make sure that we are using them in the most efficient manner possible and that the tools we have are sufficient for the task.

Most importantly, the agency needs to take aggressive action aimed at permanently expelling the worst offenders from the securities industry. All too often, we see the same individuals and firms featured prominently in examination reports and enforcement actions. As an agency, we need to seek out the repeat offenders and revoke their licenses and registrations rather than repeatedly mete out injunctions that can be violated and penalties that can be paid from the fruits of misconduct. Unless we put these offenders out of the industry for good, they will continue to take advantage of retail investors.

With respect to the most egregious and recidivist violations of our securities laws and regulations, whether by broker-dealers or investment advisors, we need to ask ourselves a fundamental question: should the violating entity retain the privilege of participating in our capital markets? Unbeknownst to many, both the Exchange Act and the Investment Advisers Act authorize the Commission to deregister entities if it finds such action to be in the public interest, although we have rarely done so.[6] This authority, of course, should only be invoked after full due process has been afforded to the entity in question, but it should indeed be invoked when appropriate. I have seen several instances in which I believe it would be appropriate since I’ve been a Commissioner.

As a federal agency charged with protecting investors, the SEC needs to make such existential threats—and, where appropriate, deliver on them—in the most egregious circumstances. Otherwise, the cockroaches of the industry will continue to abuse the system, shrugging off the well-meaning but all too often ineffective remedial actions taken against them.

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In closing, I want to convey my sincere belief that most of the men and women who work as professionals in the securities industry have proven themselves worthy of that privilege by conducting themselves with honesty and integrity. The unparalleled strength of our capital markets is in large part the product of the work ethic and high moral character of the professionals who work with the millions of individual and institutional investors that participate in those markets.

Unfortunately, the stability, security, and attractiveness of our markets are all too easily tainted by the misconduct of a handful of reprehensible miscreants who abuse the system time and time again. Working as a registered broker-dealer representative or an investment adviser representative, holding a securities license, or operating a securities firm are privileges that carry with them a heavy responsibility, privileges that can and should be taken away in cases of abuse. As an agency, the SEC needs to lead the way in targeting and eradicating the worst offenders from the markets altogether.

Once again, thank you for this opportunity to share my thoughts with you, and I wish you an enjoyable and productive conference.

[1] The Large Firm Project, A Review of Hiring, Retention and Supervisory Practices, Divisions of Market Regulation and Enforcement, United States Securities and Exchange Commission, May 1994, available at

[2] Regulator Deletes Red Flags From Brokers’ Records, Says Study, Wall St. Jrnl., March 7, 2014, available at

[3] Plan to Fix Cracks in Broker Records — Wall Street Regulator to Propose Rules for Background Checks, Measures to Identify Red Flags, Wall St. Jrnl., Apr. 16, 2014, available at

[4] See Jim Angel, On the Regulation of Investment Advisory Services: Where Do We Go from Here?, available at

[5] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 913, 124 Stat. 1376, 1824 (2010) (requiring analysis and rulemaking regarding fiduciary obligations of investment advisers and broker-dealers).

[6] See 15 U.S.C. 78o(b)(4) (stating that the Commission “shall . . . revoke the registration of any broker or dealer if it finds . . .[that such] revocation is in the public interest and that such broker or dealer” committed certain actions enumerated in the statute); 15 U.S.C. 80b-3(e) (stating that the Commission “shall . . . revoke the registration of any investment adviser if it finds . . .[that such] revocation is in the public interest and that such investment adviser” committed certain actions enumerated in the statute).

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