5 highlights from the year in enforcement

December 19, 2023 10:00 AM

Most of the attention for enforcement cases in 2023 once again tended to be directed at the top executives at crypto and other digital asset firms.

This year it wasn't just Sam Bankman-Fried, the disgraced former CEO of the crypto exchange FTX who was found guilty of fraud, conspiracy and money laundering in November. Regulators also tightened their nets around FTX's rival exchange Binance and its founder, Changpeng Zhao, as well as the digital asset firms Terraform Labs, Coinbase and Kraken and their principal officers.

But all the time given to cryptocurrencies and similar products tends to obscure what was perhaps a greater concern for regulators: broker and advisor communications with clients and others via social media and messaging systems like WhatsApp. Some of the biggest regulatory cases to hit the industry the past year have come in response to firms' alleged failure to track and record these sorts of messages or to make sure their contents were accurate and verifiable.

For a summary of the past year in enforcement trends, scroll down:

A new medium for the message

Despite regulators' making it clear in 2023 that advisors and brokers should be very careful about how they use WhatsApp and similar services to chat up clients and business partners, many companies apparently didn't get the message.

One sizable contributor to the Securities and Exchange Commission's more than $5 billion regulatory haul this year was firms that failed to abide by the regulator's rules on so-called "off channel" communications. Speaking on Dec. 12 webinar organized by the compliance systems firm SMARSH, Brian Rubin, the co-head of securities enforcement practice at Washington, D.C.-based Eversheds Sutherland, the numbers have caught plenty of people's notice.

All told, he said, there were 23 cases involving violations with electronic communications in 2023. Firms paid more than $400 million in total for those infractions, he said.

"Which is obviously huge, and that's why it's getting everybody's attention," Rubin said.

Generally speaking, the SEC requires all discussions of business between advisors or with clients to be recorded for compliance review if needed at a later date.

WhatsApp, Signal and other messaging services make this difficult because they send information in encrypted form. Some even delete chats shortly after they go out.

That the SEC views all this as a big "no-no" can be seen in the size of some of the fines it imposed throughout the year. In August, the regulator imposed $289 million in penalties on Wells Fargo and eight other firms and their affiliates over their alleged failures to track and record messages sent by employees reaching as high as the senior executive level. A month later, the SEC hit six firms, including Baird and Interactive Brokers, and their affiliates with nearly $80 million in penalties for similar alleged infractions.

Fraud and fines

Of course, 2023 had plenty of fraud cases that had nothing to do with new messaging systems or digital assets. As in previous years, garden-variety fraudulence unfortunately continued to make up a big part of what kept regulators busy.

This year once again saw the elderly as common targets of scams. One of the more shocking cases involved a former LPL advisor who pleaded guilty in March to stealing nearly $3 million from a couple in their 80s but now remains a suspect in the death of the wife, Betty Cabral. The advisor, David Del Rio, is now serving a 15-year prison sentence while investigators look to see if they have a homicide case against him.

In another case showing the elderly population's susceptibility to abuse, an advisor in the rural California community of Orcutt stands accused of ingratiating herself with older women as part of a scheme to siphon off their assets. Julie Anne Darrah, who sold her firm Vivid Financial Management to Wealth Enhancement Group in 2021, is believed to have stolen $2.25 million from clients who sometimes viewed her as "the daughter they never had." Perhaps the lowest point of all was hit by a former Morgan Stanley vice president who was accused by the SEC in June of stealing $1.7 million from his elderly mother and mother-in-law.

But it wasn't just fraud cases that took up regulators' time. They also found themselves levying some hefty fines against large institutions found to have been a little too careless about how they were charging customers.

In July for instance, state regulators fined two brokerage affiliates of Raymond James Financial more than $12 million over allegations that they had overcharged customers for hundreds of thousands of equities transactions over a five-year period. In September, Deutsche Bank agreed to pay $25 million over failures related to environmental, social and governance investing, or ESG, and its anti-money laundering policies. And in November, Bank of America was hit with a $24 million fine for failing to catch a "spoofing scheme" two former employees in its securities department had run to manipulate the market for U.S. Treasury bonds.

Reg BI violations trickle in

Regulators slowly started accelerating their enforcement of a rule meant to make sure broker-dealers are always looking out for their clients' best interests, whether they have conflicts or not. The SEC's Regulation Best Interest, in effect since June 2020, was meant to give brokerage customers protections similar to those enjoyed by investors working with fiduciary advisors.

Reg BI, as the rule's known for short, may not have insisted on as thorough an elimination of conflicts of interest as does the stricter fiduciary rule for investment advisors. But at least it went beyond the brokerage industry's former conduct standards by making it clear that brokers ultimately work for their customers.

Despite warnings that enforcement was coming, the number of cases citing Reg BI violations has resembled a trickle more than a flood. In May, the Financial Industry Regulatory Authority — which the SEC has deputized to regulate the brokerage industry — did reach an important milestone: It invoked Reg BI for the first time in a decision to boot a firm from the industry.

To skeptics of Reg BI, one common theme in this latest spate of cases is that most, if not all, of them could have been brought under the SEC's previous suitability conduct standard for broker-dealers. That standard, which was replaced by Reg BI, had merely called on brokers to make sure any investments they were recommending were well-suited to their clients' needs and goals.

Michael Edmiston, a former president of the Public Investor Advocates Bar Association and a securities lawyer at Jonathan W. Evans & Associates in Studio City, California, said he's still waiting for a Reg BI case that clearly defines what regulators mean when they talk about clients' best interests. He's also curious to see how FINRA and the SEC will treat wealth managers' duty under Reg BI to show they've considered alternatives to any risky investment they might recommend.

Will regulators, Edmiston asked, try to make sure advisors didn't just list the names of other investment opportunities? Will they look, he said, to see that they took the additional necessary step of investigating their fees, likely returns and other traits?

"We have not seen that kind of case yet," Edmiston said. "I know it's coming. It's just a matter of when."

The ‘cop on the beat’

The SEC's collection of fines and disgorgements was down slightly in 2023 — it brought in only about $5 billion in penalties. The previous year's total was more than $6.4 billion.

Lest anyone think that regulators had simply grown complacent in 2023, the SEC pointed out that the number of enforcement actions it took was actually up by 3% to 784. Bill Simpson, the director of compliance at the consulting firm Hearsay Systems, said he was struck by SEC Chairman Gary Gensler's use of the phrase "cop on the beat" this year to describe his agency's role in overseeing the financial services industry.

Simpson said Gensler seems to have taken a stricter stance than some of his predecessors and that the results show in the SEC's enforcement numbers.

"In certain ways, it almost feels like a little bit of an adversarial relationship that that engenders between the regulators themselves and the participants in the market," Simpson said in an interview. "So from my perspective, that was a bit of a shift."

SEC's partner in industry oversight — the Financial Industry Regulatory Authority — is meanwhile showing a slight slowdown in its enforcement actions. Andrew Mount, a securities industry attorney at Eversheds Sutherland, said on the same webinar that his colleague Rubin appeared on that FINRA had brought 287 enforcement cases by the end of November this year. That's down roughly 35% from the figure for the same period in 2022.

Fine collections, though, are on the rise for the broker-dealer industry's self-regulator. FINRA has so far collected $47 million in 2023, Mount said. That already exceeds the $45 million total the agency had for all of last year, he said.

Existential challenges to regulators

Amid all of this, the bedrock institutions charged with overseeing securities markets have been put to legal challenges the likes of which the industry has never seen before. The agency subject to the biggest threats is the Financial Industry Regulatory Authority, a self-regulation organization deputized by the SEC to oversee broker-dealers.

Alpine Securities, a brokerage firm with a history of run-ins with regulators, filed a legal complaint in October accusing FINRA of being an unconstitutional mixture of a private group and public organization with enforcement powers. The widely watched case, which has been echoed by plaintiffs in several other challenges, stands a real chance of rolling back the agency's authority.

The SEC meanwhile is faced with its own challenge over its use of in-house administrative law judges, or ALJs. The agency's internal justice system has come under increased scrutiny as the now right-leaning Supreme Court continues to show willingness to roll back the administrative power of the federal government.

In November, lawyers for a hedge fund manager accused of fraud went before the Supreme Court to argue that the SEC's reliance on in-house judges had unconstitutionally deprived their client of his right to a jury trial. The Wall Street watchdog has meanwhile retreated from its reliance on ALJs, instead pursuing most cases now through the regular court system.

If the commission's critics are successful, the courts may soon be regulators' only real option.