SEC Director Speaks to Root Causes of Investor Harm

Andrew Barton, Director of the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) recently gave a speech entitled “People Handling Other People’s Money”, where he drew on his experience to make assessments of the sources of investor harm.  He described how, despite people “trying to do the right thing by their clients, colleagues, owners and…even regulators” and their willingness to “make a good-faith attempt to remediate on their own”, issues still exist which must be addressed:

“In trying to focus OCIE resources on the root causes of harm to investors and our markets, I’ve reviewed most exam results and enforcement actions in the investment advisor area for the last several years and beyond … and concluded that almost all of the serious problems we address arise because:

(1) some people lie, cheat, and steal;

(2) some people act recklessly; and

(3) some people don’t see, think, or act clearly or fairly because their judgment is clouded … or contaminated … by conflicts of interest.”

Mr. Barton then addressed the risks associated with each source of harm.  Regarding the first category, Mr. Barton suggests that

The ways and means of man are many, but the methods used by some people to separate their brethren from their money are relatively unchanged….While I believe that liars, cheaters, and thieves are a very small minority of the industry, the SEC spends a significant amount of time and resources trying to detect their bad behavior and to prevent them from harming investors. You must also.  From the moment you hire your second employee, or your 20th, or your 2,000th, the odds increase that you have employed someone who will resort to bad acts to separate other people from their money.”

With regard to the second category, Mr. Barton describes how these people/entities

“forget that they are fiduciaries and caretakers of their clients’ money….[whose policies are] an accident waiting to happen.  It could have been a problem employee with a drug, alcohol, or gambling problem who was tempted to misappropriate client funds … or it could have been a client who tried to stick it to the firm and falsely claim that a withdrawal or series of withdrawals were unauthorized and there would be no record of the authorization.  Someday, somehow, the absence of controls was going to bite the firm.”

Mr. Barton described the third category as

“the vice that is most difficult for the people within an organization to detect because they are often impaired by it….otherwise honest, hard-working people are blind to the fact that they are putting their interests ahead of their clients….Conflicts are also interesting and insidious, because we see them at an individual, firm, and industry level.  One person, a close group of people, or seemingly everyone in the entire system, can incrementally, over time, through the accretion of justifications, customs, and excuses convince themselves that they are entitled to money and opportunities that fairly belong to their clients.”

In order to combat these pitfalls, entities and their leadership must remain vigilant, guard against conflicts of interest, and most importantly, have proper internal control processes in place.  Segregation of duties, appropriate oversight and review, and options for reporting employee concerns, such as a whistleblower hotline, are all important parts of the toolkit.

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