The following excerpt is from the SEC website:
by
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
Washington, D.C.
November 3, 2011
Good morning. It is a pleasure to be with you today to discuss fraud and how we might be better able to prevent it.
I’d like to thank the Stanford Center on Longevity and the FINRA Foundation for sponsoring an especially timely conference. Today, we live in a world in which fewer individuals retire with defined-benefit pension plans; more people are paying more money out-of-pocket for higher education; and once solid savings strategies — like home ownership — seem unsure.
People simply don’t have the safety net they had — or felt they had — just a few years ago. At times like these, fighting financial fraud is an especially urgent task.
It’s not just the timing of this conference that makes it important, though. It’s the recognition by the sponsors and participants that there is no single strategy or entity that can eliminate fraud by itself. We need to mount a comprehensive, multi-lateral approach to fraud prevention, one that brings together government agencies, private and non-profit institutions and investors themselves.
Of course, the SEC needs to play a central role in this effort. Protecting investors is our most important mission. It is why we exist. Our divisions and offices have unique power to regulate, oversee, examine and prosecute those in a position to commit fraud or engage in unscrupulous activities.
But we have long relied on self-regulatory organizations (SROs) like FINRA to support us in this mission, and we look forward to continuing to work closely with the Center on Longevity and other partners to pursue this fight against fraud.
This collaborative approach is something we are emphasizing inside and outside the agency. Inside the SEC, key offices and divisions are working together in all areas of our anti-fraud effort. And outside the agency, the SEC is collaborating more often, and with better results, with everyone from state securities regulators to criminal prosecutors to local nonprofits focused on fighting fraud.
Rather than confronting fraudsters with a series of separate efforts, we are weaving our initiatives into an increasingly fine-meshed net, one that we hope is ever-harder to escape or avoid.
The investor protection net we’re weaving has been reinforced with new leadership, more effective organizational structures, enhanced technology and a staff that is bringing greater industry experience, improved training and a renewed energy to the task of preventing fraud.
Division of Enforcement
The cornerstone of our anti-fraud effort remains the Division of Enforcement. Charged with detecting, deterring and prosecuting fraud, the Division is benefitting from an aggressive new management team, a more efficient structure, and upgraded technological support.
One key step was restructuring the Division, redeploying veteran attorneys from management to investigative and prosecutorial positions, putting more troops on the front lines.
Another was creating specialized units to concentrate on high-priority areas of enforcement. One such unit, the Office of Market Intelligence, serves as a central office for handling tips, complaints and referrals about wrongdoing, and houses the Whistleblower Office created by the Dodd-Frank Act. This office allows enforcement attorneys to provide a unified, coherent, coordinated response to the huge volume of potential leads the agency receives. In addition, when the SEC adopted rules creating the Whistleblower Program, we were finally able to offer substantial cash rewards to insiders and others with useful information about violations of the securities laws and abuse of the public trust. The result of all this is that the quality of the tips we receive has improved substantially and generated a number of cases now in the pipeline.
Our handling of those tips has improved, as well, as the creation of the TCR system has allowed us to consolidate multiple, dispersed repositories for tips and complaints into a single, searchable database. In addition to capturing and storing information and making it broadly available to investigative staff, the system will eventually include risk analytics tools that will help the SEC quickly and efficiently identify the highest value tips and search for trends and patterns.
Relying in part on information gathered through the TCR system, Enforcement is working to focus its limited resources on Division priorities by developing risk-based initiatives that anticipate and detect suspicious behavior, allowing Enforcement to move more rapidly in investigating and stopping fraud.
One area of particular interest to Enforcement is affinity fraud — the targeting of specific groups tied together by shared characteristics, such as ethnicity, religious affiliation or profession. In these cases, fraudsters often rely on group members to provide recommendations and word-of-mouth advertising that brings in new victims.
In one recent case, we obtained a court order freezing the assets of a company that targeted Deaf investors in the U.S. The company solicited several million dollars and promised extraordinary returns of 1.2 percent per day. In reality, those funds went into foreign banks and the 14,000 investors — half of them in the U.S. — never saw a penny returned.
Of course, affinity fraud isn’t our only focus. Last winter, Attorney General Holder announced a dramatic example of a coordinated effort against schemes ranging from affinity fraud to Ponzi schemes to foreign exchange (FOREX) and business opportunity frauds. “Operation Broken Trust” was the first national operation of its kind to target such a broad array of investment frauds, all of which preyed directly on retail investors. Actions were brought against 189 civil defendants and 310 criminal defendants for fraud schemes that harmed more than 120,000 victims and involved more than $10 billion.
These SEC collaborations with the Justice Department reflect an important symbiotic relationship. The SEC can only win civil judgments: monetary damages and industry bars. But we often provide the specialized investigative expertise that allows Justice to build a criminal case. In return, Justice wins criminal convictions that result in hard time for guilty parties — a particularly powerful deterrent.
The Microcap Fraud Working Group is another collaboration, this one inside the agency. This team brings together the Division of Enforcement and the Office of Compliance Inspections and Examination (OCIE) in a coordinated, proactive approach to detecting and deterring fraud involving microcap securities.
This type of fraud is often perpetuated through “pump and dump” schemes in which the securities are promoted or “pumped” through the release of false and misleading information while insiders profit by selling or “dumping” the promoted stock to the public. Many of the promoters and boiler room operations involved in pump and dumps are unregistered, making them harder to discover and shut down.
Nonetheless, the SEC has closed down several of these operations this year alone.
Last January, for example, we brought a case against a New York fraudster who was pushing millions of shares of penny stocks on his website and posting price predictions with no basis in reality. When these promotional efforts brought dramatic, but temporary, increases in volume and price, the perpetrator sold shares from his personal account, earning almost $3 million in profits.
In addition to bringing cases against individuals who perpetrate microcap fraud, we also target the issuers themselves. In June, we suspended trading in 17 microcap stocks whose issuers were suspected of pumping stock prices by providing inadequate and inaccurate information to investors.
Microcap stocks are often where fraud meets social media, with posts on message boards by stock-touting websites, twitter users, and anonymous individuals taking the place of the classic boiler room phone banks. In these cases, online hype often led to price spikes that didn’t last much beyond the time needed for their promoters to dump shares and pocket investors’ money.
The challenges of policing these evolving markets are enormous but new strategies, technologies and organization are coming together to foster more and more effective enforcement.
OCIE
OCIE is another stalwart in the SEC’s battle against fraud and a source of referrals to enforcement for prosecution.
Like Enforcement, OCIE has also undergone substantial changes over the last two years, with an energetic new leadership team working with agency veterans to create the National Exam Program (NEP).
Working with the SEC’s Division of Risk, Strategy and Financial Innovation, the NEP is creating and continuously improving metrics that allow OCIE to target registrants that pose higher risk. A recently-established Office of Risk Analysis and Surveillance unit within OCIE guides that targeting strategy across different program areas and sharpens focus on registrants and practices that pose the greatest risk to investors and market integrity.
Working with filings and public information, OCIE targets registrants that show unusual patterns of activity — claiming returns that are consistently high, for example, even when the markets are down or are mixed. Other discrepancies that can serve as red flags include overstatement of assets, non-disclosure of affiliates or misrepresenting custodial arrangements. Even something as simple as a tip that an individual is lying about their college degree, or that a broker claiming a PhD in finance cannot answer basic technical questions, can trigger additional scrutiny — particularly if a registrant emphasizes those credentials in promotional material.
This ability to target more effectively has become even more important in the wake of Dodd-Frank as OCIE’s responsibilities increase rapidly — including expanded responsibility for hedge fund and rating agency examinations — but the SEC’s budget grows much more slowly. This creates a number of risks, not the least of which is that investors will have the impression that because an entity or activity is subject to registration and regulation, that means that it is being adequately examined.
Once an exam is triggered, a lot depends on the skills of the examiners themselves — the ability to grasp complex and misleading accounting, the tenacity to deal with extraordinary amounts of data, and the skill to conduct an effective interview. As a result, we are focused not just on technology and targeting, but on our staff and the way they conduct examinations.
OCIE is continuing its restructuring efforts, including the development of specialized working groups in six key areas: Equity Market Structure and Trading Practices, Fixed Income and Municipals, Marketing and Sales Practices, Microcap Fraud, New and Structured Products, and Valuation. These working groups will serve as forums in which the NEP and other agency staff collaborate on issues, initiatives, and concerns. They will serve as ongoing resource for training and for disseminating this specialized knowledge.
Stronger teamwork and collaboration between OCIE and the Division of Enforcement both led to an increase in referrals by OCIE to Enforcement and allowed the SEC to move more swiftly to protect investor assets when irregularities were discovered.
One major case this year involved a Connecticut hedge fund advisor and related entities that were engaged in a multi-year, $200 million Ponzi scheme. The fraud was first discovered by OCIE examiners during a risk-based exam of a registered adviser affiliated with the fraudster. Despite conduct that ultimately led to a criminal obstruction of justice charge, OCIE and their colleagues in Enforcement obtained evidence of the fraud - evidence that also led to criminal charges by the U.S. Attorney.
Much of OCIE’s work serves investors by improving and probing the quality of registrant’s disclosures — determining if investors’ funds are being handled safely and reported accurately, and discouraging any temptation to do otherwise.
Office of Investor Education and Advocacy
Another of our most important collaborations is with individual investors.
As you know well, an informed and skeptical investor is the best defense against securities fraud. Unfortunately, many investors are just sophisticated enough to be excellent victims — more educated, affluent and financially literate than is generally thought.
So, at the SEC, we’re working to elevate investor education to the next level — where people recognize not just opportunities, but warning signs, a level where investors act not just on instinct, but on the basis of solid information.
The Commission’s Office of Investor Education and Advocacy (OIEA) leads that effort: answering investor questions, making information available through a variety of media, and bringing new light to issues surrounding investor protection.
Every day, we get questions about the securities markets and complaints, about brokers, investment advisers, and particular investments. Often these disputes can be settled quickly, after OIEA forwards the complaint to the entity involved.
In more serious cases, OIEA staff enters the complaint into the SEC’s TCR database for review by either the Division of Enforcement or OCIE.
Our goal, however, is to reach out to investors before they need to reach out to us, ensuring that they have the information and background they need before making potentially risky investment decisions.
There are a number of ways we try to do that.
In 2009, we launched Investor.gov, a website focused exclusively on investor education for individuals. It offers investors information topics such as how to research investments and investment professionals, understand fees, and detect fraud. For investors who prefer print, we continue to offer this information in hard copy, as well. And, of course, all of our materials are available free of charge and without copyright, encouraging the widest possible dissemination.
We also reach out to investors directly, electronically and through partnerships with other organizations.
In the past year, we have published Investor Alerts and Bulletins on subjects including fake securities-related websites, pre-IPO investment fraud, stock trading basics, margin rules, and potential issues with reverse merger transactions. In addition to using Investor.gov and the SEC’s website to disseminate materials, we also use other channels, including a designated RSS feed, GovDelivery, press releases, and our Twitter account — @SEC_Investor_Ed — which has over 22,000 followers.
And we are also reaching out through partnership with other government agencies, local governments and private sector financial education organizations. We work, for example, with the FINRA Investor Education Foundation and its Investor Protection Campaign for Older Investors, which is conducted in conjunction with state securities regulators and AARP.
Some of OIEA’s most important, recent contributions to investor protection are the studies it is conducting.
One study, required by the Dodd Frank Act, looked at how investors get information about investment professionals and suggested ways to help them access and use it more effectively.
It proposed, for example, combining FINRA’s BrokerCheck and the SEC’s Investment Adviser Public Disclosure (IAPD) databases and adding a ZIP Code search function, so investors can more easily obtain results about both advisers and broker-dealers no matter which database they search. And it suggested that educational content be added to both systems, so investors can better understand the information they find and make clearer red flags that might sometimes signal a potential fraud.
Another study, also required by Dodd-Frank, involves a broad survey of retail investors’ financial literacy. Issues include:
Evaluating the existing level of financial literacy among retail investors.
How to improve the timing, content, and format of disclosures regarding financial intermediaries, investment products, and investment services.
How to make it easier for investors to understand expenses and conflicts of interest in transactions involving investment services and products.
What the most effective existing private and public efforts to educate investors are.
A key component of this study is investor testing currently underway that is aimed at determining the effectiveness of current SEC-mandated disclosure documents. The results of this testing will be used to determine how disclosure materials could more effectively communicate the information that SEC registrants are required to provide.
For many people, investment information that you and I would consider important and easily available, is difficult to access and hard to understand. And their failure to access it leaves them vulnerable. These studies will help the SEC put clear, necessary information in front of investors and help keep them keep their nest egg safe.
Today, 100 million Americans are invested in the financial markets. The trillions of dollars they entrust to others make a tempting target.
Fortunately, many frauds are slow-motion crimes, and alert investors can detect them before they take place.
Unfortunately, too few investors know what to look for, or how easy it is to get answers from the SEC, FINRA, and many other organizations able to steer people away from risky or fraudulent investments.
Our Office of Investor Education and Advocacy is working to change that. And they’re looking forward to changing that in partnership with you.
Collaboration
There are so many more other collaborative efforts underway than I have time to note. For example:
We’ve leveraged the capacity of the private sector by adopting regulations requiring that broker-dealers and investment advisers which have custody of their clients funds be subject to a surprise audit every year to help ensure that customer funds are protected.
We’re working more closely than ever with state regulatory agencies, leveraging the differing strengths and jurisdictions that federal and state agencies bring to the table, to build the strongest possible case when fraud is suspected.
This year, a number of Chinese companies suspected of providing false or misleading financial statements to investors were delisted from U.S. exchanges. The SEC is working with the Public Company Accounting Oversight Board, and the Chinese government to increase cooperation on audit oversight of public companies and ensure accurate financial reporting.
And Risk Fin, the SEC’s “in-house think tank,” is playing a key role in developing our risk-based targeting strategy.
The fact is no single agency can take all the actions needed to contain and reduce the kind of fraud that threatens life savings, turn “golden years” into dust, and steal dreams invested in over a lifetime.
But no agency or institution is better placed, better prepared or more motivated to stand at the center of this fight, bringing our expertise to bear wherever possible, and taking advantage of the expertise of others whenever we can.
Today, there’s a new energy and a smarter approach to the SEC’s efforts: more experience and better training in the staff, more effective organization and improved collaboration; and upgraded IT to support it all. Perhaps most important of all, though, is our understanding that in an age of limited resources, the SEC has to work collaboratively with other organizations, agencies, academics, and activists to protect investors.
The fight against fraud will take a serious effort from us all."
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