Do rogue brokers and advisors face lower odds of being penalized by regulator for their misdeeds?

That's one of the questions raised in the wake of a decision last month by the U.S. Supreme Court that declared as unconstitutional the Securities and Exchange Commission's use of inhouse judges to resolve enforcement actions. As a result, SEC fraud complaints will have to go through the regular court system.

Not long after the ruling, meanwhile, Bloomberg News intensified the spotlight on financial regulation when it reported that there has been a steady decline in Finra enforcement actions and penalties.

Industry insiders say it's still too early to know if the court ruling will lead to less enforcement actions, but it's almost certain that the SEC will have to pick its battles carefully

“I don’t necessarily think you’ll see fewer SEC investigations or sweeps," former Finra attorney Michael Edmiston said. "They’ll still do them and find wrongdoing. But in terms of bringing enforcement actions, the SEC will be required to bring their actions in court as opposed to administratively, which requires a higher burden. So they’ll have to pick messaging enforcements.”

Despite the fact that the Supreme Court ruling may require the SEC to bring a greater percentage of its cases in court, “the SEC still has all of the existing investor protection tools and remedies available to it,” said Cetera Chief Legal Officer Lisa Gok, who served as an SEC attorney for 11 years.

Gok added, “It may make the SEC enforcement staff think a little harder about which cases to bring and what remedies to seek, but we do not see that as material in the near term. ... The [SCOTUS] decision may mean that more cases end up at FINRA than the SEC, but that depends primarily on the facts and circumstances of a particular matter, and it is probably too early to tell what might happen,” Gok added.
 
Former PIABA President Andrew Stoltmann argued however that the Supreme Court “has put a 'kick me' sign on the back of individual Investors and I have grave concerns about the integrity of the capital markets in this country.

“I think it’s pretty clear that consumer protection related issues have now taken a backseat to corporate profitability. The SCOTUS decision has effectively gutted the SEC. Finra actions have plummeted for a multitude of reasons, not the least of which is a lack of stomach by the organization as well as the surging stock market. Investor-related protections are at DEFCON one right now,” Stoltmann said.

Knut Rostad, founder and president of the Institute for the Fiduciary Standard, said the Supreme Court decision “is concerning because it disrupts how the SEC combats fraud to protects investors. How concerning is unclear. Let’s see how it plays out in six months.”

Edmiston said matters are exacerbated by the fact that brokers and insurance agents who run into regulatory issues often reinvent themselves as state- or SEC-registered investment advisors.

In 2023, the number of enforcement actions brought by Finra, the brokerage industry’s self-funded regulator, slid to the lowest level in its history, according to Bloomberg. While total fines picked up last year. They are down by about half since a peak in 2016. Meanwhile, Finra’s staff headcount and budget have expanded.

Finra rejects the idea that it has pulled back on enforcement. Finra spokesman Ray Pellecchia told Bloomberg, “Any suggestion that we have let up on our regulatory focus is just dead wrong.” But Bloomberg reported some Finra staff members are pushing the regulator to become more aggressive in pursuing and promoting cases.

In 2023, Finra announced it was creating a "restricted" broker-dealer label and set of restrictions for firms that continued to hire bad brokers. But as of right now, there is not one firm that has been listed as restricted, according to multiple sources.

“All these firms were supposed to be given the scarlet letter if they employed these bad brokers. Well, the time for reporting these firms has come and gone. Finra has taken the position that the firms cleaned up employment of these troubled brokers. Ultimately I don’t know, I’m not inside Finra, so only time will tell,” Edmiston said.

Rok said it’s important not to make enforcement numbers a sole determinant effectiveness. “Some consumer advocates have suggested that a lower number of enforcement actions means that regulatory agencies are not as vigilant,” Gok said. “This is very much an oversimplification. In addition, we would note that Finra arbitration filings by investors have been declining for the past few years. The correlation is not perfect, but the number of investor claims can be viewed as an indicator of the level of actions that merit enforcement.”

Edmiston, however, remains concerned. If more investors fall through the cracks, “it leaves us private attorneys as the last bastion to prevent some of these bad actors from getting away with their frauds,” he said. “Frankly as much as that’s good for my business, it’s terrible for our society to be dependent on private attorneys for enforcement.”