Financial Institutions Can Do A Better Job Of Protecting Consumers From Investment Fraud

Publication: Inside Indiana Business
March 11, 2009
By Zach McCoy – Senior Vice President, Operations & Finance,, Kaplan Compliance Solutions

It seems that whenever an economy goes through a strong contraction, the fraudsters float to the surface. Just think back to our last recession in the early 2000s and the shenanigans uncovered at Worldcom and Enron. Then fast-forward seven years. Today’s global markets are in a recession unlike any previous one we have seen in more than seven decades. Top executives of the world’s largest investment firms have been confronted with the reality that their once stable organizations now are on the brink of collapse. Our largest companies—AIG, General Motors, and others—are selling stock to the United States Federal Reserve Board or taking bail out “loans” to avoid bankruptcy. And who is popping up? The fraudsters. In December there was Bernie Madoff, the famous New York trader charged with perpetrating what may be the largest investor fraud ever committed by a single person. Then there was the dramatic “disappearance” of Marcus Schrenker, who now faces two counts for working as an investment adviser without being registered and is alleged by his clients to have deposited their investments directly into his own account. One has to wonder how many other Madoffs and Schrenkers are out there, and why financial institutions don’t do a better job of protecting consumers from investment fraud. The reasons are part systemic and part laziness. The licensing and appointing process for insurance agents and securities representatives is a complex system in which each state has its own specific rules and regulations for producers who sell insurance and securities products within their state. Because of the disparities between state regulatory requirements, many of these rules and regulations are subject to different interpretation by the insurance and securities companies. The disparities also create the opportunity for producers to act unethically, or even illegally, and “slip through the cracks” without being noticed by the regulators. While the system is imperfect, there are steps that insurance and securities companies can take to help protect investors. First, they shouldn’t wait for mandatory compliance regulation. Getting by with the minimum oversight required by law is not in the best interest of consumers. Proper due diligence is critical to ensure that financial institutions are onboarding properly qualified, ethical and law abiding producers and representatives to sell their products. The first and most critical step in this process is a thorough background investigation of producers and representatives. Background investigations currently are conducted for each individual who chooses to sell insurance and securities products as part of the onboarding process. However, not all states explicitly require background checks and many financial institutions choose not to perform these background checks in states in which they are not required. In addition, few if any organizations perform follow-up background investigations after this initial check. Financial institutions need to be much more diligent and should conduct follow-up background investigations on their agents/representatives on a regular basis to ensure that their records have not changed over time. Another opportunity for insurance carriers to perform due diligence on their producers is to utilize a service such as Vector One. Vector One, for example, enables insurance carriers and agencies to perform checks to ensure that producers do not carry a debit balance with organizations. A debit balance can occur when the producer receives commission advances on policies that are never permanently placed. Many organizations state cost as the primary reasons for performing only the minimum required due diligence while onboarding producers. One must wonder if all the bad press and subsequent mistrust from customers is worth the cost savings of not performing thorough background and Vector One checks. Insurance and financial institutions also can utilize compliance software applications to help track complaints consumers make against a producer/representative. Brokers/Dealers are required to follow specific procedures when a consumer files a complaint. Kaplan Compliance Solutions developed software that is available today that helps broker/dealers track complaints, then file timely and accurately reports to the Financial Industry Regulatory Authority’s (FINRA) centralized complaints database. Consumers and financial institutions can access FINRA’s complaints database to check specific broker/dealers and investment firms to see if they have conducted any unethical activity. The talk in Washington is all about transparency. The tools to provide a level of transparency to help avoid investment fraud already are available. Financial institutions must be committed to using them. Given the recent events that have taken place in the financial sector, it’s likely that more regulations and procedures will be imposed to protect consumers in the coming months. How extensive the regulation will be is yet to be determined.

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