These 2 state regulators are financial markets’ first responders when trouble strikes

The banking turmoil that sent a shudder through the U.S. economy originated in northern California with the collapse of Silicon Valley Bank and the wobble of First Republic.

On the other side of the country, a state securities regulator was among the first to launch an investigation of First Republic. Massachusetts Secretary of State William Galvin opened a probe into potential insider trading at the bank.

First Republic is headquartered in San Francisco but has branches in Massachusetts, where Galvin’s constituents were part of the collateral damage.

“We had people standing in the street trying to get access to their money,” Galvin said in an interview. “That is unacceptable.”

One of the most aggressive regulators in the nation — at the state or federal level — Galvin didn’t sit still. He has concerns about what he says were risky First Republic lending and business practices. The fact that several large banks have given First Republic a $30 billion infusion doesn’t assuage him.

“I don’t think $30 billion is sufficient to simply say the problem is solved,” Galvin said. “We want to make sure as this goes forward, our consumers in Massachusetts are protected.”

It’s not clear where Galvin’s First Republic investigation will lead but it’s an example of how state regulators can be first-movers in responding to potential investor and consumer harm, compared to the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc.

It’s why the state regulators instigate enforcement actions that punch above the weight of the penalties they impose and the restitution they obtain.

They may not hit as many homers as the feds and Finra, but they get the bat on the ball in a way that scores many enforcement runs. Galvin said national enforcement has improved over the years, yet states play a key role in policing the markets.

“The states oftentimes have been ahead of the curve because they’re on the ground,” Galvin said. “They tend to be more nimble. In general, we add eyes and ears and move rapidly when we have something that affects our constituents.”

Another state regulator who can strike fear into financial firms and advisors who violate securities laws is Joseph Borg, director of the Alabama Securities Commission. He has been president of the North American Securities Administrators Association a couple of times and is a leader of its enforcement section.

Members of the organization often point out that state regulators have led the way on enforcement in areas such as cryptocurrency, the metaverse and sales of unregistered securities.

“We’re usually the first ones on the scene when it comes to retail investors,” Borg said in an interview. “We see [malfeasance] from the ground level. That doesn’t mean we understand all the nuances. But we see there are issues and we can bring them to the forefront and where needed combine the resources of the 53 U.S. jurisdictions.”

Several states joined forces recently in an enforcement action against Robinhood Financial that resulted in a $10.2 million settlement. Their investigation centered on platform outages, deficient supervision of approval of options and margin trading eligibility, and customer service breakdowns, among other issues, from Oct. 1, 2019, to March 2021.

State regulators were behind the SEC and Finra on punishing Robinhood over its operational breakdowns prior to the trading frenzy in GameStop Corp. shares in early 2021. But the states took a unique approach to ensure that Robinhood was delivering the customer support sought by the SEC and Finra.

“We wanted to make sure they’re progressing on their improvements rather than issuing an order first,” Borg said. “We were looking at the granular level on how they do business with Main Street investors.”

Generally, they found that Robinhood’s reforms seem to be working, which is one reason the Robinhood penalty was modest — about $200,000 per state.

“We’re going to go back for an audit within two years,” Borg said.

Galvin also has gone after Robinhood. He’s pursuing a lawsuit against the online brokerage that alleges that its marketing practices violated the state’s fiduciary rule for investment advice. Massachusetts is one of only two states that has implemented its own investment advice rule, which is now being tested in the state’s court system. There will be a May 3 hearing before the Massachusetts Supreme Judicial Court.

“It’s a significant case,” Galvin said. “I’m confident I’m right, but I’m not sure the court is going to agree with me. I’m going to leave it up to the justices to make their decision.“

Even if the Massachusetts judges rule against Galvin, he’ll continue to find novel ways to protect Massachusetts investors. Borg is set to retire next month, but Alabama investors likely will have another energetic champion in his successor, Amanda Senn.

Keep an eye on state enforcement. It’s a first mover that grabs an important share of the enforcement market.

Related Topics: North American Securities Administrators Association Inc (NASAA)