Below is a letter I sent to several Congressmen and Senators regarding the new Financial Regulatory Reform: A New Foundation. You may be interested in some of the key areas. Many thanks to Bob Veres of www.bobveres.com for providing the foundation of the letter.
Speaking as a professional financial planner, and also as a financial consumer and concerned citizen, I am writing to ask you to support some of the key provisions of Financial Regulatory Reform: A New Foundation.Â I realize that this is one of many issues as we try to rebuild the global economy. However, this will be the most important piece of legislation that you consider this year, because it represents a framework for making sure that we don’t get into this kind of situation again.
As a financial planner and investment advisor representative registered with the State of Michigan, I’ve watched brokerage firms and investment banks wreak financial havoc on financial consumers, retirees–and many of your constituents.Â Now, those same companies, and their trade organizations, are spending millions of our taxpayer dollars, out of the TARP fund, to try to lobby against more effective regulation–just as they have been–for years–successfully lobbying against being held to a fiduciary standard of care whenever they give investment advice.Â I ask you to resist their self-serving pleas and stand up for consumers.
Here are the provisions that I support, along with a brief explanation of why.
Page 71 of the Blueprint points out, correctly, that “Retail investors are often confused about the differences between investment advisers and broker-dealers,” and that “retail investors rely on a trusted relationship that is often not matched by the legal responsibility of the securities broker.”Â The report says that investment advisors, and not brokers, are legally required to act as fiduciaries, and calls for all broker-dealers who provide investment advice about securities to retail investors to be “raised to the fiduciary standard to align the legal framework with investment advisers.”
This provision, by itself, would go a long way toward strengthening consumer protection in the investment markets.Â It would require brokers to recommend not just suitable products, but investments that would benefit their customer’s financial situation.Â It would cause brokerage firms to think twice about encouraging their representatives to recommend highly-profitable toxic or misleading derivatives products, and it would finally bring to light the under-the-table payments to brokerage firms for product recommendations and sales.
The current SEC Chairperson, a former CEO of the FINRA (brokerage industry) regulatory organization, has been strongly focused on lowering standards for advice to a compliance or suitability standard, which any securities attorney will tell you is far inferior to the consumer protections afforded by a fiduciary standard.Â You will no doubt hear her, and the brokerage firms whose executives make up the FINRA board and served as her employer, argue vigorously against holding brokers to a fiduciary standard, or transferring regulatory authority for registered investment advisors from the SEC to FINRA.Â They may even say that it is impossible for them to function under such restrictions.Â Please remember that more than 50,000 investment professionals already operate under a fiduciary standard as registered investment advisors.Â They may argue that fiduciary standards are not a panacea, and I would agree.Â But they represent a big step up from current regulatory obligations.
On pages 55-70 of the proposal, under the headline “Protect Consumers and Investors from Financial Abuse,” the report talks about creating a new Consumer Financial Protection Agency which would regulate investment products before they ever reached the shelves of brokerage sales offices, before they could be recommended to financial consumers.Â It is clear that the financial world is rife with products which benefit the sales organization much more than consumers.Â This includes equity-index annuities and variable annuities with surrender charges that last 15 years or more, complex derivatives and packages of loans whose credit quality is never examined, cash value life insurance policies with hidden fees and commissions–and, of course, tricky mortgages that are sold without full disclosure.
I support this provision because it attacks the problem of unsafe financial products directly, rather than how FINRA has always tried to control them, by determining whether the product was “suitable” to the financial consumer’s circumstances.Â Thus, if a consumer needs life insurance protection, it becomes “suitable” to sell a fully-loaded variable life insurance policy, even though a no-load policy or a term insurance contract might have been a far better recommendation.
In addition, the Reform proposal would empower the CFPA to require plain-English disclosures of sales commissions, expenses and risks.Â It’s a breath of fresh air to see that somebody in Washington finally realizes that 47 pages of dense legalese is not effective disclosure of these issues.
I also support measures outlined on page 21 and thereafter which would raise supervision and regulation of the “too big to fail” financial firms, described in the blueprint as Tier 1 Financial Holding Companies.Â Regardless of who takes on the ultimate regulation of these firms, if there is an implicit guarantee that these firms will be bailed out by the government whenever they engage in risky behavior, then it is prudent to clearly identify these firms (page 23), raise their capital requirements and liquidity standards (page 24), raise supervision and the standards of public disclosures (page 25), and align their executive compensation practices with long-term shareholder value rather than short-term risk-taking (page 29).
This enhanced supervision might serve as a disincentive for these firms to expand into so many areas that they become “too big to fail;” even if it doesn’t, the goal should be to prevent the government from ever having to write multi-billion dollar taxpayer-funded checks to companies who may have done irreparable harm to our financial system.Â And I agree with the proposal’s discussion (page 23, second major paragraph after the bullet points) of these firms’ continued right to innovate and respond to innovations in the financial markets.Â The point is not to stifle creativity or inhibit capital formation; it is to prevent danger to consumers and the financial system at large.
In the recent meltdown, regulators became aware of something which we in the financial planning world have been aware of for years: that the credit rating agencies have operated under a significant conflict of interest: they are paid by the organizations whose bonds or products they rate.Â Page 46 of the blueprint suggests that the SEC investigate the conflicts of interest and promote the integrity of the ratings process.Â This is a long-overdue review, and the changes implied here should not be difficult–investors pay for independent evaluations of stocks and mutual funds; why not ask the ratings agencies to sell their information in database form to professional and retail investors under much the same business model?
With this proposal on the table, even if it is not enacted into law, this should provide a fair test of whether the SEC and its current Commissioner is totally focused on reforming the markets, or is captured by the industry and is attempting to protect the status quo.Â Given the importance of credit rating failures in the recent meltdown, I hope you will pay close attention to this issue, and hold the SEC accountable for implementing what would appear to be a relatively simple, yet important, shift from conflicted to impartial delivery of information.
The Financial Regulatory Reform blueprint would also strengthen regulation of futures contracts, and it would require those organizations that originate loans to carry a 5% interest in them–essentially putting them on the hook if the loans fail.Â (I would suggest that a higher percentage interest would provide stronger incentives to write sound loans.)Â It has an excellent proposal that would allow shareholders in public companies to vote on executive compensation packages, which would stop large company CEOs from looting their companies for their own profit.Â Â Although I did not discuss these proposals, I agree with them and hope you too will support them on behalf of financial consumers.
It is hard to overstate the importance of these proposals; they represent a well-considered set of protections, not just for consumers, but also for the global financial system at large.Â You will undoubtedly hear from brokerage industry representatives and lobbyists who, against all logic, want to be rewarded for their reckless and self-serving behavior by being allowed, now, to write their own regulations.Â This path would inevitably lead to more trauma in the financial markets, and a greater transfer of wealth from your constituents’ retirement and investment accounts to Wall Street bonus pools.Â And as they lubricate the lobbying process with hired representatives and campaign contributions, please understand that this is taxpayer bailout money they’re spending to convince you of the rightness of their position.
The bottom line here, in my opinion, is that the Financial Regulatory Reform blueprint offers a surprisingly good, potentially effective set of proposals for addressing the real underlying risks and conflicts in our financial markets.Â It represents a better way to protect consumers than the systems we have today, and would, if implemented in whole or in part, make it far less likely that we would experience the kind of financial trauma that swept through the markets last Fall and Winter.
I have no doubt that it will require political courage for you and your peers in Congress to support these initiatives in the face of vigorous lobbying by the powerful Wall Street firms and their trade organizations.Â My guess is that you will hear that these proposals are “unrealistic,” or that they fly in the face of capitalism.Â Please understand that I and tens of thousands of other financial advisors voluntarily live under these standards every day.Â Â Your constituents and American investors deserve the chance to receive clear, unconflicted, professional advice, disclosures in plain English, and a promise that they won’t see their tax dollars shunted to large “too big to fail” firms that lost risky bets with no accountability.
I also want to recommend that you give credence to the views of the National Association of Personal Financial Advisors, the Financial Planning Association, the Consumer Federation of America and the CFP Board of Standards, who are attempting to speak on behalf of investors and those advisors who put investors’ interests first.Â If you want further reading on these subjects, I recommend that you follow these links: http://online.wsj.com/article/SB124545477468032915.html (on the subject of full financial disclosure); http://online.wsj.com/article/SB123819596242261401.html (on the fiduciary standard); and http://www.financial-planning.com/fp_issues/2009_6/the-schapiro-doctrine-2662090-1.html (about competing regulatory concepts favored by the brokerage industry).
Thank you for your attention, and in advance for your help in creating better regulation, protection and standards.
Richard. T. Feight, CFP
Fee-Only Certified Financial Planner