An open letter to the new SEC chair:
Now that SEC Chairwoman Mary Jo White has said she will leave at the end of the Obama administration, the President-elect has one more task added to his considerable to-do list. Presuming a candidate can be quickly identified, nominated and approved, a new agency chief could be in place soon after Donald Trump takes office.
Congratulations on the new gig! As you take office, you’ll almost certainly be familiar with issues like insider trading and corporate governance. You’ve seen testimony by Fabulous Fab and know that some of the brokerage firms think that doing a great job means selling investments they know will fail, for a commission, and then betting against them for their own account.
What you may not know is that there is a whole cadre of advisers who aspire to serving their clients fairly and impartially.
Check with your staff, and they’ll tell you that these RIAs, many of them fee-compensated financial planners, have been a low regulatory priority for decades — for obvious reasons. They fully disclose their fees, their clients’ money is held by a custodian, and they primarily recommend low-cost mainstream investments like mutual funds and ETFs. They embraced the fiduciary concept long before it became a talking point in lobbying efforts.
STREAMLINE YOUR PROCESSES
So why am I writing you? Because I’d like to propose a way that you can streamline your regulatory processes while, at the same time, do a better job of protecting the public.
As you take office, you’re going to hear that the commission has done a terrible job of inspecting the offices of these planning professionals — the usual statistic is one visit every 11 years or so. This is a direct reflection of how dangerous the SEC staff has traditionally considered these would-be professionals (namely, not at all). But now that the brokerage firms are yelling that fee-only advisers are unregulated rogue brokers and have managed to get their surrogates in Congress to call for more frequent visits, the SEC is under pressure to start cracking down on the most honest segment of the advice business.
What I would propose is that you answer back with a regulatory inspection scheme that makes sense, based on the actual risks that exist in the marketplace.
Meaning? Let the inspection regime be dictated by the number of conflicts of interest that different service providers intentionally, deliberately embrace in their business model. The hierarchy would look something like this:
THE HIERARCHY OF CONCERNS
1. Brokers with wirehouse firms. This should be your highest priority — for obvious reasons. If a firm is manufacturing its own investments and selling them to the public, there’s a pretty big temptation to arrange the transaction so that it favors the firm and not the customers.
Wirehouse derivative contracts are opaque and potentially suicidal for financial customers; in fact, I suspect that your biggest headache, down the road, will come when another trillion dollars worth of wirehouse-created derivatives blow up and compromise the balance sheets of banks, retirement plans and public pensions. Meanwhile, it’s a wonderful testament to the sales skills of their brokers that their mutual funds, some of which combine inferior performance with high expense ratios, are still in existence, much less managing billions of customer dollars.
And you might want to investigate the separately managed accounts that their brokers recommend. They’re laden with under-the-table revenue sharing arrangements — thinly disguised pay-to-play schemes that the regulators have allegedly outlawed.
Taking in a bigger picture, the brokerage firms have created a competitive sales culture that rewards asset gathering and sales, and provides incentives for brokers to cut corners. To top it off, the brokerage firms have managed to lobby themselves an exemption from SEC registration, which means that they provide advice but don’t have to adhere to the standards imposed on RIAs. You might take a few minutes to wonder why the wirehouse community is so adamant about not allowing their reps to register.
There’s a reason that FINRA receives 3,000 to 5,000 arbitration cases a year from this cohort. With so many conflicts of interest built right into the business model, a wirehouse is a hothouse environment for the kind of things that regulators exist to protect customers from.
Check with your staff, and they’ll tell you RIAs have been a low regulatory priority for decades — for obvious reasons.
You’ll have to work with FINRA to rein in the worst abuses, but I’m cautiously hopeful that the new FINRA chairman, Jack Brennan, actually takes consumer protection seriously.
THE MATTER OF ANNUITIES
2. Insurance salespeople. When someone primarily recommends annuities as investments for client portfolios over ETFs and low-cost funds, you can bet there’s an incentive — and you don’t have to look far to find it: high commissions. A toxic subset of this community routinely recommends equity-indexed annuities, which (in my opinion) ought to be banned altogether, but absent that, the practice should attract close scrutiny from regulators.
There are many excellent insurance agents out there. But in my experience, the ones who register to sell equities (read: annuities) tend to be taking full advantage of their conflicts of interest.
3. Dually registered reps of independent broker-dealers. This cohort is probably your toughest challenge because they’re all over the lot. But I would prioritize. If the dually registered adviser is 90% fee-compensated and sells term insurance for nominal commissions, then your inspector should move on to a more promising (conflicted) target.
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In the face of political uncertainty, planners are clinging to cash and reallocating client assets to short-term investments.
September 13 -
A tax bill passed in 2017 normally would go into effect in 2018, but the fear is that it could be retroactive, which happened once before under a President Clinton.
October 26 -
Clients are anticipating volatility and favoring defensive allocations no matter the outcome, say advisers who participated in a recent poll.
August 18
If there is sales activity involving nontraded REITs, and a lot of variable annuity recommendations, however, you can bet this rep is embracing serious conflicts of interest, and you should be visiting every year to make sure customers are being protected.
4. Financial planners and fee-compensated RIAs. This should be your lowest priority. They have voluntarily given up the most distracting conflicts of interest, they don’t have any way to touch client assets, and their recommendations are made in the interests of the client. Assuming these individuals aren’t taking custody or creating pooled investments, you should be able to verify from custodial records and client statements that the clients’ money is where they say it is, and review their fees, policies and procedures without even visiting their offices.
LOOK AT THE RECORD
I’m guessing that you’re still skeptical. Can it really be this easy? Please don’t take my word for it; take a look at how many actual cases of abuse you can find from fee-compensated financial planners versus (to take a handy example) those who nearly took down the global financial system with reckless greed and self-serving product creativity. I know what you’ll find: there’s an occasional bad apple in the financial planning profession who has figured out a way to take control of client assets — and your comparison of custodial records with client statements should be ongoing as a precaution. (Can this not be automated?)
Meanwhile, where sales are concerned, and particularly when the nontraded REIT industry implodes and the brokerage firms are caught short on trillions of dollars of derivative obligations, you’re going to find genuine horror stories well worth the time and energy of your inspectors.
Good luck. I hope this helps you prioritize where to spend your time, energy and resources, and to recognize that even when they’re lobbying you in your office, the big financial services players are serving themselves rather than the public at large.
