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May 1, 201212:00 AMFinancial Perspectives

with Michael Dubis, CFP

Congress' answer to consumer protection: Make everybody a broker

Just last week, on April 25, Rep. Spencer Bachus (R-Ala.) and Rep. Carolyn McCarthy (D-N.Y.) introduced a bill that, according to the accompanying press release, would enhance consumer protection in light of the Bernie Madoff scandal and the 2008 market meltdown that took the U.S. economy to the brink of collapse.

Here’s their solution: expand the regulatory authority of the organization that currently regulates brokers. Make all who give investment advice answer to the organization that sat idle during the sale of trillions of dollars of toxic mortgage pools and derivatives, and that once had Bernie Madoff on its board of governors.

The Bachus-McCarthy bill, also known as the Investment Oversight Act of 2012, talks about enhancing the protection of financial consumers by allowing the Securities and Exchange Commission to delegate its oversight of many thousands of independent registered investment advisors to a self-regulatory organization. As many press reports have pointed out (see links below), the self-regulatory organization would be the Financial Industry Regulatory Authority (FINRA), the regulator that oversees Wall Street, and that has Wall Street executives sitting on its board of directors.

FINRA is the same organization that was in charge of policing Wall Street when the 2008 scandals broke. Bernie Madoff was under FINRA jurisdiction for his entire career, and was also subject to the oversight of its predecessor organization, the National Association of Securities Dealers (NASD). He also served as a member of the board of governors of the NASD in 1984, and on numerous committees. His brother and business partner, Peter Madoff, was elected vice chairman of the NASD in November 1992.

One of the agendas of the bill seems clear: to give Wall Street (through its regulatory arm) control over its most persistent competition: independent advisors like myself, who, in contrast to the investment sales culture, put the interests of their clients first when giving financial advice. In other words, this reform would create a world where fiduciary advisors could be forced to become brokers, and consumer access to independent, objective advice would be severely limited. Investors, try to imagine what that means to your financial well-being.

So before I elaborate further, let me be clear: I do not support handing over expanded regulatory authority to FINRA.

At a time when Wall Street's credibility is at its lowest ebb, when consumers are walking away from the opportunity to send their retirement dollars into the bloated brokerage industry bonus pools, Congress’ preferred solution is not more transparency and an effort to change the culture in order to put the consumer's interests first, but rather the creation of a new regulatory overlay on the competition that will bury them in paperwork!

In fact, when the Boston Consulting Group evaluated the expected cost of FINRA regulation on registered investment advisors, it concluded that it would be $51,700 a year for the average independent advisor. This is more than twice as much as it would cost to develop enhanced oversight by the Securities and Exchange Commission. (See the link below for more detail on the numbers.)

There are other ways to estimate the cost differential. FINRA (as mentioned earlier) is not exactly transparent about its salary structure, but public records show that current SEC chairperson Mary Schapiro's base salary as FINRA CEO came to $3.2 million a year – plus a $9 million bonus payment she received when she left to join the SEC. (We only know this because a number of news outlets filed Freedom of Information Act requests that were vigorously resisted before the data were finally handed over.) Schapiro's current salary at the SEC: $163,000 a year. If we simply compare that with her base salary at FINRA, without including the bonus, it would appear that FINRA regulation is a remarkable 19 times more expensive than SEC regulation of RIA activities.

There is reason to think this is a low estimate. In 2009, FINRA collected more than $700 million in regulatory fees, user fees, dispute resolution fees, transparency services fees, and contract services fees. In the same year, FINRA’s leadership used the dues collected from its members to pay its top 10 executives $11.6 million in order to spend more than $1 million lobbying Congress and the SEC (do regulatory organizations engage in lobbying activities?), and to spend undisclosed amounts on advertisements in The Washington Post and on CNN touting its record as a regulatory body. In 2008, eight FINRA executives received more than $1 million in compensation and benefits, and the top 12 most-compensated employees received more than $24.8 million. One might fairly question the organization's stewardship of dollars allocated to regulatory efforts.

In addition, consumers and members of the press might be astonished at how little transparency FINRA operates under. To take a recent example, just last year, Amerivest Securities President Elton Johnson (a former Green Beret) managed to get seven proxy votes onto the agenda at FINRA's 2010 annual meeting. These initiatives would, among other things, have required FINRA to do things that any guardian of the public interest would normally do as a matter of course: tell us the compensation paid to its 10 most highly paid employees, disclose FINRA's investment transactions to members and the public, and open up its board meetings or at least provide transcripts of the discussions among Wall Street executives and others who currently (this, to me, is amazing) make the organization's decisions in secret.

All seven of these initiatives passed overwhelmingly, garnering more than two-thirds of the membership vote – some more than 80%. Yet the FINRA board of directors debated these measures in a closed meeting, and decided to reject them.

There may also be significant conflicts of interest in the way this legislation was crafted and produced. It has long been clear that Rep. Bachus speaks as a proxy for FINRA on the subject of "enhanced" regulation, and I don't think anybody close to the profession can see this as anything but a way to let FINRA take over regulation of the fiduciary RIA profession. The press release accompanying the legislative proposal goes so far as to praise the diligent regulation of broker-dealers and the lax regulation of RIAs. I think this one line offers particular insight into where this legislation is coming from:

“Customers may not understand the different titles that investment professionals use but they do believe that ‘someone’ is looking out for them and their investments. For broker-dealers that is true, but for investment advisers, it is all too often not true and that must change,” concluded Chairman Bachus.

In other words, the RIAs, who are required by law to live up to a fiduciary standard (and put their clients' interests first in all advice-giving) are the bad guys in the marketplace!? They must be watched much more vigilantly, while the brokerage firms (which have resisted registering their brokers as RIAs and thus can evade this tougher standard) are the good guys who protect consumers!?

This is outrageous!

This, of course, is taken straight from the mouths of FINRA and SIFMA (the brokerage industry's lobbying group), and it is not hard to find out why this particular legislator has been so persistent on this subject. When you look up where the lobbying money has gone, you find that Rep. Bachus' top 10 contributors include commercial banks (a total of $213,650 in 2011-12), insurance companies ($191,010), securities and investment firms ($184,277), finance/credit companies ($90,438), and "miscellaneous finance" ($89,250). In the 2011-12 election cycle, he was the number one recipient of funds from commercial banks, from finance/credit companies, and from mortgage bankers and brokers. (All of that can be found here.)

When you connect the dots on this piece of legislation, it becomes frighteningly clear that the agenda could be something very different from the stated goal of consumer protection. Yet unless the public learns about this power grab, consumers may find themselves living in a world where everybody who gives investment advice is a broker, and regulated like one.

If you are anywhere near as concerned (and angry) as we are in my world about this effort to brokerize our financial system, then you might want to contact your elected officials, as we are doing.

Our message is very simple, and I have included it here to make it easier for you to cut and paste and add your own thoughts:

I want to express my strong opposition to the recently proposed Bachus-McCarthy bill, also known as the Investment Oversight Act of 2012.

This piece of legislation has the potential to do significant harm to your small business constituents by subjecting them to yet another layer of bureaucratic regulation. Worse, it would hand off regulation to an entity – FINRA – that has proven to be extremely ineffective at protecting consumers. FINRA is the organization that regulates Wall Street, which failed to prevent the 2008 scandals, including the sale of toxic investment products. Bernie Madoff was under FINRA regulatory jurisdiction for his entire career.

Please, if you agree, and if and when you have an opportunity to vote on this measure, vigorously oppose this effort to build yet another bloated regulatory bureaucracy in Washington.

There are far better alternatives for enhancing consumer protection than allowing Wall Street's regulator to expand its authority over the many small businesses that provide fair and transparent advice to consumers.

Sources:

A special thanks to Bob Veres for providing many of the talking points.

The SRO would be FINRA: http://www.financial-planning.com/blogs/veres-sro-sec-finra-2678577-1.html

http://www.investmentnews.com/article/20120425/FREE/120429948#

The excessive cost of FINRA regulation: http://www.fa-mag.com/fa-news/9412-rias-back-sec-as-regulatory-body.html

http://www.financial-planning.com/news/finra-sro-napfa-2678574-1.html

FINRA's regulatory effectiveness (or lack thereof): http://registeredrep.com/advisorland/opinion_finra_is_an_ineffective_regulator_1006/

FINRA's lack of transparency at the board level: http://www.dailymarkets.com/stock/2010/06/22/finra-owes-america-answers-on-these-proposals/

http://newsandinsight.thomsonreuters.com/Legal/news/2011/02_-_february/court_refuses_to_dismiss_lawsuit_demanding_finra_transparency/

Rep. Bachus insider trading scandal: http://www.washingtonpost.com/politics/rep-bachus-faces-insider-trading-investigation/2012/02/09/gIQA21Ui2Q_story.html

Do brokerage industry representatives actually sit on FINRA's board of governors? Here's a list of the current board of governors: http://www.finra.org/AboutFINRA/Leadership/P009756. Among others, you find representatives of Morgan Stanley Smith Barney, LPL Financial, Deutsche Bank, and Edward Jones.

But look more closely at some of the "public" members of the board of governors. John Schmidlin, who is listed as a member of the consuming public, is the former chief technology officer and managing director at J.P. Morgan Chase (http://www.harlemacademy.org/about/board-trustees). Richard S. Pechter, another member of the consuming public, is actually former CEO of Donaldson, Lufkin & Jenrette, and chairman of the board of Credit Suisse USA. (http://investing.businessweek.com/research/stocks/private/person.asp?personId=12665753&privcapId=165284&previousCapId=23021&previousTitle=SONY%20CORP-SPONSORED%20ADR) Kurt Stocker was chief corporate relations officer of Continental Bank Corp. (http://investing.businessweek.com/research/stocks/people/person.asp?personId=11713969&ticker=NYX:US&previousCapId=3777896&previousTitle=Rensselaer%20Polytechnic%20Institute) "Public" governor William Heyman is the former chairman of Citigroup Investments and executive vice president of the Travelers Companies.

Michael Dubis is a fee-only certified financial planner and president of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at financialperspectives@gmail.com.
This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services described in this website or that of the author’s. Mike Dubis does not guarantee the relevancy, appropriateness, or accuracy of any outside information or links. Mike Dubis does not render or offer to render personalized investment advice or financial planning advice through this medium. All references that might be made to an investment or portfolio's performance are based on historical data and one should not assume that this performance will continue in the future.
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