Holding Wall Street Executives Accountable for Allegedly Deceiving Their Brokers and Clients

In addition to stratospheric salaries, one of the great benefits of holding a very senior position at a Wall Street firm is never being held accountable for any wrongdoing or questionable behavior.  Sadly, regulators typically go after hapless mid-level employees who merely - and often innocently - carry out orders and directives from the top brass. One of the most egregious examples of underlings taking the fall were the “market timers”  - see Forbes story. Not one senior Wall Street executive has been charged or prosecuted for market timing wrongdoing.

So a little noticed story about the SEC and Finra filing charges alleging that Morgan Keegan fund manager James Kelsoe, along with Joseph Weller, who headed the firm’s Fund Accounting, conspired together to hide significant losses in various bond funds with heavy exposure to subprime mortgages gives me some hope.  The SEC and Finra could have opted to go after the Morgan Keegan brokers who aggressively peddled the funds, however, they acknowledged that the brokers were also misled about the true condition of the bond funds.

While I commend the SEC and Finra for going after some executives with real authority, let’s be honest here: Morgan Keegan is a second-tier Wall Street firm, and the firm likely doesn’t have the deep pockets or legal resources of a Goldman Sachs or a Morgan Stanley to engage in an extensive battle with regulators.   A more telling test of the SEC’s and Finra’s resolve will be how they handle their reported investigation of UBS’s aggressive marketing of Lehman 100% Principal Protected Notes.

UBS brokers apparently were repeatedly misled by their firm about the safety and soundness of Lehman Brothers, and they are now worried about facing regulatory action.

Absolving the Morgan Keegan brokers for selling the firm’s dubious bond funds but going after UBS brokers for selling Lehman Principal Protected Notes seems like a double standard. But after thirty years in the securities business, I’ve learned that major Wall Street firms are held to a much lower regulatory enforcement standard in matters relating to individual investors.

Regulatory “Reform” Bill Shafts Individual Investors

I should have known it was too good to be true.  A few months ago I was enthusiastically optimistic that the regulatory reform bill Congress was looking to pass would include an important investor protection measure known as the “fiduciary duty” standard, which would require brokers to put their clients’ financial interests ahead of their own.  Senator Christopher Dodd (D-CT) said he supported the measure, as did SIFMA, Wall Street’s lobbying arm. Indeed, John Taft, head of the SIFMA committee on regulatory reform, even acknowledged, “It’s a big deal for our industry to do this.”  The SEC and FINRA also indicated support for adopting the standard.

Despite all the declared “public” support, it’s near certain that the regulatory reform bill Congress is expected to pass next week won’t require holding brokers to a fiduciary standard.  The provision has been quietly dropped from the proposed legislation currently being circulated.  The omission should be of major concern to investors who buy stocks, bonds, and other financial products from Wall Street brokers.

Wall Street brokers currently must adhere to what’s known as the “suitability” standard, which Wall Street maintains means that they are only required to sell financial products suitable for clients at the time of sale and they don’t have to disclose commissions.  On a practical level, for example, if a broker puts a client into a certain stock, Wall Street maintains that the broker isn’t responsible for monitoring the performance of that stock after the sale is completed.  The stock only has to be “suitable” at the time of sale.  Under the “fiduciary duty” standard, the broker could be required to monitor a client’s entire portfolio and ensure that it remains consistent with the stated investment objectives.  The broker also could be required to sell financial products at the lowest available cost.

Put simply, the fiduciary duty standard would dramatically raise the standard of client conduct brokers would be legally required to maintain.

There is a compelling argument for requiring brokers to adhere to a fiduciary standard.  They typically market themselves as financial “advisers” and a $875,000 study the SEC commissioned in 2008 found that’s how most investors regard them.  As the saying goes, “It it quacks like a duck…”

It’s not yet clear to me how the fiduciary standard provision from the latest draft bill proposal disappeared, but there is evidence that Wall Street was possibly head-faking support while quietly moving to kill the measure.   A Morgan Stanley memo recently uncovered by Bloomberg advocated that the SEC “should be given the responsibility to thoughtfully review brokerage services and regulations, and promulgate new, specifically tailored rules for the brokerage business.”  Translation: Let’s refer the matter to the SEC and let their staffers study and bury the matter.  Morgan Stanley, the firm with the biggest broker network, has good reason to fear the adoption of a fiduciary standard: the standard could ultimately cost the firm up to seven percent of its earnings, according to an analyst.

Given that Wall Street brought the nation to near ruin, one might have expected that Congress would finally have had the will to stand up to the industry’s powerful lobbyists.  But once again Wall Street has trumped the system.  And the SEC and FINRA, which unilaterally could implement the fiduciary standard, have opted to remain on the sidelines.

Individual investors should take note how there is no one in Washington moving to protect their interests.

Wall Street Endorses the Fiduciary Standard

An utterly improbable thing occurred last week when Wall Street endorsed the fiduciary standard for brokers.  This is certainly a sea change for investors.  A fiduciary standard similar to that which governs so-called “financial advisors” is something I’ve advocated for years.  The new standard forces brokers to put customer interests ahead of their own, which seems logical enough even though up until now Wall Street fought against the issue tooth and nail.

But last week SIFMA, Wall Street’s lobbying group, got behind the idea which almost assuredly means Congress will turn it into a law.  It’s long overdue and Congress should quickly pass legislation, lest Wall Street gets cold feet.

The fiduciary standard goes to the core of the relationship between individual investors and Wall Street.  Wall Street is not just selling a product. There is a professional relationship.  The relationship is much less like a car salesperson and buyer as much as it is like a doctor and patient where the diagnosis is just as important as the prescription.

That is why applying a fiduciary standard to the broker-customer relationship is so important.  Wall Street enjoyed having it both ways, especially when it came to disputes.  It’s undeniably common sense that a retiree should never be recommended speculative tech stocks or auction rate securities and other structured products.  But if that retiree filed a case against the broker who recommended the bad investment, Wall Street wouldn’t deny that it was wrong, but would argue that technically the broker didn’t have to put his client’s interest above his own.  Going forward the onus is on the broker to defend the recommendation as meeting the fiduciary standard.  The burden of proof is back on Wall Street.

Earlier I posted about a recently leaked memo from SIFMA about their plans to improve Wall Street’s image.  Actions, such as adopting the fiduciary standard is an important first step and will go further than spin.  Much more action on the part of Wall Street is necessary before Main Street’s trust can be restored.