Wall Street Will (Again) Kill The Passage of a Fiduciary Standard

The Cato Institute recently reported that there are no less than 28 “studies” recommended in the Senate’s version of the financial regulatory reform bill.  Of all these “studies,” the most wasteful and harmful is the proposed SEC study on a broad application of the fiduciary standard for brokers.

It’s wasteful because the SEC already conducted a study on the fiduciary standard in 2008 at a cost of $875,000 to tax payers. And it’s harmful because the results of the 2008 study show that investors do not see a distiction between a financial advisor, which adhere to the fiduciary standard and put client interests ahead of their own, and a broker, who can recommend any product so long as its “suitable.”

As an investor advocate over three decades, I can say with authority that when a broker recommends a product, the investor thinks this is a form of financial advice.  Yet unbeknownst to most investors, brokers often act in their own interests and compensate themselves accordingly.  Indeed, brokers are much closer to car salesmen earning commissions than to financial advisors.

Because of this confusion, and the ubiquitous salesmanship of complex securities on Wall Street, its necessary that brokers adhere to a fiduciary standard.  Just a few months ago Wall Street, regulators and investor advocates were in agreement that a broad application of the fiduciary standard would be included in the reform bill. The change’s effect would have been better service for Wall Street’s customers, more disclosure, and lower fees, yet it didn’t make Senator Dodd’s final bill.

This is even after Goldman Sachs was discovered to have torpedoed its own clients with securities built to fail, and outraged members of Congress stole headlines announcing plans to support the broad application of the fiduciary standard.

While the House financial reform bill includes a fiduciary standard for brokers in limited circumstances, I’m fairly certain history will repeat itself and the provision will mysteriously and entirely disappear when the House and Senate reconcile their respective bills.  Congress has yet to show it has the political will to pass a measure that would dramatically curtail Wall Street’s highly lucrative business exploiting 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.

Annuities and the Avoidance of the Fiduciary Standard

There’s a saying on Wall Street: “Structured products are never bought, only sold”. The same could be said of annuities.

Selling annuities is an extremely lucrative and virtually risk-free business, which is one of the reasons why insurance companies and some Wall Street firms are aggressively lobbying Congress not to require brokers and other purveyors of financial products to adhere to a so-called “fiduciary standard.” Under the proposed standard, brokers and insurance salesmen would be required to put their clients’ interests ahead of their own, likely forgoing high-commission annuities for other, more appropriate investments.

Not surprisingly, Morgan Stanley has voiced concerns that the fiduciary standard would cut into its business. Morgan Stanley has good reason to worry: The firm earned $37 million from selling annuities in the first quarter of 2009 alone, or 1.22 percent of its noninterest income, according to a report by the American Bankers Insurance Association (ABIA). A Morgan Stanley spokesman recently told Bloomberg that expanding the fiduciary standard to include brokers would impinge upon the firm’s ability “to provide clients with products and services they want.” Or, perhaps more accurately, don’t want.

Some annuities are suitable products for investors, however, more times than not, they come with hidden costs and penalties (commissions can be as high as 7-10%) that vastly diminish their value.  Even FINRA has acknowledged the problem.  Richard G. Ketchum, the head of FINRA, recently acknowledged in the New York Times that there “had long been problems with how brokers disclosed their conflicts and how they pushed products.” Last year FINRA fined Fifth Third Securities $1.75 million for what they declared to be 250 unsuitable variable annuity transactions and five other broker-dealers were fined a total of $1.65 million for unsuitable sales of annuities, mostly to elderly investors with conservative investment objectives.

The securities industry likes to say it supports a broad fiduciary standard, but that’s far from the truth.  SIFMA, Wall Street’s lobbyist, has publicly supported a proposal by the House of Representatives which would create a new, “limited” fiduciary standard for brokers only when they are giving “personalized investment advice” to their retail clients.  In other words, brokers would have the discretion to decide when they are providing financial advice and when they are selling snake-oil. FINRA also supports the House bill.

Senator Chris Dodd has issued a much needed proposal that removes the distinction between brokers, insurance agents and an investment advisers.  This, combined with a comprehensive fiduciary standard would go a long way to protecting investors.

However, it’s increasingly unlikely that the fiduciary standard, under pressure from the insurance lobby and Wall Street, will ever see the light of day. Once again the interests of individual investors will be ignored.

SEC Enforcement: The More Things Change…

In my last post I was downright jubilant that Wall Street endorsed the fiduciary standard for brokers. And don’t get me wrong, this is a major development. But, as they say, one step forward…two steps back.  To wit, I read with great dismay two recent cases where the SEC enforcement division levied fines equivalent to a love tap for what appears to be serious wrongdoing.

In what I’m sure was a delight to Morgan Stanley’s PR office, the first case was buried in the Wall Street Journal in a five paragraph blurb on page C4. So allow me to give you some background.

Morgan Stanley was recently censured a paltry $500,000 by the SEC for allegations that one of its former financial advisors misled his clients and failed to disclose conflicts of interests. According to the SEC, William Keith Phillips, who was based in a Nashville, Tennessee branch of Morgan Stanley, breached his fiduciary duty when he allegedly recommended “unapproved” money managers to clients.  Under the terms of a proprietary program, Morgan Stanley would provide custody, execution, performance reporting, and, importantly, due diligence on money managers for their clients.

The SEC alleged that Mr. Phillips had a financial incentive to recommend these three money managers, after developing a relationship with them and negotiating $3.3 million in commissions.  Moreover, two of the unapproved money managers convinced some clients to open advisory accounts with the Morgan Stanley Nashville branch, generating an additional $200,000 in fees and commissions, a portion of which was paid to Morgan Stanley.

Investors harmed by this will no doubt file arbitration cases.  And while I’m sure Morgan Stanley wasn’t happy to sign a check to the United States Treasury for $500,000, I’m pretty sure they did the math a realized they were still ahead.

The second case involved Perry Corp., a $6.6 billion hedge fund managed by Richard Perry.  According to the SEC, Perry Corp. withheld a critical regulatory filing which serves to give the market notice when an investor has amassed more than a 5 percent stake in a public company.  The goal of the rule is to ensure investors understand if there is another investor that could influence company decision making.  In this instance, it is alleged Mr. Perry bought a 10 percent stake in Mylan Inc. in order to throw his weight behind a potential merger in which he stood to profit.

Representing Mr. Perry was William McLucas, who ran the SEC’s enforcement division for eight years before leaving the agency in 1998. When I say the there is a “revolving door” phenomenon between the SEC and Wall Street, this is precisely what I mean.  Mr. McLucas negotiated a measly $150,000 fine with his old employer.

Not surprisingly, Mr. Perry called the settlement a “satisfactory conclusion.” What is “satisfactory” to Mr. Perry most assuredly isn’t for other shareholders in Mylan Inc.  Nor will it likely deter anyone else from playing the same game.

On the other side, David Rosenfeld, associate director of the SEC’s New York regional office, who oversaw the case, said he “[hopes this] will deter others from engaging in this type of conduct.” I wish I could be so hopeful but I’m afraid the fines are a far cry from a deterrent.

What happened to “getting tough” on Wall Street?

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.

SIFMA’s Leaked Memo Rubs Investors the Wrong Way

As I write this post, a collection of highly educated, enterprising professionals (whose skills would no doubt be better suited for more constructive endeavors) are on a conference call scheming ways to blunt what Wall Street considers a “populist overreaction” to the banking crisis.  Indeed, as reported by Bloomberg a few weeks ago in memos detailing confidential meetings at the Securities Industry and Financial Markets Association (SIFMA), Wall Street has launched an image improvement program led by former aids to Hank Paulson who meets every morning.

The reason being is that Wall Street fears that it won’t have a seat at the table when it comes time to hash out the details of President Obama’s regulation reform without a facelift.  What better way to do it than spend nearly $100,000 per month on consultants after receiving $700 billion in TARP loans?

It seems outrageous on the surface, but to be fair it’s not uncommon for a trade group such as this to embark on a PR campaign.  And according to Bloomberg one of the goals is to communicate “accountability,” which is admirable.  Having said that, to categorize the public’s outrage over what has occurred as a “populist overreaction” is an insult to the millions of American’s whose lives are now ruined because their life savings were decimated by Wall Street’s fraud and greed.

These were Wall Street’s customers and they are more than justified to be irate.  Families are feeling real pain while bankers are upset that bonuses will only come-in at $750,000 this year.  It doesn’t make sense to them.  Their only recourse is anger and an explosion in litigation and arbitration claims.

According to the leaked memos, SIFMA plans to empower the legions of brokers to be “foot soldiers” that will deliver message points directly to the masses on a grass roots level.  This is not a surprise to me.  After all, it was the brokers that were conduits for misinformation their superiors crafted in order to sell dubious products such as structured notes, auction rate securities, hedge funds tied to subprime mortgages or shares in Fannie Mae, Freddie Mac, Lehman Brothers and other failed financial institutions.

Brokers were often encouraged to lie and commonly didn’t receive any training with regard to the complex securities they told their customers to buy.  Wall Street charged underwriting fees then a commission on the very same products, thus doubling and sometimes tripling fees for investors.  They traded out of their own accounts knowing the markets were going to tank and hedged against their own clients.  So I doubt seriously that after the losses sustained by individual investors that they will be receptive to a call from a broker saying “it’s not our fault and you can trust us now.”

It was recently reported that 2009 will be another bonus bonanza on Wall Street.  Clearly Wall Street is not ready to take responsibility for their terrible decision making and fleecing of individual investors and until it does, no amount of spending on PR programs will do any good.  Instead of PR, Wall Street should be concentrating on repairing its relationships with customers by compensating those that were ripped off for their losses.

Moreover, they should embrace the fiduciary standard for brokers.  At least then, Wall Street’s customers will know that their interests are being looked after and it’s not just a bunch of PR spin.