Will The Republican Election Sweep Damage Investor Protection?

Wall Street poured millions into Republican campaigns in the mid-term elections. The goal and thrust of Wall Street’s investment was to have a Congress that was friendlier to its interests and less friendly to investor protection regulation.

Will Wall Street’s investment pay off?

A major test of the election result will be whether there is a chilling effect on the Securities and Exchange Commission enforcement of standards designed to protect investors.

The Republican win appears to put them in line to quash two significant efforts to protect investors: the creation of a universal fiduciary standard for those who sell securities and the revision of minimum financial standards for wealthy investors who wish to invest in high risk deals.

First, the fiduciary standard.

Recently, SEC Chair Mary Jo White said that she wanted the agency to decide by the end of the year whether it will proceed with the rule that will establish a uniform “fiduciary duty” for retail investment advice. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act gave the SEC the authority to promulgate a fiduciary duty regulation but it hasn’t acted in almost four years.

Right now, common retail brokers at firms like Merrill Lynch and Morgan Stanley do not work under such a standard, the adaption of which would mean putting their clients’ interests’ firsts. Right now, those Merrill and Morgan brokers are just that, salesmen, who must adhere to a much less stringent policy of suitability when selling a stock, bond, mutual fund or REIT.

The difference between the broker and the fiduciary is simple. If you go shopping for a pair of shoes, and the salesman squeezes you into a one-size fits all pair of flip flops, he’s a broker. If he makes you try on several pairs, discussing and analyzing the price, style and comfort of each, he’s a fiduciary.

The brokerage industry likes its 300,000 sales people working as “one-size-fits-all” brokers. The industry fears it would be too costly to have their sales people toil as fiduciaries and having you try on all those shoes. So much easier to sell you the first pair that comes along! And the change to a fiduciary standard would also open securities houses like Merrill and Morgan up to costly lawsuits because of the higher standard of care those firms would be required to work under.

According to a recent article by Mark Schoeff of industry trade paper InvestmentNews, two Republican SEC members oppose the fiduciary duty rule-making, with presumably the two democratic members in favor of it. It comes down to whether Chair White will demonstrate a willingness to proceed and pass the fiduciary duty reform on a 3-2 vote.

SEC chairs typically want to get all the other commissioners in line when taking such a significant vote. That may not happen in this case. Indeed, Barbara Roper, director of investor protection at the Consumer Federation of America, said that Ms. White must be willing once again to proceed with a majority rather than unanimity when it comes to the fiduciary duty rule.

According to Schoeff’s report: “This should not be a partisan issue, but if Chair White must take a 3-2 vote to bring it about, so be it,” Ms. Roper said recently on a conference call. “This is an issue of sufficient importance to the basic financial well-being of millions of investors that the chair must be willing to take that vote.”

The report continues: “The problem, to be frank, starts with the SEC staff itself,” said Ms. Roper. “There seems to be a reluctance within the staff, particularly within the Division of Trading and Markets, to acknowledge any problem with a regulatory policy that allows brokers to remake themselves as advisers while still regulating them as salespeople.”
Next comes the potential to redefine the guidelines investors must meet to buy high risk deals, such as hedge funds and private placements.

In a disturbing development, an SEC Committee study last month also recommended that the SEC’s leadership “radically redefined the standards for determining who can invest in risky offerings such as limited partnerships and private securities transactions”.

The recently passed “Jump Start Our Business Start-Ups Act,” better known as the JOBS ACT, allows for “accredited investors” to invest in private funds and other private issuers which provide for less disclosure than in public offerings. The current “accredited investor” rule restricts such investments to those with significant household wealth – either an investor with more than $1 million in assets (excluding their home) or annual income of $200,000 or more.

Those standards, however, date back to the 1970s and, at a minimum, the SEC should consider revising the financial limits upward to keep pace with inflation. It’s obvious that those standards are out of date and the bar to buy into such high risk deals should be raised. Will Republican influence now quash common sense in such matters?

With the Republicans now controlling the extremely powerful Senate Banking Committee, will Congress and the administration move in favor of their Wall Street patrons? The SEC will also soon be called upon to continue enforcement actions against illegal insider- traders and large banks who commit fraud and who have been considered as “too big to jail” by federal prosecutors. What will Republican dominance do to those efforts?

Keep an eye on the SEC and how it votes over the fiduciary standard, a vote likely to happen next year. An independent agency, the SEC will have to determine if they are part of this political movement or if they really are there to protect investors.

It’s simple. Investor protection must be a continual goal of the SEC. It simply should not be a function of a swing in a mid-term election.

Zamansky LLC are securities and investment fraud attorneys representing investors in federal and state litigation against financial institutions.