Financial Regulatory Reform – My letter to Congress

Dear Representative (Senator):

 I know that you and other members of Congress have a variety of reform proposals and initiatives on your desk.  As a member of the financial services profession, I'm asking you to give special consideration and support to proposals from the white paper entitled Financial Regulatory Reform: A New Foundation.  Some of these proposals would solve several of the most persistent and difficult problems in our financial system and improve the safety and soundness of our investment markets.

 I urge you to put the considerations of retirees and consumer investors first.  I believe that if Congress does not act responsibly in this debate and if certain of the Regulatory Reform proposals are emasculated by lobbyists representing the large brokerage firms, then it will inevitably lead to yet another industry scandal, costing would-be retirees billions and perhaps trillions of dollars.

 One of the most important consumer protection proposals in the Regulatory Reform report can be found on page 71, dealing with a fiduciary standard.  In the financial services industry, there has been a lot of talk about how consumers are confused about the difference between brokers who call themselves "financial advisors" or "investment advisors" and registered investment advisors who are held to a fiduciary standard.  The report acknowledges this confusion, but notes that consumers are not at all confused about what they want from their advisor: they want a "trusted relationship," which is, in general, what a fiduciary standard means.  (A more precise definition would be "putting the interests of the client/customer ahead of your own.").

 The Financial Regulatory Reform blueprint proposes to hold all who give investment and financial advice to this legal and regulatory standard of care.  This would be a big step up for brokerage representatives, who are currently held to a "suitability" standard of care under FINRA's regulatory oversight.  "Suitability" means that the broker (who calls himself a "financial advisor") would have to determine that there was a general need for the kind of product he is recommending before recommending it.  But under these suitability standards, he would be free to recommend an expensive, commission-laden, high-expense investment instead of much better, less expensive alternatives--and brokerage firms frequently encourage their representatives to offer these products for the simple reason that they are more profitable.  If you vote to require them to live up to a fiduciary standard of care, you would be effectively preventing them from slyly--and perfectly legally--transferring billions of dollars out of your constituents' retirement portfolios into their bonus pools.

 As the debate progresses, please be aware that the current SEC Chairperson and the executives at FINRA--who have denounced the fiduciary standard--are strongly in favor of transferring regulation of registered investment advisors from the SEC to FINRA.  This would be a back-door way to accomplish the same goal: to eliminate the fiduciary standard by enforcing it through compliance and suitability procedures.  If the goal is to reduce or eliminate the sale of toxic products, then please remember that all the FINRA regulations did little to prevent them from flooding our financial system--just as they do not currently prevent the sale of expensive annuity contracts with 15-year surrender charges, or investment programs that charge enormous annual fees of 3% a year when there are many superior, less expensive alternatives.

 I support the creation of a new Consumer Financial Protection Agency, which would, for the first time, control the sale of investment products whose entire reason for existence is to transfer wealth from consumers and retirees to brokerage and financial product organizations.  I also support the requirement of plain-English disclosures of sales commissions, expenses and risks, many of which are currently either not disclosed at all, or buried in the middle of a lengthy prospectus.

 I also support measures outlined on page 21 which would raise supervision and regulation of the "too big to fail" financial firms, described in the blueprint as Tier 1 Financial Holding Companies.  Regardless of who takes on the ultimate regulation of these firms, if there is an implicit guarantee that these firms will be bailed out by the government whenever they engage in risky behavior, then it is prudent to clearly identify these firms (page 23), raise their capital requirements and liquidity standards (page 24), raise supervision and the standards of public disclosures (page 25), and align their executive compensation practices with long-term shareholder value rather than short-term risk-taking (page 29).

 In the recent meltdown, regulators became aware of something which we in the financial planning world have been aware of for years: that the credit rating agencies have operated under a significant conflict of interest: they are paid by the organizations whose bonds or products they rate.  Page 46 of the blueprint suggests that the SEC investigate the conflicts of interest and promote the integrity of the ratings process.  This is a long-overdue review, and the changes implied here should not be difficult--investors pay for independent evaluations of stocks and mutual funds; why not ask the ratings agencies to sell their information in database form to professional and retail investors under much the same business model?

 Given the importance of credit rating failures in the recent meltdown, I hope you will pay close attention to this issue, and hold the SEC accountable for implementing what would appear to be a relatively simple, yet important, shift from conflicted to impartial delivery of information.

 The Financial Regulatory Reform blueprint would also strengthen regulation of futures contracts, and it would require those organizations that originate loans to carry a 5% interest in them--essentially putting them on the hook if the loans fail.  (I would suggest that a higher percentage interest would provide stronger incentives to write sound loans.)  It has an excellent proposal that would allow shareholders in public companies to vote on executive compensation packages, which would stop large company CEOs from looting their companies for their own profit.   Although I did not discuss these proposals, I agree with them and hope you too will support them on behalf of financial consumers.

 Taken together, these proposals represent something very like what consumer advocates (and those financial advisors who care about consumer protection) might have drafted.  In fact, precisely because it is likely to be effective, there will be proportionately vigorous opposition to the Regulatory Reform blueprint.  My guess is that most of the opposition will come from those firms whose business models are built on conflicts between their self-interests and the interests of their customers: the brokerage firms who recklessly (I would say greedily) led our financial system to the brink of collapse.  Please don't allow their self-interested lobbying efforts to override your concern for and protection of your constituents' best financial interests. 

Your friend,

 Buz Livingston, CFP® 

buz@livingstonfinancial.net