More On Legal & Compliancefrom The Advisor's Professional Library
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
SEC Chairman Mary L. Schapiro said at SIFMA’s annual meeting on Nov. 9 that the SEC will look closely at advisor compensation practices that may harm investors.
In particular, bank-wirehouse brokerage firms have used large up-front retention or recruiting incentives or loans that can amount to 300% of retail brokers’ trailing 12-month production. Advisors typically promise to stay for a number of years and work these payments off in the course of their production
It’s good for investors that the SEC is looking closely at this kind of compensation.
For investors, and for the financial services industry over the long term, these very high signing payments are injurious since, as investing is a zero sum game, the money to pay these bonuses comes from—wait for it—customers or clients.
These customers are part of the army of retail investors that pays the fees and commissions that enable the banks and insurance firms to pay 300% to brokers to pledge to stay on for some number of years.
These fees are also part of the money rolling around at the banks and insurers who bankrolled the financial services lobby last year and this one to fight financial reforms—to the tune of about $500 million. That’s half a billion dollars to fight reforms for problems caused by some of these same firms. Have a look at the analysis by John Bogle, founder of Vanguard, who has spoken so eloquently of the $600 billion in fees that annually go to the “financial-industrial complex.”
Individual investors, for the most part, don’t understand this at all, just as they don’t understand how much of their true cost of investing is hidden in fees layered into products created at some these same bank-wirehouses or insurers. These are fees that are outside of the commissions revealed on confirmations.
The SEC Chairman spoke on Nov. 9 about “Having a culture that puts the investor first, the integrity of the marketplace first, the integrity of the firm before profits.”
This editor is a member of the Committee for the Fiduciary Standard, which advocates that those who provide advice to individual investors should put investors first, as fiduciaries, as investment advisors do now under the Investment Advisors Act of 1940. The SEC is studying that issue now as part of Dodd-Frank financial reforms.
Schapiro said, in an interview with Charlie Rose, that regulators have been discussing “having compensation programs that incentivize the right kind of behavior and conduct on the part of the industry. We will be writing with our fellow regulators a series of rules in this area.”
Rose asked what’s necessary in this area; and Schapiro answered: “Clearly what’s unnecessary are compensation programs that compensate and incentivize people to take short-term risks at the expense…of the long-term franchise and at the expense of investors. So whether it’s how brokers who deal with retail customers are paid, with big up-front bonuses, or compensation for high levels of turnover in portfolios or senior management that’s compensated solely on the short term numbers—these are things that absolutely have to change.”
This is not the first time the Chairman has brought up compensation practices. In a letter last year to BD CEOs, she wrote: “Reports suggest some firms are offering substantial inducements to potential registered representatives, including large up-front bonuses and enhanced commissions for sales of investment products,” and Schapiro reminded them “of the significant supervisory responsibilities you have under the federal securities laws to oversee broker-dealer activities, particularly with respect to sales practices.”
SEC in a Unique Position
Acknowledging these conflicts is a big deal. The SEC is in a unique position to make rules that will positively affect the American investors who helped banks and insurers and their affiliated brokers to get back on firm footing through TARP and other emergency measures these past years—all the while these same individual investors felt the stinging drops in their retirement and other portfolios, and some have felt the lag in portfolio performance caused by layers of fees.
These high signing payments hurt the financial service industry in another way—they, of course, make it more difficult for brokers to move to the independent side of the business.
We encourage the SEC to be bold in their rulemaking and provide American investors with, as the Chairman said, “compensation programs that incentivize the right kind of behavior and conduct on the part of the industry.”
Chairman Schapiro was traveling in the UK on Monday and could not comment directly to AdvisorOne.com on this issue by deadline.