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Regulation and Compliance > Federal Regulation > SEC

Who's in Charge?

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As the turf war between state and federal regulators rages on, industry officials are debating whether that competition is good for investors. Ron Rhoades, chief compliance officer and director of research for Joseph Capital Management in Hernando, Florida, is of the mind that competition “is healthy for consumers.” But Rhoades thinks that competition becomes dangerous when federal regulators attempt to preempt states’ authority to regulate the securities industry. “Federal legislators need to understand that fraud is pervasive, and state regulators need to be able to police the securities markets.”

Rhoades made his comments at the North American Securities Administrators Association’s (NASAA) public policy forum in Washington last month. Rhoades was part of a panel entitled Regulatory Reform and Consumer Protection: Striking a Responsible Balance. Also on the panel was Barbara Roper, director of investor protection at the Consumer Federation of America; Tom Herndon, a partner with Southern Strategy Group in Tallahassee, Florida; Arthur Wilmarth, professor of law at George Washington University; and Ralph Lambiase, director of the securities and business investments division of the Connecticut Department of Banking, who moderated the panel.

New York Attorney General Eliot Spitzer has beaten the Securities and Exchange Commission to the punch in uncovering fraud in the mutual fund, brokerage, and insurance industries. Herndon said that federal regulators are indeed “late to the dance” in cracking down on corporate shenanigans. However, recent fines by federal agencies against some firms may actually be having a positive impact because top officials are now being forced to dig into their own pockets, he said. “I’m glad to see [this]; the fines are an appropriate way to enforce the law.”

Fines Don’t Work

But Wilmarth of George Washington University believes the fines being levied aren’t big enough in some cases. “The intent of the penalties is to get some attention, but sometimes these firms don’t get it,” he said. Wilmarth cited Citigroup, for instance, which had to pay $5 billion to settle fraud charges. At the time the fine was levied, Chuck Prince, Citigroup’s CEO, scoffed that it was a mere quarter percent of the financial services behemoth’s earnings, Wilmarth recalled. “Can you really exert fines on these firms to make an impact?” he asked. “These banks and securities firms are huge and they affect market stability.” Wilmarth said Spitzer could have indicted more firms, but he was afraid of what that might do to the stability of the market. “The question is how do you really regulate these firms and get their attention?” he said. One way is to turn down merger applications, Wilmarth suggested, and also bring actions against the top officials. “I don’t see this happening.”

The Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS)–which have both been trying to preempt states’ authority for years–approved the recent mergers of Bank of America with Fleet as well as JP Morgan with Chase Manhattan Bank, despite the fact that all of the firms were named in the mutual fund scandals, Wilmarth says. “The OCC’s view is as long as there are no safety and soundness issues, we are pro merger,” he said. “This does not speak well for consumer protection.” Wilmarth added that state regulators have been uncovering fraud that bank regulators have overlooked because banks tend to focus on safety and soundness issues, not consumer protection. Moreover, Wilmarth said the OCC and OTS are “involved in deregulation,” and added that fraud became pervasive in the late 1990s “when Congress starved the SEC for money.” Lambiase with the Connecticut Department of Banking noted that some states are attempting to cap the size of penalties.

Ron Rhoades of Joseph Capital Management said the backlash from corporate misconduct is that it has “upped the risk for investors to invest in individual stocks.” Investors have lost a “tremendous” amount of confidence in the markets, he said. He cited a recent poll by the American Association of Retired Persons (AARP), which found that 62% of those polled believed there is dishonesty in the brokerage industry.

Bad Public Policy

The panelists were unanimously opposed to the SEC’s recent decision to exempt brokers from having to comply with the Investment Advisers Act of 1940, under the so-called Merrill Lynch rule. Rhoades called the ruling “bad public policy” and said that he’s “for fee-based accounts, but not when a fiduciary duty is not applied.” Roper with the Consumer Federation of America said the SEC was “speaking out of both sides of its mouth” with the ruling. “The distinction between a [broker and an investment advisor] has been erased everywhere except in our securities laws,” Roper said. “There needs to be a distinction,” she said, “because investors can not tell the difference” between an investment advisor and a broker.

Roper also noted that the SEC rule should not only require broker/dealers to adhere to fiduciary rules, but it should also require them to disclose any conflicts of interests they may have with clients.

In a separate interview, Rhoades told me that he thinks the SEC will study the “fiduciary issue, and whether it should apply to fee-based accounts.” He said the broader question the SEC must address is: Should fiduciary duties apply to anyone who gives financial planning advice? “We know that financial planners who are investment advisors are fiduciaries. Under what circumstances should brokerage firms–even if they’re selling on a commission basis–have fiduciary duties applied to them?” That’s a “real broad area,” he said, “and we’re going to see a lot of attention on the issue this year and next year.”

A positive development at the SEC, Roper said, is the fact that the Commission is testing its disclosures to see if investors understand them. Lambiase wondered whatever happened to a legislative proposal that was floated a few years ago that would have created an office of consumer protection at the SEC. The proposal never went anywhere, but Roper said it’s a shame because everyday investors aren’t afforded the same access to the SEC as the industry. “By the time an investor advocate comes to the table, the [SEC] rules have already been formalized,” she said. The NASD, on the other hand, “has done a much better job of reaching out to the investor.” Herndon agreed, and said investors “don’t have access to the SEC that the industry does. That has to change.” Moreover, Rhoades said the SEC should be hiring more consumer advocates than securities lawyers.

Washington Bureau Chief Melanie Waddell can be reached at [email protected].


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