Amid the hubbub over the potential for more regulation of the financial services industry arises an important question: whose interests are being served? The libertarian in me eschews restrictive oversight that smacks of social control, but the protective side wants to save the innocent from the fools and the crooks.
This tug of priorities came to light when I recently participated in an international forum in Prague sponsored by the Convention of Independent Financial Advisors (CIFA). My panel debated the pros and cons of allowing individual investors to make their own investment decisions without consequence to the advisor. The panelists were asked whether this was an unlimited right, and if not, when, and with what justification, should it be restricted. The moderator was Daniel J. Mitchell, PhD, a senior fellow at The Cato Institute.
With frustration building over spurious lawsuits and expensive compliance hurdles for investment professionals, an attitude of caveat emptor was clearly palpable with the idea that clients should know enough about personal finance to smell a problem before it happens. This seems quite different than the prevailing U.S. view.
The fundamental belief in each individual’s right to freedom resonates well with many Americans. Yet while social liberties have emerged in countries that used to be restrictive, legislators and some bureaucrats have become more involved in our personal and business lives with the blessing of both Democrats and Republicans.
While investors have the freedom to make unsound investment decisions, they may have to forfeit this right if they do not exercise appropriate restraint. When an investor’s actions and those of their advisors put others at risk or negatively impact confidence in the capital markets, we must act to protect the rest of us. We must also safeguard individual rights and try to avoid using the law as a substitute for individual responsibility.
Let’s look at the mortgage crisis. The scores of people who took out adjustable rate mortgages to buy homes they could not afford can be seen as victims of their own bad judgment. They were hurt when interest rates jumped, but many other people anticipated and avoided this risk. While we can blame the individual’s problems on his greed or ignorance, the truth is that all bad acts occurred with a financial professional watching and, in many cases, advising.
In our industry, we know of RIAs as well as registered representatives who, in order to get greater yield, placed clients into preferred shares of funds invested in auction rate securities that are now illiquid. We know advisors of all stripes who recommended mutual funds based solely on historical performance.
The negative headlines about the liquidity crunch and subprime mortgages reveal that no matter how doltish individual investors are, the entire financial services industry gets slammed when problems arise. Somebody who knew something should have done something! Moreover, the general marketplace, the media, and legislators do not differentiate between the different flavors of those who provide financial advice. Securities brokers, banks, financial planners, investment advisors, and wealth managers are all splashed by the muddy puddles of out-of-control investment vehicles.
The financial services industry contains multiple regulators and regulations depending on your business model. FINRA, the SEC, the OCC, and insurance and securities regulators in every state all touch us as either consumers or practitioners. The cost of compliance is probably the fastest growing expense in broker/dealer and registered investment advisory firms, and eventually these costs get passed on to the public.
New rules arise after critical events. The Great Depression spawned the Securities Act of 1930 and the subsequent Act of 1934. The Sarbanes-Oxley Act of 2002 emerged out of major corporate and accounting scandals such as Enron. The USA PATRIOT Act was created to intercept terrorists after the horrific attacks of 9/11.