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On Dodd-Frank’s 2nd Birthday, Should Investors Celebrate?

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If the Dodd-Frank Act, passed two years ago, on July 21, 2010, was meant to send a jolt of increased responsibility through the financial services industry, recent developments suggest any success has been fleeting, and the basis for renewed confidence in Wall Street or its regulators hard to find. Take, for instance, the Facebook IPO fiasco and the JPMorgan ‘Big Whale’ trades, now estimated to cost the firm $6 billion, or The New York Times’ expose on JPMorgan’s successful campaign to sell high-priced proprietary products. The growing LIBOR debacle is the newest pimple on the industry and regulators.

In fact, the law firm Labaton Sucharow recently released a survey of 500 senior executives in the United States and England, and found that 24% of the respondents said they believed financial services professionals may need to engage in unethical or illegal conduct in order to be successful. 

On Dodd-Frank’s fiduciary standard status, the issue Congressman Barney Frank called the most important requirement for individual investors in Dodd-Frank, the SEC has yet to propose a fiduciary rule to require broker-dealers to meet the fiduciary standard when providing investment advice. Separately (and not part of Dodd-Frank), the Department of Labor withdrew its proposed fiduciary rule in September 2011. 

Elsewhere in the Dodd-Frank legislation, 221 rulemaking deadlines have passed as of July 2, according to the law firm Davis Polk; 81 (37%) of the deadlines were met and 140 (63%) were missed. While a batting average of .370 in baseball is great, not so much in regulatory rule making. 

A new group comprising former Republican and Democratic public officials and regulators, the Systematic Risk Council, has formed to oversee Wall Street and advocate for regulatory reform. The group is led by Sheila Bair, the former chairwoman of the FDIC. Its mission is clear, “The great challenge is to devise a system to identify risks that threaten market stability before they become a danger to the general public,” Bair explained to The New York Times business columnist Floyd Norris, and she concludes, “Nothing has been finalized” in many areas.”The public is becoming cynical about whether the regulators can do anything right, which is undermining support for reforms.” 

Bair’s concerns over the public’s cynicism are merited. Even before a single Dodd-Frank provision became law, research suggested the public was already robustly skeptical of the legislation and its implementation. A peek into the public mind in July 2010, from a Bloomberg poll (July 9–12) is revealing. 

Bloomberg asked, “Is it your sense this legislation (Dodd-Frank) does more to protect the financial industry or more to protect consumers?”  By 47% to 38%, respondents selected the “financial industry.” Will the new rules require Wall Street banks to make “major changes,” “minor changes,” or “very little if any change?” Sixty-nine percent believed that the Wall Street banks would only have to make “minor” or “very little if any change,” while only 21% chose “major changes.” Finally, how confident were Americans that Dodd-Frank would prevent or seriously soften the impact of another financial crisis?  Just 18% were “very” or “fairly” confident, while 79% were “somewhat” or “not” confident. 

So how has this public mood revealed itself in investors’ views of brokers or investment advisors? The Gallup Poll annually measures consumers’ views of the “honesty and ethical standards” of different professions. (Investment advisors are not included.) Results reported in December 2009 and 2011 suggest stockbrokers and car salesmen remain steadfastly at or near the bottom of the professions that are viewed “very high” or “high” in terms of “honesty and ethical standards,” at 9% and 6%, respectively, in 2009, and 12% and 7% in 2011. As a comparison, nurses (83%, 84%) and medical doctors (65%, 70%) rank at the top of the 21 professions rated. (See the 2011 results of the Gallup Poll on professions here.

Investors’ trust in the stock market and banks has not been bolstered by Dodd-Frank, at least according to the Financial Trust Index. Between June 2010 and March 2012, consumer trust in the stock market has decreased from 18% to 15%, while consumer trust in banks has decreased from 39% to 32%. (The Chicago Booth/Kellogg School Financial Trust Index is a measure of confidence Americans have in the private institutions in which they can invest their money.)

How, if at all, are investor’s views reflected in client asset movements from wirehouses to independent broker dealers and registered investment advisers? While not a direct comparison, during an approximately similar time period (2010-2013) Cerulli researcher Scott Smith predicts that the market share movement in assets will change significantly. Cerulli projects the wirehouses will continue their downhill slide, with their market share as measured by client assets falling from 43% to 35%, while client assets at independent BDs and RIAs will increase from 27% to 32%. Within these data, the RIA market share increase stands out. RIAs will have the largest percentage point increase in assets over that period, Smith projects, from 11.6% to 14%.

The message:  Intermediaries that are required to meet the fiduciary standard will experience the largest growth in market share. Intermediaries generally not required to meet the fiduciary standard and most associated with practices (hidden fees) and products (proprietary) that are most at odds with fiduciary practices and putting clients’ interests first, are, according to Gallup, viewed poorly regarding their “honesty and ethical standards.” These intermediaries are also experiencing the greatest decline in market share.   

In certain respects, individual investors have responded rationally. They have not witnessed dramatic regulatory changes favoring investors, and their assets continue moving toward fiduciary advisors. They seem to have concluded that, at best, Dodd-Frank really does not matter. They believe its rules favor Wall Street and they know, as does the rest of the world, that wrongdoing and abuses on The Street seem to continue unabatedly. Simply put, Dodd-Frank is not regulatory “reform” that merits investor trust. 

It need not be this way. Former SEC Chairman Arthur Levitt testified about the vital role of enforcement before Congress in October 2008, “The unthinkable has happened: we are in the worst market crisis I have seen in my 40-plus years in and around the markets…Enforcement is so important because it holds people accountable and serves as a powerful deterrent to bad behavior … Indeed, the signals the SEC can send to investors are critical. By bringing a tough enforcement action, making a well-timed public statement, or taking action on a critical need, the SEC builds the investors’ confidence that someone is looking out for them which, in turn, builds market trust.”  

A fair question from investors, as Dodd-Frank turns two, might be whether any entity—be it a government agency or NGO—is up to the task of regaining the trust of the market by crafting and enforcing reasonable regulations, i.e., the fiduciary standard under the Investment Advisers Act of 1940 for those rendering investment advice. Time will tell.      

More on Dodd-Frank’s anniversary:

A Treasury Department official this week provided the Obama Administration’s opinions on why Dodd-Frank is working.  

The fate of Dodd-Frank may well rest upon the results of the 2012 election, AdvisorOne’s Melanie Waddell reports.


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