Congress’s Answer to Consumer Protection: Make Everybody a Wall Street Broker

On April 25, 2012, Rep. Spencer Bachus of AL and Rep. Carolyn McCarthy of NY introduced a bill which, according to the accompanying press release, would enhance consumer protection in light of the 2008 market meltdown that took the U.S. economy to the brink of collapse, and the Bernie Madoff scandal.

The solution: expand the regulatory authority of the organization that currently regulates Wall Street brokers. Make all who give investment advice answer to the organization that allowed Wall Street to sell trillions of dollars of toxic mortgage pools and derivatives, and which once had Bernie Madoff sit on its board of governors.

In other words, create a world where all advisors become brokers, and eliminate consumer access to independent, objective advice.

The Bachus-McCarthy bill, also known as the Investment Oversight Act of 2012, talks about enhancing the protection of financial consumers by allowing the Securities and Exchange Commission to delegate its oversight of many thousands of independent registered investment advisors to a self-regulatory organization. As many press reports have pointed out (see links below), the self-regulatory organization would be the Financial Industry Regulatory Authority (FINRA), the regulator that oversees Wall Street, and which has Wall Street executives sitting on its board of directors.

FINRA is the same organization that was in charge of policing Wall Street when the 2008 scandals broke. Bernie Madoff was under FINRA jurisdiction for his entire career (including its predecessor organization, the National Association of Securities Dealers or NASD), served as a member of the board of governors of the NASD in 1984, and on numerous committees. His brother and business partner, Peter Madoff, was elected vice chairman of the NASD in November 1992. FINRA’s lack of oversight continues. Joel Blumenschein, a member of FINRA’s Board of Governors, resigned. Last week, Blumenschein, president of Freedom Investors, Inc., was fined $30,000 and suspended by FINRA for allegedly failing to supervise one of his company’s brokers, Gary Gossett. The complaint claimed that Gossett made “a series of unsuitable penny stock trades in the retirement account of a customer of limited means,” without the customer’s permission. FINRA described Freedom Investors, Inc.’s oversight system as “so inadequate that Blumenschein was unable to provide a consistent or coherent description of it.” FINRA also claimed in the settlement that “his testimony, under oath, was at times both evasive and contradictory, thus highlighting the system’s inadequacies.”

We do not support handing over expanded regulatory authority to an organization that failed to prevent the flood of toxic mortgage pools, the sale of derivatives and sat by unconcerned while the Madoff Ponzi scheme continued for decades.

The real agenda of the bill is very clear: to give Wall Street (through its regulatory arm) control over its most persistent competition: independent advisors who, in contrast to the Wall Street sales culture, put the interests of their clients first when giving financial advice. At a time when Wall Street’s credibility is at its lowest ebb, when consumers are walking away from the opportunity to send their retirement dollars into the bloated brokerage industry bonus pools, the preferred solution is not more transparency, not changing the culture to put the consumer’s interests first, but to create a new regulatory overlay on the competition and bury it in paperwork.

In fact, when the Boston Consulting Group evaluated the expected cost of FINRA regulation on registered investment advisors, it concluded that the cost would be $51,700 a year in additional expenses for the average independent advisor. This is more than twice as much as it would cost to develop enhanced oversight by the Securities and Exchange Commission. (See the link below for more detail on the numbers.)

There are other ways to estimate the cost differential. FINRA (as mentioned earlier) is not exactly transparent about its salary structure, but public records show that current SEC chairperson Mary Schapiro’s base salary as FINRA CEO came to $3.2 million a year–plus a $9 million bonus payment she received when she left to join the SEC. (We only know this because a number of news outlets filed Freedom of Information Act requests that were vigorously resisted before the data was finally handed over.)

Schapiro’s current salary at the SEC: $163,000 a year. If we simply compare that with her base salary at FINRA, without including the bonus, it would appear that FINRA regulation would be a remarkable 19 times more expensive than the SEC as a regulator of RIA activities.

There is reason to think this is a low estimate. In 2009, FINRA collected over $700 million in regulatory fees, user fees, dispute resolution fees, transparency services fees, and contract services fees. In the same year, FINRA’s leadership used the dues collected from its members to pay its top ten executives $11.6 million, to spend over $1 million lobbying Congress and the SEC (do regulatory organizations engage in lobbying activities?), and to spend undisclosed amounts on advertisements in The Washington Post and on CNN touting its record as a regulatory body. In 2008, eight FINRA executives received more than $1 million in compensation and benefits, and the top 12 most-compensated employees received more than $24.8 million. One might fairly question the organization’s rigorous stewardship of dollars allocated to regulatory efforts.

In addition, consumers and members of the press might be astonished at how little transparency FINRA operates under.

To take a recent example, just last year, Amerivet Securities president Elton Johnson (a former Green Beret) managed to get seven proxy votes onto the agenda at FINRA’s 2010 annual meeting. These initiatives would, among other things, have required FINRA to do things that any guardian of the public interest would normally do as a matter of course: tell us the compensation paid to its ten most highly-paid employees, disclose FINRA’s investment transactions to members and the public, and open up its board meetings or at least provide transcripts of the discussions among Wall Street executives and others who currently (this, to me, is amazing) make the organization’s decisions in secret.

All seven of these initiatives passed overwhelmingly, garnering more than two-thirds of the membership vote, some more than 80%. The FINRA board of directors debated these measures in a closed meeting, and decided to reject them.

There may be significant conflicts of interest in the way this legislation was crafted and produced. It has long been clear that Rep. Bachus speaks as a proxy for FINRA on the subject of “enhanced” regulation, and I don’t think anybody close to the profession can see this as anything but a way to let FINRA take over regulation of the fiduciary RIA profession. The press release accompanying the legislative proposal goes so far as to praise the diligent regulation of broker-dealers and the lax regulation of RIAs. I think this one line offers particular insight into where this legislation is coming from:

“Customers may not understand the different titles that investment professionals use but they do believe that ‘someone’ is looking out for them and their investments. For broker-dealers that is true, but for investment advisers, it is all too often not true and that must change,” concluded Chairman Bachus.

In other words, the RIAs, who are required by law to live up to a fiduciary standard (and put their clients’ interests first in all advice-giving) are the bad guys in the marketplace, who must be watched much more vigilantly, while the brokerage firms (which have resisted registering their brokers as RIAs and thus evading this tougher standard behavior) are the good guys who protect consumers.

This, of course, is taken straight from the mouths of FINRA and SIFMA (the brokerage industry’s lobbying group), and it is not hard to find out why this particular legislator has been so persistent on this subject. When you look up where the lobbying money has gone, you find that Rep. Bachus’s top ten contributors include commercial banks (a total of $213,650 in 2011-12), insurance companies ($191,010), securities and investment firms ($184,277), finance/credit companies ($90,438) and “miscellaneous finance” ($89,250). In the 2011-2012 election cycle, he was the number one fundraiser from commercial banks, from finance/credit companies and from mortgage bankers and brokers. (All of that can be found here: http://www.opensecrets.org/politicians/industries.php?cycle=2012&cid=n00008091&type=I&newmem=N)

Beyond that, Rep. Bachus has been accused of a peculiarly Wall Street crime: insider trading (see link below).

When you connect the dots on this piece of legislation, it becomes frighteningly clear that the actual agenda is something very different from consumer protection. Yet unless the public learns about this power grab by Wall Street just a few years after it brought the economy to its knees, consumers may find themselves living in a world where everybody who gives investment advice is a broker, and regulated like one.

The SRO would be FINRA: http://www.financial-planning.com/blogs/veres-sro-sec-finra-2678577-1.html

http://www.investmentnews.com/article/20120425/FREE/120429948#

The excessive cost of FINRA regulation: http://www.fa-mag.com/fa-news/9412-rias-back-sec-as-regulatory-body.html

http://www.financial-planning.com/news/finra-sro-napfa-2678574-1.html

FINRA’s regulatory effectiveness (or lack thereof): http://registeredrep.com/advisorland/opinion_finra_is_an_ineffective_regulator_1006/

FINRA’s lack of transparency at the board level: http://www.dailymarkets.com/stock/2010/06/22/finra-owes-america-answers-on-these-proposals/

http://newsandinsight.thomsonreuters.com/Legal/news/2011/02_-_february/court_refuses_to_dismiss_lawsuit_demanding_finra_transparency/

Rep. Bachus insider trading scandal: http://www.washingtonpost.com/politics/rep-bachus-faces-insider-trading-investigation/2012/02/09/gIQA21Ui2Q_story.html

Do brokerage industry representatives actually sit on FINRA’s board of governors? Here’s a list of the current board of governors: http://www.finra.org/AboutFINRA/Leadership/P009756 Among others, you find representatives of Morgan Stanley Smith Barney, LPL Financial, Deutsche Bank and Edward Jones.

But look more closely at some of the “public” members of the board of governors. John Schmidlin, who is listed as a member of the consuming public, is the former chief technology officer and managing director at JP Morgan Chase (http://www.harlemacademy.org/about/board-trustees). Richard S. Pechter, another member of the consuming public, is actually former CEO of Donaldson, Lufkin & Jenrette, and chairman of the board of Credit Suisse USA. (http://investing.businessweek.com/research/stocks/private/person.asp?personId=12665753&privcapId=165284&previousCapId=23021&previousTitle=SONY%20CORP-SPONSORED%20ADR) Kurt Stocker was chief Corporate Relations Officer of Continental Bank Corp. (http://investing.businessweek.com/research/stocks/people/person.asp?personId=11713969&ticker=NYX:US&previousCapId=3777896&previousTitle=Rensselaer%20Polytechnic%20Institute ) “Public” governor William Heyman is the former Chairman of Citigroup Investments, and Executive Vice President of the Travelers Companies.

This was taken from a recent press release received.

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