Keating: The SEC and Breaking Trust

November 23, 2015

by Maryann O. Keating, Ph.D.

In times gone by, dress salesladies would often volunteer an opinion, at risk of losing a sale, if a garment were inappropriate for the buyer. This advice was generally welcomed, particularly when offered by someone who represented a similar taste in fashion. It was most likely to be sought and followed in male haberdasheries.

In many cases, conflict of interest exists and is recognized. We find ourselves going along with the recommendations of the individual self-employed plumber or dentist for expensive services. After all, the tooth aches now, or the basement is quickly filling up with water. Only a hasty check of comparable prices on the Internet suggests whether or not a quoted price is in the ballpark.

But consider employees of a firm in which the stated goal is making profit. As clients, are we consciously sabotaging this goal in requesting an opinion that is perhaps contrary to the interests of the firm? Are we necessarily forfeiting our own self-interest when we accept such advice? Oftentimes, buyers cannot gauge the quality and appropriateness of a good or service; trust becomes an issue in both market and professional transactions. In some instances, either for the sake of customer loyalty, corporate mission or morality, employers knowingly hire individuals who work on behalf of both firm and clients and who are recognized by clients as doing so. To paraphrase Marshall McLuhan, the behavior of the person is the message.

In times past, a respected stockbroker might call to suggest selling losers in your portfolio for tax purposes or note excess liquidity accumulating in your account. Of course, the broker would use the opportunity to recommend certain “opportunities” available in the market. One knew more or less how agents earned commissions, and were willing to accept, within a range, something less than the highest possible rate of return. Right or wrong, you felt that the broker would not consciously steer you into transactions inappropriate for your income and risk tolerance or indeed into instruments beyond your financial comprehension. Recently, we note a reluctance on the part of professionals to offer such advice.

There is certainly a distinction between the hustling sales broker and the financial adviser who acts in a client’s best interest. Stockbrokers have long been held to a standard whereby they are expected to hold up a standard with respect to the “suitability” of the financial instrument for the client. On the other hand, financial advisers are held to a higher “fiduciary” standard by which they are expected to put their clients’ interests ahead of the firm and their personal goals.

The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) tasked the Securities and Exchange Commission (SEC) with issuing rules concerning standards of conduct for brokers, dealers and investment advisers. At the same time, the U.S. Department of Labor is considering new guidelines for those who offer financial instruments related to individual retirement accounts. SEC Chairman Mary Jo White supports a tighter uniform standard for both broker-dealers and financial advisers recommending stocks, bonds and funds to individual investors. However, as of Nov. 10, neither the Department of Labor nor the Securities and Exchange Commission had yet to issue new rulings dealing with conflicts of interest between buyers and sellers of financial instruments.

The SEC chairman justifies this delay in terms of the time needed to ensure that new regulations do not result in unintended adverse circumstances. Of concern are the inevitable increased costs of providing client-centric advice. These additional costs could adversely affect small to mid-range individual saver-investors. Higher costs associated with providing additional financial services necessarily decrease returns to both the buyer and seller. It is possible, therefore, that certain specialized financial services will choose not to deal with individual saver-investors.

In some cases, clients may be willing to pay higher fees and accept lower returns to ensure the safety of funds set aside for retirement income. Other saver-investors, fully aware of conflicts of interest, like the freedom to seek higher returns on their assets. These private individuals, counting on competition between brokers and their known track records, wish to deal directly in the market, are willing to accept risk and do not value protective financial services.

There is an additional issue when individuals are inadvertently relegated to financial organizations, claiming to operate in clients’ interests but offering a limited range of options at higher cost. At issue is the level of financial expertise provided when the hallmark of the firm is consumer protection. Is it reasonable to assume that even well-intentioned advisers can keep up to date on every type of specialized financial service? Who, other than active saver-investors, watches those who are supposedly watching out for clients’ interests?

Theoretically, if wealthy, you could hire a personal assistant to ensure that each of your commercial and professional transactions is done in your best interest. Such an assistant may be well versed and operate in your best interest, but would he or she be an expert in law, medicine, plumbing and fashion? We are free to ignore our dentist’s advice on flossing daily for half an hour, but we assume at least that the dentist has some expertise in teeth.

In the end, paternalistic government regulations that determine the characteristics and types of experts with whom we may consult only deny us choice.

Maryann O. Keating, Ph.D., a resident of South Bend and an adjunct scholar of the Indiana Policy Review Foundation, is co-author of “Microeconomics for Public Managers,” Wiley/Blackwell.



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