The SEC Comes Full Circle with Retail Investor Protections
Issues to watch as Securities and Exchange Commission regulators train their sights on retail advisers.
This article is brought to you by Duff & Phelps. It originally appeared in the 2018 Middle-Market Trends Report.
In September 2017, the Securities and Exchange Commission revealed an important business and enforcement goal: the establishment of a retail strategy task force that would focus exclusively on the protection of individual investors—an effort that has, in many ways, brought the commission full circle.
Joseph Kennedy, the commission’s very first chairman, said it best. The “cards have been stacked too close to those who have power,” he said. “The federal government is the only power which can assure to the buyer that he is purchasing gold value and not gold bricks.” The current chairman, Jay Clayton, echoed Chairman Kennedy’s sentiments: “There is no room for someone who ruins somebody else’s life using the capital markets.”
It is obvious that investment products and risks have changed significantly since Chairman Kennedy warned against the sale of “gold bricks.” So what issues can we expect regulators to examine in today’s markets as they train their sights on retail advisers?
In an October 2017 speech, the commission’s co-chief of enforcement, Stephanie Avakian, offered a clue. “Issues in this space are extensive,” she said, “and often involve widespread incidents of misconduct, such as charging inadequately disclosed fees, and recommending and trading in wholly unsuitable strategies and products.” She identified the following additional areas of concern:
Inadequate disclosure and suitability are hardly new offenses; why, then, does it seem that retail fraud is more common than ever? One reason, ironically, is the Dodd-Frank act.
- Steering customers to mutual fund shares with higher fees, when lower-fee shares of the same fund are available.
- Buying and holding products like inverse exchange-traded funds (ETFs) for long-term investment, when they are generally used as a temporary downward hedge.
- Selling structured products that fail to fully and clearly disclose fees and other factors that can negatively impact returns.
- Churning and excessive trading that can generate large commissions at the expense of the investor.
Inadequate disclosure and suitability are hardly new offenses; why, then, does it seem that retail fraud is more common than ever? One reason, ironically, is the Dodd-Frank Act. It essentially directed the SEC to de-register all small (primarily retail) advisers and leave regulation to the states, where oversight and enforcement practices are inconsistent, unreliable and resource-constrained.
But Dodd-Frank got it backward. Rather than requiring registration of all the largest advisers, Congress should have required oversight of all the smallest managers, since institutional investors are generally more capable of detecting fraud and mismanagement than are “Mr. & Mrs. 401(k),” as Chairman Clayton calls them.
In 1934, President Franklin Roosevelt signed into law a bill that vested a new agency with the responsibility of instilling confidence and fairness into the securities markets. As he signed, the president asked, “Now that I have signed this bill and it has become law, what kind of law will it be?” An aide replied, “It will be a good or bad bill, Mr. President, depending upon the men who administer it.”
Prioritizing the protection of Main Street investors answers President Roosevelt’s question affirmatively: The bill creating the Securities and Exchange Commission is a very good one indeed—as measured by the men, and now women as well—who are administering it.
This article originally appeared in the Middle-Market Trends Report addition of Middle Market Growth. Find it in the MMG archive.
Rosemary Fanelli is a managing director and chief regulatory affairs strategist for Compliance and Regulatory Consulting at Duff & Phelps. She joined Duff & Phelps in January 2016 as a result of Duff & Phelps’ acquisition of CounselWorks, a firm she cofounded and ran for almost 10 years.
