John Lefferts' Blog

Thursday, October 29, 2009

Two Hats and Two Faces

The entire financial services industry has been waiting for what has been termed “sweeping” regulatory change for close to a year since the fallout of the financial crisis began. It reminds me of the old Heinz ketchup commercial set to the tune of “Anticipation”. You know the lyrics…”Antici-pay-ay-tion...It’s making me late…keeping me wa-a-a-iting”... while the commercial shows nothing coming out of the ketchup bottle as it is shaken. It kind of feels the same with regulatory reform. We’ve been shaking the proverbial regulatory bottle, but nothing is coming out. And there's been a great deal of anticipation. Finally this week, it appears that we’re at last seeing the regulatory bottle start to give us some drips.

Naturally, everyone is attempting to evaluate how changes will affect their particular business, whether they be SEC or State regulated advisors, B/D Reps, insurance professionals and financial planners. From comments made by Mary Shapiro this week, it’s clear we’re headed towards a harmonized and not watered down fiduciary standard for all who give investment advice. Isn’t this what the fee only advisor has been arguing for and the B/D’s have been fearing? Well…not really. The fee only crowd had thought that by fiercely arguing to keep to the highest fiduciary standard, it would somehow repel B/D’s and FINRA, the 900 pound gorilla that regulates them. The objective?...keep them separate and as far away from the advisory business as possible. But I'm afraid for them that this may have been a gross miscalculation.

While in New York recently, I visited a CEO of a large 12,000 registered rep organization to hear his perspectives on the regulatory issue among other things. I asked, “Aren’t you concerned about the effect a fiduciary standard will have on your field force?” His response may seem surprising except to those of us who have been under the thumb of FINRA for some time. He said, “As a large highly visible organization, we’re already held to the highest standard. A harmonization will actually give us a competitive advantage and make our business easier”. I’m fairly sure CEO’s and distribution heads of the country’s largest FINRA regulated organizations feel the same way. While on paper, one would assume that a fiduciary standard is more restrictive and consumer focused than the suitability standard of care, in practice, not so much. And so I don’t completely lose and offend my fee only friends, I’m not saying a fiduciary standard is a lower one, just that there is little in place to hold one accountable to that higher standard.

In the late 90’s, I headed an initiative to transist a national field force into fee based financial planners. This involved re-licensing and retraining an entire sales force numbering in the thousands, while changing their product offerings, compensation and recognition. Because the lawyers had an absolute fear of the field force holding themselves out as planners but really only acting as salespeople, our process built a Chinese wall between advisory activity (the planning) and the implementation of the plan (product recommendations). One would think that the fear would come from the SEC who is to hold investment advisors to the higher standard…right? Nope, the SEC was no where to be found. The fear was from FINRA which not only breathes down the necks of registered reps, but also rep’s who offer advice. A product recommendation (aka sale) couldn’t even be made until the client had signed off on a final plan which took up to 3 to 5 separate meetings, often resulting in no product implementation. In this sense, it was viewed that we were wearing two hats. First the investment advisory hat while planning, and then the Registered Rep hat while making product recommendations. But we all knew, the only regulatory body holding us accountable was FINRA for all our activities. And it’s my bet that the fee only investment advisor knows this. While RIA's will pontificate about not wanting to be watered down to a standard and regulator set up for salespeople, what they’re really thinking is how ominous it would be to have a regulator hold them to ANY standard. Enjoy the benefits of the public perception a higher standard gives, but have no serious accountability for doing so. It looks kind of two faced to me.

So, while the regulatory changes unfold, I think the impact will be far greater on the non FINRA registered RIA who heretofore has had very little accountability and not on the large FINRA regulated firms already held accountable to a very high standard. The FINRA rep’s will be happy to toss one of the two hats in favor one big hat. The challenge will be fitting that one big white hat on two faces.

Friday, October 9, 2009

Extreme Arrogance

Belief is a powerful positive force. It can open prior closed doors, bring out talents one may not have thought they had and can help overcome obstacles that previously seemed insurmountable. With such positive outcomes from belief, it's easy to believe to an extreme at the exclusion of all else. But in this world of ebb and flow, yin and yang, summer and winter, few things are absolute all the time, except, of course, death and taxes.

After a trip to Capitol Hill this week to meet with senators and congressmen about Financial Regulatory Reform, it is clear to me and others that the atmosphere is more polarized between Democrats and Republicans than ever before. An attitude of "if you're not for me, you're against me" prevails. All yin and no yang. Belief can be a good thing, but belief without humility can turn into arrogance and extremism. Extremism in politics, religion, business or really anything can be a powerful negative force. Perhaps it's my inherit skepticism that one can be 100% right, 100% of the time that has shaped my relatively moderate views on many things, including politics.

At this unique and transformational period of time in the financial services business, I see the same levels of extreme views being taken within the industry. Speaking with a congressman this week, he made the comment, "perfection is the enemy of the good". In other words, in our fight to make everyone see things perfectly and absolutely our way, nothing gets done. He also said, "in politics, civil war is fatal". By this, he meant that infighting should take place and be resolved behind closed doors and in private. Not doing so in a public civil war risks an outcome that no one can live with. In the effort to get the "I win-you lose" scenario, they end up getting the lose-lose. This is exactly what concerns me about the financial services industry as 26 year old staffers write and mark up legislation that will materially affect our business and livelihood.

With the issue of "harmonization" the lines seem to be drawn to one side being the SEC regulated fee only investment advisor-"don't associate me with a salesman" group, and the other being the FINRA regulated registered reps. While the FINRA RR group is concerned about how and when the fiduciary standard will be applied they have acquiesced to being held to a fiduciary standard. The SEC advisors seem to have taken the extreme position unwilling to bend in any way. In fact, one investment advisor was so bent about being remotely associated with a salesman that he wrote an article in this week's investment news espousing his extreme views.

He arrogantly infers that FINRA regulated rep's are akin to used car salesmen, and I don't think it was meant in a good way. Let's see,...there are roughly 650,000 FINRA registered reps and about 11,000 SEC regulated investment advisors. It has been cited that a full 1/3rd of all Ponzi schemes come from the RIA's. Simple math tells me that short of 2% of the population between the two are producing 33% of the Ponzi schemes. Does this mean that all investment advisors are crooks? No more than one can infer that all FINRA RR's are unprofessional used car salesmen. Each discipline has it's bad eggs and fortunately they both have far more professionals who are very good at what they do.

In hind sight, It's unfortunate that the various segments of the industry didn't work together before publically waging their civil war protecting their respective turfs. I'm hopeful that as uninformed much of congress is about this issue, that they'll be able to see through the arrogance of a vocal minority protecting their sacred "advisor" turf and find a win-win solution that meets the needs of the American consumer. And as importantly, that the minority of investment advisors who take the extreme view find some humility for the future credibility of the industry.

Friday, October 2, 2009

Be careful what you ask for...

After a summer of simmering and debate, the Financial Regulatory Reform is finally gaining some traction and showing signs of taking shape. Paul E. Kanjorski (D-PA) has prepared a draft piece of legislation authorizing the SEC to make and enforce "harmonized" rules. Apparently it imposes a "fiduciary duty for brokers, dealers, and investment advisors in providing personalized investment advice to act in the best interest of retail customers without regard to the financial or other interest of the broker, dealer or investment advisor who is providing the advice". The draft legislative language also empowers the SEC in other ways under this new standard of conduct by: (1) giving the agency authority to examine and prohibit sales practices, conflicts of interest and compensation schemes the SEC deems contrary to investors' or the public interest; and (2) increasing its resources and providing rulemaking authority for enforcement purposes.

This is the first piece of legislation to bring the highly anticipated regulation of Investment Advisors and Registered Reps under a single harmonized roof. As part of my financial services industry involvement (I'll be at the Financial Planning Assoc meeting in OC later in the month), I'm headed to Washington DC next week on behalf of AALU to get a better "finger on the pulse" of proposed regulation and perhaps influence some senators and congressmen with some more balanced points of view. I don't know about you, but the increased government involvement in everything has me more than a bit uncomfortable. While initially hopeful that an Obama election would bring needed change, it seems the only thing he has done is stick the governments fingers into everything we do with trial attorneys and labor unions in his back pocket. I think he is a gifted orator and has favorably changed the international perception my folksy neighbor "W" portrayed, but he has empowered certain politicians, as well meaning as they may be, who could be on the path to destroying the "American Dream" as we know it. I had hoped for better.

Without question, the regulations in the financial services industry are outdated, misaligned and in serious need of reform. I, along with others have been calling for better aligned regulations, not necessarily more. But in the "be careful what you ask for, you may just get it" department, I'm afraid in laying the responsibility for re-regulation in the hands of well meaning, but misinformed politicians, what we may get is worse than what we've had. A copy of a speech AALU sent me done by UK insurance producer Tony Gordon is very instructive and provides a window into what could be our future. His comment, "The greatest risk to your business today is government interference with it, excessive regulation." is more true now than ever. Try this link for the entire speech:

It provides insights into what the future could look like in the US as they have been more progressive with financial services regulation than we have been over the past decade. And it isn't pretty.

Yes, we need re-regulation and now is that time. But bigger and more is not better. In fact it is a potential nightmare scenario for the financial services industry and the American people it serves.
I'll write next week upon my return from DC about my perspectives. Stay tuned...