Speaking with almost anyone outside the field of finance, the mere mention of rules or regulations will almost invariably result in glazing eyes and a frantic glance for the nearest exit. Few realize the changes currently developing in the world of regulatory oversight; oversight not just confined to the financial industry. Fewer still realize these changes potential effects for the rest of the world.
Recently FINRA, the quasi-governmental regulatory body for the financial industry that is funded by financial firms, has solicited the Securities Exchange Commission for additional regulatory authority over investment advisors. This is an authority typically reserved for the SEC.
At the same time, thanks to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC has been narrowing the number of firms it will oversee. The agency has been changing its rules in order to shift many “smaller” firms to state oversight, though it plans to retain the right to examine those small firms. This means that while the SEC is shifting liability to individual states; it will still be able to poke through advisors’ records. And if something goes wrong, the SEC will still be able to point a finger at the states.
Finally, the Commodity Futures Trading Commission (CFTC) has been able to gain significant oversight of the newly-regulated derivatives markets through substantial lobbying by its Chairman, Gary Gensler.
Each of these developments, along with the new rules and regulations that will inevitably follow, will impact the financial world. But not the way most people think. The real issue at hand is whether more rules make the investment world safer from theft and fraud. The answer, of course, is that they do not.
In the 1970s there were far fewer rules than there are today, but a much higher degree of customer protection. The rules then focused on keeping crooks out of this industry, rather than making sure that they acted ethically.
Since then, entire manuals of rules have been written and re-written; and yet Bernie Madoff was still able to steal billions from his clients. In fact, despite these new rules an entirely new market was able to form and flourish in derivatives, finally collapsing in 2008 and losing untold trillions of dollars for clients.
While government bureaucrats focus only on rules and regulations, they fail to see that rules do not PREVENT fraud and more than speed limits PREVENT anyone from speeding. The same misperception is shared by many naïve investors who fail to realize that the sole purpose of regulators is to come in AFTER a crime, clean up the mess, and decide who to prosecute.
Instead of protecting customers against theft or fraud as hoped, new regulations will impact clients negatively. With each additional rule firms incur increasing costs of compliance, costs that will ultimately be passed on to the firm's clients. This can already been seen in firms like Morgan Stanley and Merrill Lynch, who have been punishing small accounts for years.
While the big firms detest small accounts, regulators continue to create an environment that is burdensome for small firms who would otherwise pick up the small accounts shunned by big Wall Street firms. What FINRA and the SEC fail to realize is that they are getting dangerously close to burdening many small firms out of business.
The real irony is that it wasn’t the small firms who cost clients trillions of dollars in the derivates meltdown, but Wall Street giants – which, by the way, regulators have done nothing to prevent from reoccurring. Meanwhile Goldman Sachs and JP Morgan continue business as usual, aside from the occasional multi-billion dollar settlement in civil suits from clients.
Of course, it must be purely coincidence that most regulators have little or no experience in finance before going to work for FINRA or the SEC, and that they work for these agencies to gain experience until they can get a job with a firm – maybe even one they previously oversaw. The fact that the big firms are also the biggest employers is simply a coincidence.
The real fraud being perpetrated here is not among firms who are portrayed as money-hungry villains, but regulators who sing their siren-song that increased regulation results in more customer protection. The fact is that they don’t care about customers; they’re only looking out for their own best interest. The more rules they have to write, the more job security they have.
Consider this: If regulators truly cared about investors, would they be focused on fighting for oversight of the multi-trillion dollar derivatives market that has been previously unregulated and will require hoards of new rules and expanded budgets, or would they be doing something to shelter investors amid the bankruptcy filing of Ambac, one of the world’s largest bond insurers?
Answer: Regulators aren’t really worried about client protection, but about wrestling for greater oversight authority that translates to increased job security. Leave it to government….
This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.