SEC Staff Study on Investment Advisers and Broker-Dealers

Click the link for the Study on Investment Advisers and Broker-Dealers.

http://www.sec.gov/news/studies/2011/913studyfinal.pdf 

Everybody has opinions and I am no different. The views expressed herein are the opinions of Rick Johnson.

It appears to me that the SEC Staff is biased toward keeping the status quo. They recommend against eliminating the broker-dealer exclusion from the definition of "investment adviser" in the Advisers Act. They also recommend against applying the duty of care and other requirements of the Advisers Act to broker-dealers. The SEC Staff apparently believes that what registered representatives do is essentially the same thing as what investment adviser representatives do. I for one, beg to differ.

Investment Advice from a Wall Street firm

If you as a client were to walk into a Wall Street firm for investment advice, you will most likely be sold some combination of these products:

Stocks
Mutual Funds
Bonds
Variable Annuities
Unit Investment Trusts

Let me delve a little deeper into why I do not think this is good for investors. Wall Street firms routinely buy large blocks of shares of stock that they in turn sell to their customers. They may have bought the stock that they recommend to you at $30, but sell to you as a recommendation at $35. As an investor, you may be misled into believing that all the Wall Street firm made from the stock recommendation was the $29.95 they charged in trading commissions. Did you know this?

When mutual funds are recommended, in a lot of cases, the Wall Street firm recommends a favorite set of mutual funds. Technically, their compliance department only approves a limited number of mutual fund families that their registered representatives can recommend. Wouldn't you know it, the stock mutual funds that they recommend have a 5.75% sale commission on them.

When a Wall Street firm sells you some bonds, they charge a markup. Legally, they can charge you up to 5% markup on the bond. You as the investor do not see it, because it is built into the price of the bond. For example, if a bond's price is 100 to the Wall Street firm, they may sell it to you at 102.50. The registered representative usually doesn't bother to tell you this when he is recommending it. Most of the time, the registered representative probably does not even know what his Wall Street firm is making on each bond. However, I can guarantee you one thing. They are making money on the bonds they sell to investors.

Variable Annuities carry high commission charges and ten years or more surrender penalties. Oh, I almost forgot. They have high expenses, too. Did you know that you could pay a registered representative 6 to 8% in commissions if you buy a Variable Annuity from them? Did you know that there are Variable Annuities with no sales charges, no surrender penalties and low expenses? I wonder why your Wall Street firm registered representative did not tell you this?

Personally, I cannot stand to see Unit Investment Trusts in an investor's portfolio. Right away, I know that the investor may be locked into this investment for a period of time and there may be significant restrictions on selling the UIT as they are called. Most of these UIT's have a sales commission of 3.95% or so. They may defer some of it, because after all, they know that their investors are locked in to the investment anyway. This does not seem like much of a benefit to investors to me.

Strangely enough, I searched the entire SEC Staff Study and could not find one reference to quotas. Each Wall Street firm's registered representative has what is known as a revenue quota, or "nut to crack." This was an egregious omission in my opinion. Most of the large Wall Street firms require their registered representatives to produce $250,000 to $300,000 in revenue for the firm. How do they do this? By selling investors stocks, mutual funds, bonds, Variable Annuities and Unit Investment Trusts. It is really very simple to understand. Registered representatives for Wall Street firms have to produce revenue to keep their jobs. As a result, they sell products that make them the most revenue, not because they want to, but because they have to, otherwise they risk losing their job. Before you start feeling sorry for them, ask yourself "How does selling me products that pay high commissions benefit me and my goals, needs and objectives?" The truth is that it does not benefit you. It benefits the Wall Street firm first and their registered representative second. Investors are third on that list, unfortunately.

The last sentence of the Executive Summary of this SEC Staff Study says, "The Staff developed its recommendations with a view toward minimizing cost and disruption and assuring that retail investors continue to have access to various investment products and choice among compensation schemes to pay for advice." If you analyze this statement with with I just explained above you will see that the SEC Staff believes it is okay for you to be sold various investment products, (described above) choice among compensation schemes to pay for advice. (I think they mean commissions and fees.) I am curious as to their use of the word "schemes" in that sentence.

They are right about the investors having a choice. You can refuse to do business with any Wall Street firm whose first priority is themselves. This includes Banks who own most Wall Street firms today, too.