Tuesday, August 31, 2010

Upcoming Changes to Registered Investment Adviser Disclosures

The SEC and the States have come out with their joint effort on the Final Rule for Registered Investment Advisers known as IA-3060. This final rule has a couple of clauses in it that will dictate more disclosures for both Registered Investment Adviser firms and their Investment Adviser Representatives.

The firms will now have to explain the risks associated with what they primarily invest in for their clients. Form ADV II Part 2A (Brochure), Item 8.C. of the rule reads says "If you recommend primarily a particular type of security, explain the material risks involved. If the type of security involves significant or unusual risks, discuss these risks in detail."

In my case, I primarily recommend Exchange Traded Funds or ETF's. My interpretation of this clause is that I will need to provide a summary of the significant types of risks in detail. To me, this means a summary of items like Stock Market Risk, Country/Regional Risk, Emerging Markets Risk, Currency Risk, Index Sampling Risk, Interest Rate Risk, Income Risk, Credit Risk, Sovereign Debt Risk and Stock Exchange or OTC (Over-the-Counter) Risk. It also means that ETF's are not guaranteed or insured. This new disclosure requirement is good in that it makes people understand more about the risks of investing in general.

Another interesting item in the required disclosure for the actual person giving the investment advice. In the past, you did not have to disclose your disciplinary history unless your were an officer of a Registered Investment Adviser firm. Now, as a result of this new SEC rule, all disciplinary history will not have to be disclosed in writing in the Brochure Supplement. This is surely going to "separate the wheat from the shaft" so to speak. My experience is that there are numerous financial advisers and insurance agents who have had some type of complaint on their record. I personally will be curious to see how they explain themselves and their records going forward.

Also, there is a clause that says if you say that you have a financial designation to your clients, then you must disclose the requirements for obtaining that designation. This means the minimum qualifications to obtain the designation. Although this will also add more pages to the required disclosure Form ADV Part 2B (Brochure Supplement) for Investment Adviser Representatives, it will give the client the ability to look at the designation and see if it is "something of value" as stated in the SEC rule. The end result is that the Investment Adviser Representatives with financial designations will have more pages of disclosures than those who do not hold a financial designation.

All in all, these new items will be beneficial for clients who are looking at Registered Investment Adviser firms (Brochure) and their Investment Adviser Representatives (Brochure Supplement), although you may have twenty plus pages to read.

Friday, August 20, 2010

Why Do Bankers Rule the Mortgage Market?

There has been a lot of talk lately about what to do with Fannie Mae and Freddie Mac. Should the government get rid of them altogether? The banks say no. Have you ever wondered why they say no?

Currently, FHA guarantees loans including the very popular 30 year mortgage with as little as 3.5% down. When a bank loans you the money for a house, they turn around and package your loan with other similar loans and sell them on the secondary market. At this point, they become mortgage backed securities. In recessionary times, the government steps in and buys these mortgage backed securities, because the banks do not want to hold onto the responsibility of the loan in case of default. This is a situation where a bank has a financial incentive to sell the loan, but not to be responsible in case of loan default. In other words, they have no risk. If they have no risk, because of the government stepping in, then they have no incentive to do proper loan underwriting. Therefore, today, the banks are jumping up and down saying that they are not going to take the risk on 30 year mortgages. The banks are putting political pressure on Congress to continue to snap up these 30 years mortgages.

Now, let us examine this in a little more detail. What if the government quit stepping in on the bank's behalf? Then, the banks would probably not offer 30 year mortgages. If you could no longer get a 30 year mortgage, then what kind of mortgage could you get? Mortgage interest rates would temporarily go up, but if you look at things today, this will not really be a problem. If people are not willing to buy a house now with rates under 5%, then why would a bank think that people are going to rush out and borrow money at higher rates? They will not, believe me. However, once things settle down and the banks realize that they actually need the consumer to make money, then they will realize that they have to offer residential loans, like it or not.

Even if the banks do what they threaten to do and abandon the mortgage market altogether, I still believe that American Capitalism would take over and somebody would step up and offer 30 year mortgages. The banks are frankly too stupid to stand idly by and watch some other firm make the money on mortgages. Look what happened with credit default swaps. Once one bank starting making money with these instruments, then all the other banks followed suit. What did we poor consumers end up with? A bailout.

Personally, I do not think that banks should be allowed to underwrite a loan and pass off the risk. This is totally ridiculous. If they approve the loan, then they should keep the risk. Period.

Conversely, if banks take the risk, then they will underwrite the loans a little tougher. Yes, this means less people in housing and higher down payments, but this is the way it should be. There is no right to a house. I do not know about your neighborhood, but not too far from my house, there are some really nice apartments that are way better than anything that I ever lived in when I was younger. They have garages, exercise rooms, pools, whirlpools, saunas and even restaurants in some. Apartments are not so bad anymore.

This is a serious conflict of interest here when the bank can lend the money, but not be responsible for the loan. When did we agree to this? In reality, when we allowed the same people to stay in Congress for years and years. These terrible people have caused the problems that we are having today. Fat chance that these same people will do anything to fix it. They do not work for the American people. They work for the banks. It is patently obvious by now.

It may take an election or two, but we need to vote them out of office. It is really the only hope we have as Americans to get back control of our country.

Monday, August 9, 2010

Demand to See their Form ADV Part 2 (b) Brochure Supplement

The SEC has come out with their final rule on the much needed revamp of the Form ADV. In the past, a lot of pertinent background history could fall through the cracks as far as retail investors were concerned. Imagine if you received investment advice from someone who worked at a large Wall Street firm. Well, if this was the case, then the old Form ADV II did not have to disclose the background history of the person dispensing the investment advice. It only was a requirement to disclose the background history of the principal officers of the Wall Street firm. A glaring gap in disclosures that the SEC has now closed in conjunction with the states.

Now, with the new Form ADV, there will be a Part 2 (a) and a Part 2 (b). Both Parts will be in a new narrative form with easy to read language instead of the former check the box format. In addition, Part 2 (b) will be a new Brochure Supplement that will have to disclose the background of the person dispensing the investment advice to you.

Caution: If there are two people talking to you about investment advice in a meeting, then you should demand (that's right, I said demand) to see the Brochure Supplements of both people. If they only produce one Brochure Supplement, then this should raise a red flag with you. This might be indicative of one of the people giving you advice not actually being licensed, or they could be hiding their Brochure Supplement. Why would they do this? They may hide their Brochure Supplement because it contains their bad background. To get around this, they may bring to the meeting someone else in their office who has a cleaner background for disclosure.

I would be very concerned if someone whom you know to be insurance licensed is advising you to sell all of your investments in order to buy their annuities. Especially, if they do not produce a Brochure Supplement and instead produce a Brochure Supplement of someone else in the meeting or not in the meeting at all. First of all, an insurance agent who is not registered as an investment adviser cannot advise you to sell any of your investments without being licensed. It is against the rules of most, if not all, states in the country. Secondarily, doing business this way should raise a red flag with you. If they are hiding this, then what else are they hiding? Also, if they give you a Brochure Supplement of someone who is not even in the meeting, then I highly recommend not doing business with this firm. They are hiding something for sure.

Of course, it makes further sense that if an insurance agent is advising you to sell your investments to buy their annuities and they do not produce a Form ADV Part 2 (a) to Part 2 (b), then they are violating state rules and regulations in giving you that advice. You probably did not even know that.

Another thing to watch out for is if you only receive Form ADV Part 2 (a) and you do not receive a Part 2  (b) at all. This also is against these new SEC and state rules regarding full disclosure.

Even though, this new rule revolving around the new Form ADV Part 2 (a) and Part 2 (b) is a giant step forward, there are still reasons to stay on your toes. Now that these two Parts will be in a narrative format, it will be much easier to read and I would highly recommend that you do so.