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U.S. Securities and Exchange Commission

Speech by SEC Commissioner:
Remarks Before the National Association of Securities Professionals 1st Annual Legislative Symposium


Commissioner Roel C. Campos

U.S. Securities and Exchange Commission

Washington, DC
March 29, 2006

Good Morning. I hope you've all had your first cup of coffee and are ready to get started. Before we do, however, I'd like to thank Linda Jordan, Cheryl Marrow and Donna Simms Wilson for inviting me to join you this morning. I find it particularly important as well as satisfying to participate in events like today's conference. The importance of involving all members of society in the financial community cannot be underestimated. The need stretches across race, gender and age. The reason for this stems from the dynamic created by including all facets of society and the various experience and knowledge everyone has to offer. In other words, this is more of an endorsement of the melting pot theory to produce the best soup than the notion that too many cooks spoil the broth. To limit one self to tried and true resource pools because of familiarity risks opportunity losses. Such short-sighted thinking is antithetical to the notion of entrepreneurship, commerce, capital and growth. In today's fast paced, electronic world, the closed mind, stuck in its antiquated rut, is the loser.

Which leads me to the notion of change and the topic of today's conference: What's at Stake for Securities and Financial Services Firms in a Changing Regulatory Climate. In the interest of sticking to the agenda, I'd like to spend some time discussing two recent rule makings that have the potential to alter the business of the financial sector: the Commission's proposal on point of sale disclosure and the Commission's rule on broker-dealer exemptions from the Advisers Act. I'd like to conclude my remarks with a few comments regarding the importance of diversity in the financial sector and the need to think outside the box.

Before I go further, I must remind you that the remarks I make today are my own and do not represent the thoughts of the Commission or my colleagues.

Now, let's turn to the Commission's proposal on point of sale disclosure and the way in which it could change current industry practice for the better.

Point of Sale Disclosure.

The Commission's point of sale proposal is an initiative that would help investors in mutual funds, variable insurance products and 529 plans better understand - before they buy - what they are paying for and whether their brokers have conflicts of interest.

I'm sure we can all agree that customers should base their investment decisions on solid information. Whether an investor is guided by a salesman's recommendations, or is largely self-directed, the investor should understand what he or she is buying. Regrettably, the Commission's investor outreach has underscored that many retail investors who buy mutual funds, 529 plans or variable annuities do not clearly understand the layers of costs associated with those products. Also, many retail investors do not clearly understand their brokers' financial stake in selling those products, including so-called "revenue sharing" arrangements.

We have a number of potential solutions to this problem. Many industry commenters who responded to the Commission's 2004 point of sale proposal or 2005 supplemental release have emphasized that mutual funds already are required to produce highly detailed prospectuses. The problem, they say, is that investors do not read those prospectuses, although they disagree as to whether that is the fault of the prospectus requirements or of the investors. Those are important points, and we are looking at ways to improve mutual fund prospectuses. We may be able to build on the model provided by fund profiles - which funds are permitted to issue but largely have not pursued - to construct a slimmed-down mutual fund prospectus that will be more useful to investors. This, of course, would be a longer-term initiative.

Moreover, it would not be a substitute for brokers who sell mutual funds and related securities to help ensure that the customers know what they are buying and the broker's stake in selling it. Even the most idealized prospectus cannot specify the full range of costs that an investor can expect to incur, based on his or her particular investment, the way that brokers can. Prospectuses cannot identify fees or compensation arrangements that are unique to the brokerage firm, including payments that particular brokerage firm may receive by special arrangements, and brokerage's own arrangements for compensating its sales personnel. When those arrangements lead to special incentives to sell particular funds, investors should be alerted to them.

More fundamentally, there always will be a partial disconnect between the written prospectus and the fact that many if not most sales efforts are spoken rather than written. In short, brokers must play a critical role in getting key information to investors before they buy.

In developing point of sale disclosure requirements, we can build on what we have learned in talking to investors and reading hundreds of comments. We know that, often, "less is more" when it comes to disclosure. Simple disclosure - whether written or oral - that sets forth a few key facts and concepts can be more effective than disclosure that seeks to be more comprehensive. Moreover, we have learned that investors want "one stop shopping" through a snapshot about all the costs they will incur, rather than focusing only on distribution costs. Another result of our outreach - which I doubt will be surprising to many of you - is that lawyers often have trouble drafting "Plain English" disclosure documents. But with some help from consultants, we think we are now well on the road to figuring out how to give people information they can understand and use effectively.

What should be in point of sale disclosure?

Our investor feedback shows that customers want disclosure of information about both sales loads and ongoing fund expenses at the point of sale. While standardized disclosure appears to be effective and efficient, there should also be a mechanism to provide investors with personalized disclosure upon request.

Investors also want to be alerted to conflicts of interest facing their brokers, and to have the opportunity to access additional information. Point of sale disclosure can serve that goal by alerting investors to three key conflicts of interest: (a) "does the brokerage receive special compensation for selling the fund, such as so-called 'revenue sharing'?"; (b) "does the brokerage favor the sale of particular funds by paying differential compensation to their sales personnel?"; and (c) "is the brokerage affiliated with the mutual fund complex?" The Internet can be used to supplement that information to permit interested investors to see more details about compensation arrangements and conflicts.

We recognize, as industry commenters have pointed out, investors should not buy mutual funds on cost alone. The goals and risks of a fund also are important, and investors should consider how those aspects of the fund correspond with their personal investment goals, expected holding periods and ability to tolerate risk. The most suitable security for an investor may not be the lowest cost security.

While registered representatives already have an incentive to describe information about investment goals and risks, as well as past performance, as part of their marketing process, rulemaking may be necessary to assure that cost and conflict information is consistently provided at the point of sale.

How should point of sale information be disclosed?

We also are carefully evaluating how customers should receive point of sale information. Many industry commenters supported an Internet-focused disclosure approach. We agree that the Internet should be an integral part of the delivery mechanism. For example, brokers can use the Internet to access the up-to-date cost information that they provide to investors. Vendors might effectively provide this information. We also have learned that customers in general are more interested in the costs they will pay than in their brokers' compensation. As a result, the Internet could be used as part of a layered approach by which all investors are informed of the existence of revenue sharing and other conflicts at the point of sale, and interested investors can use the Internet to see quantitative information about the payments that broker-dealers receive from fund families.

At the same time, can we really conclude that Internet access is the alpha and omega of customer protection? For example, when a representative sells a mutual fund to an investor over the telephone, can we be confident that the investor will in fact have practical access to information if it is available on the Internet? Because most mutual funds are sold over the telephone, this is a critical point. We have to consider the prospect that any approach that forces investors to halt the sales process, walk away to find information on the Internet, and then later resume contact with the representative would not be well tailored to complement the way funds are sold. Internet availability by itself is not enough to give investors effective access to information about fund costs and about broker-dealer compensation and conflicts of interest when talking to a salesperson.

It may be more effective to follow an approach that makes disclosure an integral part of the sales process, by requiring registered representatives to provide summary cost and conflict information over the telephone when they sell over the telephone. For those sales, the Internet can supplement oral disclosure, such as by having the representative e-mail a link to point of sale information available on the Internet, when feasible. Obviously, oral disclosure has limitations. We simply cannot expect people to retain as much information when they hear it over the telephone as they do when the see it in writing. Accordingly, they may be merit in requiring brokers to make reasonable efforts to supplement oral disclosure in writing, such as through e-mail or fax.

Nonetheless, there may be no substitute for broker-dealers communicating point of sale information to customers when they sell the mutual fund in the same way they make their sales efforts.

Compliance and cost concerns

The industry has pointed out that oral point of sale disclosure could lead to some "he said/she said" situations, in which a customer denies having received point of sale disclosure prior to a fund investment that lost money, while the broker-dealer contends it did provide disclosure. We recognize those concerns, if not addressed properly, have the potential to lead broker-dealers to make changes that would slow down the sales process, or incur excessive compliance costs that in large part would be passed on to investors.

One possible way to address those concerns would be to focus the key compliance question on whether the broker-dealer has adequate procedures in place to reasonably assure that investors receive point of sale disclosure, rather than making the broker-dealer liable for occasional inadvertent errors. For example, for telephonic sales, a broker-dealer's reasonable procedures might consist of electronic checkboxes that a representative would use to confirm that he or she provided disclosure.

Other ways to make disclosure more effective

We are also thinking about other ways to streamline the disclosure, such as through excepting subsequent purchases of funds that an investor already holds (along with grandfathering of investors' existing fund holdings). Also, we no longer are focusing on creating a brand new confirmation rule, although we may need to act to be sure that all firms implement the NASD's Breakpoint Task Force recommendation for disclosure of sales loads on the confirmation. We anticipate reproposing the point of sale rule in the first half of this year, and are looking forward to industry and investor comments.

Over the longer-term, we will think about ways to build upon these initiatives. The prospect of disclosing comparative information - which would inform investors about how the costs of the funds they are considering compare with the costs of similar funds - is one interesting idea. The prospect of requiring similar cost and conflict disclosure for other products is also something to think about over the long-term. I look forward to seeing your comments on these issues.


The second topic I'd like to discuss is the division between broker-dealers and investment advisers. The SEC has been dealing with the difficult issues arising as a result of the convergence of the broker-dealer and investment adviser industries, many of which relate to the changes in how these two groups must do business in today's world. Last year we adopted a new rule under the Advisers Act that addresses when a broker-dealer is subject to the Advisers Act.

The issues wrapped up in that rulemaking are not unlike many other regulatory line-drawing disputes that have occurred in Washington regarding the appropriate application of the federal securities laws to (i) insurance, (ii) commodities futures, (iii) banking, and (iv) pension arrangements. Sometimes these disputes have been resolved by legislation and sometimes by court decisions. They are messy disputes; passions run high on both sides of the issue. Often, the different regulatory agencies are on opposite sides of the issue. The dispute between advisers and broker-dealers is entirely an intra-mural one. We at the SEC administer both the Securities Exchange Act of 1934 (under which broker-dealers are regulated) and the Investment Advisers Act of 1940 (under which Advisers are regulated).

Let me give you some background. When Congress decided to regulate advisers in 1940, it exempted from the new statute broker-dealers, which customarily gave advice as part of their brokerage activities. Broker-dealers were already regulated by the Exchange Act, which it had enacted 6 years earlier. Why does it matter? Brokers who become investment advisers have to play by an additional set of rules, and those rules are generally stricter. Advisers Act was drawn largely from the common law of fiduciaries. They owe their clients a "fiduciary duty." They must avoid conflicts of interest with their clients, which means putting them first, or at least disclosing the conflict of interest so the client can take steps to protect himself. Brokers must treat clients fairly, but unless they establish a special relationship with the client, are not generally held to the same duty as an adviser. Brokers generally don't want to have this sort of duty to their customers, or to suffer the consequences of violating the duty.

Let's go back to the Advisers Act. Congress recognized in 1940 that broker-dealers give their customers advice in the normal course of a brokerage relationship. They didn't want to regulate this "incidental" advisory activity under the Advisers Act. They wanted to avoid duplicative regulation, but at the same time they didn't give broker-dealers carte blanche to avoid the advisers act if, for example, they managed money. To be exempt, a broker dealer had to limit its advice that advice that is:

  • "Incidental" to its brokerage services; and
  • For which it received no "special compensation."

That seemed to be a workable test in the era of fixed commission rates. As long as the broker-dealer received only commissions or mark-ups or mark-downs, it was rare that an issue would arise as to whether the advice was "incidental" to brokerage. The advice was almost always given in the context of a brokerage relationship and a trade was almost always contemplated by both the broker and the customer.

The premises upon which the exception was based have eventually broken down. Perhaps the most significant event was the unfixing of brokerage commissions in 1975. But it was not until the 1990s that brokerage firms began offering retail accounts designed to compete with financial planner and money management firms. First, with "Wrap Accounts" or, as they are today widely referred to as "Separately Managed Accounts," bundle brokerage and discretionary management together for a single or "wrap" fee based on the amount of assets under management. The SEC staff made clear, early in the development of these accounts that the brokers offering them were subject to the Advisers Act, because the "bundled" wrap fee was "special compensation." No one has to my knowledge disputed that call. Second, "Fee-based Brokerage Accounts," which were introduced in the late 1990's, offered a traditional full service brokerage services for a single fee based on the amount of assets on account.

Like the wrap fees, the fee-based brokerage accounts involved "special compensation," and thus brokers would have to treat them as advisory accounts. This time, however, the brokerage industry sought an exemption from the Advisers Act. They made several arguments that the Commission found persuasive. First, they argued that fee-based brokerage accounts were not substantially different than regular full service brokerage accounts, and that the brokers should not be subject to another level of regulation merely because they had 're-priced" brokerage accounts. Second, the fee-based brokerage accounts should be encouraged by the Commission because they better align the interests of brokers and their customers. They pointed out that the Tully Report, which Chairman Levitt had commissioned, urged brokers to adopt this type of compensation arrangement for their registered representatives as a way of encouraging them to better act in the interest of their customers.

In 1999 the Commission proposed a rule under the Advisers Act that would exempt fee-based brokerage accounts from the Act. We accepted the arguments of the broker-dealers, and were concerned that if we did not act, and the fee-based brokerage accounts proved popular, most broker-dealer and most brokerage accounts could become subject to the Advisers Act-a result not contemplated by the drafters of the Advisers Act. Under the rule, these accounts would continue to be subject to the customer protection rules of the Exchange Act and the NASD-they just would not be subject to the Advisers Act.

While strongly supported by brokers, the rule proposal received what best can be described as a "Bronx Cheer" from the investment adviser community, including financial planners. Investment advisers, including financial planners, saw the switch to a fee-based compensation scheme as a transformational event-no longer were customers paying for brokerage transactions, but for a client relationship in which advisory services predominate. They pointed to broker-dealers' marketing of these programs based on the quality of advisory services as evidence that these were, in essence, primarily advisory accounts and urged that we, therefore, treat them as advisory accounts. They argued that the rule, if adopted, would deny the account holders important protections provided by the Advisers Act.

Broker-dealers viewed the new fee-based programs as providing the same services, including investment advice, they have traditionally provided to customers. They argued that rules of the self-regulatory organizations and the Exchange Act provided protections to brokerage customers similar to those provided by the Advisers Act to advisory clients, and opposed what they saw as duplicative regulation of these accounts.

Both sides earnestly argued their positions from the perspective of investor protections and costs. But we have to recognize that there is a serious competitive dispute going on here, and to some extent this rule is a sideshow. Planners and money managers have siphoned off some broker-dealers' best customers as well as brokers. The broker's are fighting back by providing the type of services today's affluent investors want-services that are not driven by the need to generate commissions. But in doing so, they have invaded financial planners' turf.

The Commission took a middle road and, not surprisingly, has made no one particularly happy. We did three things. First, we adopted an exemption for fee-based brokerage, concluding that these accounts are more like traditional brokerage accounts than advisory accounts. Second, we clarified that certain types of advisory activities are not incidental, and therefore no matter how a broker charges for them, they must be treated as an advisory activity subject to the Advisers Act. These activities are: discretionary portfolio management; financial planning, but only if the broker-dealer holds itself out as a financial planner or uses similar terms that create the inference that it is providing financial planning; and, advisory services provided pursuant to a separate contract or fee. Third, we announced that we would initiate a study to explore the larger issues of the protections afforded investors who deal with brokers and those who deal with broker-dealers.

I and others on the Commission are very concerned about investor confusion with financial services providers and the differences in the protections received depending upon what type of financial service provider is being used. These aren't easy questions. Making a broker a fiduciary with respect to each customer it deals will undoubtedly increase the costs of brokerage service. Moreover, it may not reflect the intent or the expectations of the parties. If I engage a broker to sell a portfolio of securities on behalf of, for example, an estate, I do not want or need its advice on whether or not to sell the security.

On the other hand, we see more and more brokers portraying themselves to investors as their "financial consultant" or "financial adviser," but then claiming-typically in an enforcement matter before the Commission-that they did not owe the customer any duties beyond the minimal suitability requirements. These "financial consultants" often have serious conflicts of interests-conflicts that the Advisers Act requires to be fully disclosed to clients. We need to explore seriously whether the statutory protections set up 65 years ago-which depend upon the status of the financial service provider under these old statutes--make sense today. For that reason, I am extremely supportive of moving forward quickly on the announced study. As they say, time is a' wasting.

Diversity in the Financial Sector

Speaking of time, I know we are running short on it but I'd like to end where I started by focusing on the importance of conferences such as this one which bring together individuals who may not have been in the financial industry in any significant number just a few years ago. I think it is safe to say that the success of America's economy and society in the 21st Century will depend in large part upon contributions of the minority community. Consider the makeup of the American workforce in this country and who will be paying taxes and supporting the baby-boomer retirees. It is these individuals that must be incorporated into the financial industry both as members of the industry and users of the industry.

When it comes to diversity in the financial industry, the story is mixed. On the one hand, a recent diversity study conducted by the Securities Industry Association indicates that there has been a steady increase in the representation of women and people of color employed by the industry. Most notably, women accounted for 44% of the workforce in 2005 as compared with 37% in 2003. Similarly, the percentage of people of color employed in the industry has gone up from 18% in 2003 to 21% in 2005. However, the trend also indicates that a greater proportion of women and people of color continue to work further down the executive ladder.

Accordingly, minority representation must be increased at law firms, brokerages, banks and advisers. This growth in important for representation purposes but, more importantly, it also acts as a magnet for increasing business opportunities for said business and for other minorities. Awareness and understanding is key. Once the culture of the industry recognizes the value of minorities, businesses are willing to reach out and take a chance with newer, minority owned businesses. In addition, minorities may be more willing to invest their finances with a business where they see they are welcome, as demonstrated by high minority representation within the business. This cycle of self-promotion within the minority community is the route to success in enlarging the minority population within the industry. It is also the path to improving the financial literacy of those minorities to whom the industry is, or should be, a service provider. Change is what it's all about.

And so, I hope that I have given you some insight into recent, upcoming and needed changes to the way in which business will and should be conducted in the financial industry. Thank you for your time. I'd be happy to answer any questions.


Modified: 03/30/2006