Charles D. Meyer, MBA, CFP
Meyer Advisory Services
"We ONLY Sell Advice" ©1982
204 Main Street
Hampton, NJ 08827
15 March 2004
U.S. Securities and Exchange Commission
Via Electronic Submission
Re. File No. S7-04-04
Proposed Rule: Investment Adviser Codes of Ethics
Consumers are confused about financial products and services. Billions of advertising dollars entice investors to pour money into investment products and services without regard to suitability and with no means of valid comparison. Requiring investment advisers to adopt a code of ethics is - at best - a band aid approach to arterial bleeding. As more investor dollars pour into mutual and pension funds, investors know less and less about how their money is invested and a relatively small group of financial professionals takes over this massive proxy authority. Regulatory authorities continue to deal with a patchwork of antiquated lines of demarcation, while vendors continue to integrate and cross-sell their products to a poorly educated public. The SEC and state regulatory authorities should design an integrated framework for consumer protection, one that recognizes the changes in the marketplace, mobility of society, and lack of consumer education.
Thank you for the opportunity to comment on SEC proposed rulemaking. I have no doubt that all SEC proposed rules are drafted with nothing but the best of intentions. I am in awe of the amount of staff hours that must be generated in order to get to just this stage of the rulemaking process and the forty-four page document put up for public inspection and comment! Indeed, not only must the Commission concern itself with the Background, Discussion, and General Request for Comment, it must also give consideration to Cost-Benefit Analysis, Effects on Competition, Efficiency and Capital Formation, Paperwork Reduction Act, Initial Regulatory Flexibility Analysis, and - of course - its Statutory Authority. In fact nearly 25% of the Proposed Rule concerns itself with 116 individual "Endnotes" providing either emphasis or cross references to the Rule and its content! If I were a professor of rulemaking, I would have to grade this document with an "A," just on the bases of thoroughness, format, and style. If I were a professor of bureaucracy, I would certainly give it an A+.
I have - during my over 25 years as an investment adviser - held the title of Adjunct Professor of Financial Planning at the New School for Social Research in New York City, and had the opportunity to format and offer courses in Common Sense Financial Management. Both as professor and as adviser, I have been able to see - first hand - a myriad of abuses foisted on an unsuspecting and naïve public by, for the most part, commissioned salespeople (very heavily regulated by federal, state, and self-regulatory bodies of government - most with credentials that bring a broad range of ethical standards and practices) or by boiler rooms and other fly-by-night operations whose only purpose is to fleece consumers and operate under the radar of regulatory authorities.
Prior to founding my investment advisory firm, I held management positions at a large (over 100,000 employees) bureaucratic company heavily involved with federal and state governments. One of my responsibilities dealt with drafting corporate policies and procedures and monitoring compliance. One of the reasons I left to start my own business had to do with the frustration level created by the enormous hurdles created by policies and procedures, and how little effect they actually had as intended remedies.
Certainly the concept of an investment adviser code of ethics belongs in the same category with "Mom and apple pie." Who would argue with the need for ethics? Overlay the fiduciary responsibilities inherent with advising people about their money, and it might seem difficult to find anyone willing to argue with the premise that investment advisers be required to adopt a code of ethics?
I feel we are reaching a period in the cycle of business and personal behavior where ethics has taken a back seat to greed, entitlement, and a general "anything goes as long as I don't get caught" mentality. From the Speaker of the House right down to religious officials, it seems we have reached an apogee of fraud, mismanagement, and consumer abuse. The student of history can easily see that this is a cyclical phenomenon. In other words, it will probably correct itself. The discovery of these abuses is likely to heighten consumer awareness to the point where corrective measures will be implemented by organizational entities, primarily in the interest of self-preservation.
As a regulated and registered investment adviser, I wonder why corporate and mutual fund board members and executive officers are not subject to the same oversight that I am. Imagine if a corporate or mutual fund board member had to live by the same conflict of interest standards that I do. Perhaps Enron, Tyco, Adelphia, and other corporate fiascos would have been avoided (or caught much earlier) had the officers been "Registered CEOs," or the members of their boards "Registered Corporate Directors." Perhaps there should be "Registered Mutual Fund Managers." I once worked for a man who, as the chairman of a major transportation company, put a huge pension payment for himself into a trust that was protected in the event that his company went bankrupt. This type of egregious conflict of interest would surely have been prohibited had he been guided by a code of ethics.....or would it? Would the chairman of the NASD have been entitled to over a hundred million dollar pay package had he been operating under a code of ethics? It would not surprise me if the NASD did in fact have a robust code of ethics.
Human ingenuity and greed are powerful forces to be reckoned with, and I wonder if we can expect a few well-meaning paragraphs in an already unwieldy section of the Code of Federal Regulations to effect meaningful consumer protection.
We must all accept the fact that there will be fraud and consumer abuse. Adding verbage to laws is likely to do nothing to aid the consumer. Costs will increase for already ethical advisers, and we know these costs will have to be passed on to the consumer. How does this upping of the regulatory ante truly benefit the consumer?
What increased regulatory burdens accomplish (whether intended or not) is the pricing out of the market those advisers who would prefer to cater to the small investor, at least those who do not receive compensation from the sales of financial products.
I'm not sure if it is ironic or vindicative of my business practices and tenacity that clients who began taking my advice nearly two decades ago when they had virtually no savings or investments are now multi-millionaires with what would be considered by today's standards "high net worth portfolios."
It may come as a surprise to the reader that it is much more difficult to render financial advice to the small investor than to the substantial investor. The small investor stands to be hurt more by the loss of $10,000 than the substantial investor, who might not even notice such a "small" loss.
The small investor and the small adviser must contend with billions of corporate advertising dollars promoting sexy products promising to make buyers rich. And these are legitimate products being offered by mainstream investment companies and brokerages with global reach and a huge media presence.
The small investor and the small adviser must also contend with a deluge of media "advice" suggesting that objective, fee-only advice is best but not available to the small investor. That mutual funds are the only place to be for the small investor. That there is a Santa Claus. Smiling faces on the covers of glossy magazines promise to make everyone rich, and with little effort. Unfortunately, I'm well aware that the media will never have to subscribe to a corporate code of ethics and/or a "Registered Financial Writer" or "Registered Financial Advertising Copywriter" requirement.
Mutual and Pension Funds
I would like to address the recent recognition of mutual and pension fund malfeasance and the calls for more safeguards to protect the public from excessive fees, trading abuses and conflicts of interest (much of which is referenced in this proposed rule).
I stopped using mutual funds as a primary means of designing client portfolios nearly fifteen years ago. There were many reasons why I concluded that mutual funds had outlived their usefulness as a practical means for investor participation in the securities market.
Mutual funds had become a "black box" harder to define than a real company. An investor can understand that Procter & Gamble sells soap, McDonalds sells hamburgers, and Coca Cola sells Coke but what does the BB Fund do (and will it continue to do whatever that is after I buy it and keep it in my portfolio and will I know if it has changed direction)? When Coke changed its formula or McDonalds changed its frying oil, consumers knew. When the BB Fund changes the formula in its black box, who will know?
When the number of mutual funds exceeded the number of stocks covered in the Value Line Investment Survey it became obvious to me that it was easier to find appropriate public companies to place in a portfolio than to find suitable mutual funds.
I have never understood why there should be so-called "load" mutual funds, especially type B and C load funds along with 12(b)-1 funds, other than to confuse the public and enrich the firms that promote them. As no-load funds have been promoted and better understood, the only explanation for the continuation of load funds has to be the marketing and sales departments of the major investment companies promoting them, and laziness on the part of the consumer.
For the small investor, it seems to me that investing in a portfolio of listed companies through dividend reinvestment programs offers a much wiser and less costly approach to preserving hard-earned savings than investing in a costly black box.
The mutual fund industry has gone from fairly humble beginnings to become very big business. Consumers today just assume they are the best place to be.
Perhaps the issue most lost on the investing public and least mentioned by the media is the loss of corporate democracy that has resulted from the mutual fund craze. The investing public is methodically ceding its ownership interest in corporate America to a small cadre of mutual fund (and pension) managers and directors who are in a position to vote their proxies. This has the effect of concentrating a substantial (and growing) portion of corporate power in the hands of a relative few members of the financial community.
I find it ironic that in a time where the Internet, email, blogs, and discussion groups have the potential to organize and empower the individual (and presumably the individual investor) to organize themselves and influence public opinion, mutual and pension funds are gradually taking away any hope of public power and responsibility which was considered inherent with stock ownership.
The effect of this loss of individual stock ownership, combined with the concentration of stock proxies with mutual and pension fund management equates to the de-Democratization of corporate governance and an easier environment for abusive practices.
As I see more and more regulatory layers imposed on my business, I can't help but come back to the consumer and ask myself how will this benefit her. If I could see a tangible benefit, especially one that might help the small investor who is so often the one most at risk, I would have no problem.
It is interesting to note that several previously-posted comments on this rule appear to be from actual consumers who had abuses perpetrated on them, or who have attempted to obtain remedies from regulatory agencies with unacceptable results.
Where the consumer is most confused is with finding suitable products and then evaluating them from the standpoint of commissions, fees, and component costs that reduce the actual dollars actually invested.
Competing Products, Services, and Regulatory Agencies, New Models Needed
At the present time, it is difficult if not impossible for the average consumer to compare apples to apples in the financial marketplace. If a consumer has $10,000 in a checking account should she buy life insurance, mutual funds, stocks, bonds, real estate, a mortgage on real estate (or pay off/refinance/pre-pay an existing mortgage), US Savings Bonds, gold coins, CDs, or trade penny stocks with an online brokerage account? Even if she can reason out which product(s) makes the most sense for her set of circumstances, I venture to say that 100% of consumers will be completely in the dark in attempting to evaluate the cost of investment for each product and how much of the purchase price would go to marketing, sales and administration, and how much would actually become part of the "net investment." Should a suspected abusive practice be detected by the consumer, I further venture to say that not one of these consumers would be able to name the appropriate authorities from whom they could seek remedy (IF there are such authorities/remedies).
Where does one go to get the education one needs to know how to manage one's financial affairs? It should be a prerequisite of a high school diploma, but isn't. Quite often a civics teacher in a high school will conduct a three month "investment challenge" to see which class member can construct the best investment portfolio. At best, this only validates a short term trading mentality and provides little if any long term benefit to financial consumers.
The regulatory framework in the financial marketplace is a hodgepodge of archaic regulations very narrowly defined by product orientation with more protection provided to the product vendors than to the consumers of the products.
As the public becomes more mobile, and as product vendors merge insurance, banking, and securities businesses in a "one stop shop," cross-selling to a captive consumer is the order of the day.
Meanwhile turf battles among regulators pit state regulators and attorneys general against the SEC and other federal entities.
Insurance products remain the most complicated sold to consumers, and the least regulated from a consumer protection standpoint. It is nearly impossible to determine the commissions and trailing fees that will be paid out of the average life insurance product, or to compare its investment portion to an equivalent stock or bond product. Once handed the small-type policy, all the verbal promises go out the window and the consumer is left with very little in the way of recourse or understanding of the products' suitability.
Modern day financial products and consumer choices have changed dramatically, yet the regulatory framework for consumer protection has not. Adopting codes of ethics is tantamount to closing the door after the animals are out of the barn.
A federal model of consumer protection and education should be considered which encompasses ALL financial products, and which requires plain language to describe the purpose, suitability, and fees associated with each so the consumer is able to easily determine the cost and appropriateness of each.
Additional thoughts on this subject can be found in my earlier comments to investment adviser regulation S7-03-03 found at the link below:
This document Copyright 2004, by Charles D. Meyer for the purpose of submitting an electronic Response to Proposed Rule SEC File No. S7-04-04. While this document is submitted for publication in the Public Domain, all rights are reserved.
Charles D. Meyer