Subject: File No. 4-645
From: Max H Herr

February 28, 2012

Investor literacy and education are generally a "back of the mind" concern of registered representatives and their firms. It is far more important to close the sale than be certain that the investment is suitable for the individual or even that the customer knows and understands what they now own.

As others have commented, investor knowledge today may actually be at an all-time low, despite the ease of access to, and the quantity of quality information available across the Internet, including websites operated by the SEC, FINRA, and even the federal Financial Literacy and Education Commission's website. Indeed, many investors simply do not care to do the due diligence they must because they simply trust their financial adviser to provide them with accurate information. They will never know when a misrepresentation has been made or fraud is being committed until well after the fact.

Compounding the matter are vague Conduct Rules that leave open to wide interpretation their precise meanings. This is evident in the myriad Appellate and Supreme Court opinions that all but criticize Congress, the SEC, or FINRA (and other SROs) for their abject failure to be specific or make clear their regulatory intent. In other words, there are Rules but no genuine standards.

We operate in an environment labeled "Know your customer," but there is no universal definition of that phrase that we can all look to for guidance. FINRA Conduct Rules demand that all transactions meet the "suitability guidelines", but they do not establish with any specificity what constitutes suitability or the kinds of documentation that can be relied on to demonstrate how an adviser makes his or her suitability determinations.

Indeed, this is akin to the infamous 1964 Supreme Court opinion concerning pornography, in which Justice Potter Stewart wrote that although he could not define it, "I know it when I see it." But pornography may actually be easier to recognize than the suitability of a securities transaction.

Vague Conduct Rules burden aggrieved parties with the responsibility of proving that the investment choices recommended to them were unsuitable. This is backwards. Most investment products, whether individual securities, mutual funds, variable life insurance or annuities, or more complex securities, are SOLD, not bought. It is the investment adviser who brings the recommendation to the table, and the burden should be on him/her to prove how the recommendation was determined to be suitable . . . well beyond the mere mention that "I believes the transaction was suitable based on the information I was given at the time." MAKE THEM DOCUMENT THAT Otherwise it's just a matter of He said-She said, and you might as well flip a coin to solve the question.

Additionally, and with regard to fiduciary responsibility, Congress and the SEC have created a singular abyss that divides "advisers" (Ser 65 IARs and their RIAs or RIA firms) from "brokers" (Ser 7 and Ser 6 registered reps), and characterizes brokers as mere order takers. Nothing could be further from the truth But it only places "fiduciary responsibility" on one of the two categories of persons.

All of these registered persons give advice to their customers. All of them should be held accountable for their advice based on one standard. All of them should be personally and financially responsible for the losses their customer experience when they receive verifiably unsuitable recommendations. But FINRA bends over backwards to defend the Broker/Dealers that line its coffers with operating revenue. As pure a conflict of interest as that of the registered rep who counts his commission before the ink is dry on the new account form or the investor's check.

Advice is advice. It is not better from someone who has "fiduciary responsibility." But if that is the belief, then make all persons who transact securities of any type responsible as fiduciaries.

The reality of investor literacy and education is this: You can force the investor to the literacy trough, but you cannot force them to drink from it.

Until we have actually educated an entire generation of elementary school students in the basic points of financial literacy, refine that in middle school, and polish it before they graduate from high school, little else will be accomplished.

But the fallacy of that premise should be obvious: you cannot teach what you do not know, and you cannot make illiterate person teach what they do not know. The public schools are already full of financially illiterate teachers with more on the way to replace them. The illiterate cannot make others more literate. To believe otherwise is fiction. Just as "no student left behind" has not moved all students forward.

As one commenter has written, if nothing else, create a single, standardized test of financial literacy, or risk tolerance, or product suitability. Make every registered representative use that test with their customers. That kind of a test can be created in the 21 most common languages spoken by persons over age 5 in America according to the 2000 Census. A copy can be retained in the required customer file. Recommendations can be narrowed into readily identifiable groupings based on the test score, and in the face of the score the sale can be easily identified as suitable or not.

If the investor wants something beyond his score, he can't have it until he and his adviser enter into an educational process to develop the knowledge necessary to score higher on the test. This does not deny investors the opportunity to be invested, but it serves to protect them from themselves until they have sufficient knowledge to understand what they want and the risks of owning it.

When it comes to variable insurance products, in particular, uniform marketing regulations need to be adopted that transcend state lines. The complexities of these products are currently known to all the state insurance and securities regulators, but enforcement of marketing conduct is haphazard or nonexistent. Insurance companies still permit their agents to produce "vanishing premium" illustrations, and they have refuge behind the "disclosure" that the illustration is only hypothetical and not guaranteed. Make the agents record every sales presentation and then we'll see what has or has not been disclosed, and how. We'll see exactly how many agents still tell clients, "After five (or seven) years, this policy will pay for itself." Because they still do it, and they know it's a lie.

Despite the assertion that these implementing laws and enforcing regulations exist to protect consumers, their application in civil actions or arbitations generally disfavors the product owner -- because those persons have applied their signature to a document under a statement that says they understand the nature of the product they are applying for and that it will probably not perform the way the agent has led them to believe, when, in reality, even their insurance agent probably has little or no understanding of how the product works.

Once again, we have the dilemma of the illiterate educating the illiterate. No one magically becomes literate as a result of that communication. The client's signature should not be evidence of any sort of knowledge. Most don't even read the words of the paragraph to which their signature is attached.

The only conclusion that can be reached is that it must be the "licensed professional's" public responsibility to prove that his or her client is financially literate before they can be permitted to submit a securities transaction. This must be documented with a paper trail. In many cases, the licensed professional will have to spend considerable time educating the customer if they expect to earn a commission or a fee.

And even that will not work when the representative is unethical, untrustworthy, or simply acting with criminal intent. Falsifying documents is already a problem. But at least if we apply a different legal standard to financial professionals . . . A REBUTTABLE PRESUMPTION OF GUILT . . . it will put these persons on notice that they had better do it 100% right from the get go, because that will be the only way to refute the presumption.

We can teach persons what they need to know to pass a licensing exam. We do not retest them after that to make sure they really know anything. This permits some licensed persons to operate recklessly and the public can be harmed.

When financial professionals must learn to be teachers, when they must document that their clients are educated, they will learn what it is they are marketing in order to make sure their clients have the same understanding. That is the only way to guarantee that investor literacy will be achieved. Because, as was already stated, you cannot teach what you do not know.

Finally, as at least one commenter has already said, differences between up-front sales charges and annual assets under management fees are completely lost on consumers. As was demonstrated, a 1.5% fee can mean giving up 15% of one's gains. Ask them if they realize it and you will discover that's not what those persons signed up for. What they thought they heard was, "If you don't make money, I don't make money." What should have been said was, "If you don't make money, I don't make as much. But I will always make money, and when you make more, I will make a lot more than you think."

Compare those 1% real cash fees vs. the 1% expense ratio on total returns in a mutual fund, and you may find that all the recent emphasis on mutual fund expenses has been misplaced. A $51,000 "loss" of income on a one-time $10,000 mutual fund investment (that literally only took about $500 off the top) with a 1% expense ratio and a 10% return over 30 years pales in comparison to the real effect of cumulative 1% fees in an IAR's wrap account holding the same mutual fund with the same 1% expense ratio (but from which no sales charge was initially taken), and the actual economic loss to the account when the fees have to paid from the account.

That the SEC and FINRA have demonstrated their own brand of financial illiteracy in this regard is unfortunate, and shows the depth of the literacy issue.

There is no easy solution here, as Dodd-Frank envisions. That's what happens when you turn illiterate politicians loose to craft vague legislation that only kicks the can down the road.