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U.S. Securities and Exchange Commission

Speech by SEC Chairman:
Financial Self-Defense:
Tips From an SEC Insider

Remarks by

by Chairman Arthur Levitt

U.S. Securities & Exchange Commission

Boston Globe's "Moneymatters" Personal Finance Conference

Boston, Mass.
October 16, 1999

Thank you, Matt, for your generous introduction. It's a pleasure to be here today to talk with you about investments, savings, and financial self-defense in the modern marketplace.

I want to thank the Boston Globe for inviting me. But, more importantly, I want to commend Matt and his staff for helping to expand opportunity and financial security through investor education.

Before I begin, let me say that while it's wonderful to see the participation of the many companies here today, let me emphasize that the SEC does not endorse or support any particular companies, trading strategies, or financial products which you may see today.

That was the part the lawyers in my office wrote. While it's important, I promise they didn't write anything else you are going to hear.

This is a remarkable time to be an investor. Any way you measure it, our markets have been enjoying record-setting growth. We've seen new highs, record volumes, and a greater number of new investors than ever before in our country's history.

But, as we've seen in the past few days, our markets can go down as well as up. That's why I'd like to focus on how to take a realistic view of investing and how you can protect your hard-earned dollars.

There are more ways to invest than ever before. But there also seem to be more ways to be confused – or to be misled.

America's marketplace is generally honest – but there are some crooks out there. And, there's only so much that law enforcement and regulatory watchdog agencies, like the SEC, can do.

You've got to do your part, too. In that spirit, I'm going to try to help you learn how to approach investing with greater skill, so that you can make decisions with greater confidence.

More and more Americans are saving and investing to achieve financial security. In 1980, the number of Americans who owned securities – either directly or through mutual funds or through pension funds – was one out of 18. Today, that number is one out of 3. That's an astonishing change.

The massive movement into our stock markets has provided new opportunities. But it has also increased the risks. There's a lot of euphoria among investors. Some of today's optimism is justified – but some is not.

Remember, the strong gains of the last few years are the exception – not the rule. Over the longer term – measuring over the last 70 years or so – stocks have typically earned about 10 or 12 percent each year. I'm certainly not making predictions. I'm just suggesting that it's important to have realistic expectations.

Unfortunately, too many investors have unrealistic visions. In one recent survey, most mutual-fund investors thought that the stock market – over the next decade – would gain an annual average of more than 20 percent. That would put the Dow at over 50,000 just ten years from now.

And, with the growth in on-line investing, more and more people, I fear, are entering our markets with overly aggressive expectations. The Internet and other new technologies offer clear benefits to investors – including lower costs, faster access to the market, and a wealth of information.

But, investing in the stock market – however you do it and however easy it may be – will always entail risk. Be sure your investments match your goals and your tolerance for risk. And remember that diversification should be the foundation upon which you build your investment portfolio.

So, how can you protect yourself? Don't fall for the illusion of easy money. Don't be pressured by the aggressive salesman or enticed by a glitzy website promising that you'll make a fortune with one quick gamble. And remember that frauds can be carried out anywhere – even Boston.

Does anyone remember the names Harold Lee or Alfred Almeder? Or a project called DreamWorld? It should have been called SchemeWorld.

Lee and Almeder told investors they were going to build a massive amusement park on the Cape. They lied about their financing. They lied about the land they owned. And they lied when they promised that shares in DreamWorld would rise from a dollar a share to 15 dollars a share within 2 years. In 1997, the SEC's Boston District Office caught them and put them out of business – but not before 28 investors lost more than a quarter million dollars on worthless stock.

The classic warning sign of fraud is a high-pressure sales pitch, where the salesman may pretend that he has inside information about a small company that, he says, "just can't miss." He may pressure you to send money right away, before you've had much time to think, or promise quick, easy, astronomical profits.

There's a reason that criminals often hawk their wares by phone – they don't give you anything in writing, so that you don't have the chance to study the details closely.

Investment offers on the Internet can be just as dangerous, because you never know for certain who you're dealing with.

I've talked about out and out fraud. But, you also need to be on guard when dealing with investment professionals. The vast majority of people selling securities are honest. But we do have people who walk a fine line between good sales practices and poor sales practices. And, frankly, some managers and some firms create a sales culture that pushes them right up to that line.

The most important investment lesson I can convey to you comes down to this: Ask questions. What kinds of questions should you ask? Some are about products – and some are about those who sell them.

An informed investor looks beyond the packaging of a product and also sees what's inside. Look at the prospectus. Read the annual report. Most public companies file reports with SEC. You can get these reports for free from the SEC's EDGAR database on our website at www.sec.gov. Just type in the company's name, and you can retrieve every report it has filed with the SEC in the past five years.

Now, some may ask, "Why go through the trouble of reading this material? I trust my friends, I trust the Wall Street analyst on TV or in the newspaper. I trust my instincts." Well, the answer can be found in something folksinger Pete Seeger once said when explaining the difference between education and experience. "Education," he said, "is when you read the fine print; experience is what you get when you don't."

Don't just look in the rear-view mirror. Too many investors simply look at last year's results, and then throw money into investments that did well yesterday – assuming they'll continue to do as well, or better.

If you're investing in mutual funds, make sure you know what kind of sales charge, or "load," you'll pay – front-end load, back-end load, or no-load. Look at the cost of any annual asset-based charge – the so-called "12(b)1 fee." On top of that, you should consider the management fees and other expenses that you'll pay on your fund each year. Remember that funds have expenses even if they don't have a load.

Over time, expenses and fees can really add up. On an investment held for 20 years, a 1 percent annual fee will reduce the ending account balance by 18 percent. But don't just take my word for it. Check out the SEC's Mutual Fund Cost Calculator on our website at www.sec.gov. You'll find it on our "Investor Assistance" page. Just plug in a few numbers, and you can see – in dollars and cents – how costs really add up over time. You can even use the calculator to help you choose among different funds.

So far, I've talked about investments. But some of the most important questions have to do with the people recommending the investments.

Now, here's a question for you: Have you ever asked your broker precisely how he gets paid? Commissions reward a broker for the quantity of the trades, not necessarily the quality. There are other ways to do it. Some firms offer such alternatives as a flat fee, or a percentage of the assets under management.

You can ask a broker: Do I have choices about how to pay you? Does it make sense for me to pay by the transaction? Or should I be paying a flat fee regardless of the number of transactions?

Brokers are sometimes paid more for selling mutual funds, for example, rather than stocks – or paid more for selling the in-house brand of fund rather than another. And any item that comes out of a firm's own holdings may have an extra incentive attached to it.

The extra compensation may encourage the broker to sell that stock. That's in his interest. It may be in the firm's interest. But it may or may not be in your interest.

Ask your broker: Do you make more if I buy this stock, or bond, or fund, than if I buy another? If you weren't making extra money, would your recommendation still be the same?

Here's an easy one: A broker will readily tell you the price for which he'll sell a stock to you. Ask how much he'll pay to buy the same stock from you. There's always a "spread" between the selling and buying price.

Shop around for the best price. Negotiate. Be a smart investor. I've known people to spend more time comparison shopping for paper towels than for investments. There's no excuse for that.

Check out a broker's background and experience. Ask your broker: How much training and experience do you have? Have you ever been disciplined? And remember: You can always check if any broker has a disciplinary history by calling the National Association of Securities Dealers at 1-800-289-9999 – or visiting their Website at www.nasdr.com.

You can also call the Massachusetts Securities Division for this information. That number is 617-727-3548. You should also ask the Securities Division if the broker and his company are registered and licensed to do business with you, and whether either has a history of consumer complaints.

We've covered a lot of ground today. We discussed how to protect yourself in the marketplace. We discussed how to weigh the products and practices that you may encounter. And we discussed how to ask well-informed questions.

You should know that, when you ask your broker a question, you have the support not just of the SEC, but also of the securities industry. Problems with uninformed investors can cost firms dearly. They would much rather have you ask questions before you make an investment, than to have you angry after you make an investment.

I hope all of this information about investing will be helpful for you. But there's something more. I want to hear from you about the state of our securities markets, and I want your help in making them better.

For, when all is said and done, the work of the SEC is not about this rule or that regulation. It's about hard-working people seeking a better life – buying that new home, sending their children to college, taking that much-needed vacation, enjoying a decent retirement.

It's about meeting your goals, and about giving you the chance to gain the resources to fulfill your dreams.

Thank you very much.