News, Vision & Voice for the Advisory Community
Neil Hokanson offers a boots-on-the-ground perspective about why changes brewing in Washington are bad for consumers and advisors alike
May 2, 2012 — 2:20 PM UTC by Neil Hokanson Guest Columnist
Brooke’s Note: In the battle over who will regulate financial advisors and how they will do it, there has been a missing voice — the chorus of RIA principals themselves. To some extent this is understandable: The process of hashing out these issues has been laborious, with lots of hurry-up-and-wait. It’s easy to see why a busy RIA principal would think twice before spending valuable time on such an endeavor. But really, it appears to be coming down to crunch time. This letter from Neil C. Hokanson, president of Hokanson Associates Inc., a Solana Beach, Calif. firm with $440 million of AUM and 12 employees, may be just what the doctor ordered — especially if it inspires some of you send your own notes from the trenches to the generals at HQ making critical decisions. See: Avoiding FINRA oversight may depend on talking sense to an options-trading House Republican.
Neil’s Note: I took some time from my practice to pen my thoughts on this issue because it’s so important. It’s true that having FINRA regulate advisors would be bad for the fast-growing independent advisory community and the clients it serves. The regulatory landscape simply does not need more opacity and conflicts of interest. But far more important is the impact it would have on U.S. consumers, who face the need to save in a challenging environment and with potentially more muted investment returns in the years to come. American consumers of financial advice are best served with vigorous competition in such areas as the quality of investment advice, products and services, transparency and costs. Regulation of the growing independent advisory community by the shrinking captive wirehouse model does not serve the nation’s interest.
Congressman Spencer Bachus
U.S. House of Representatives, Washington, D .C. 20515
Re: Regulation of Registered Investment Advisors (RIA’s)
Dear Congressman Bachus,
I am writing to you in your capacity as chairman of the House Financial Services Committee, and in particular with respect to address options being considered for the regulation of registered investment advisors currently regulated by the Securities and Exchange Commission, as you are well aware.
As you know, there are three options being considered with respect to this issue: (1) continued regulation by the SEC, (2) establishment of a self-regulatory organization (SRO) and (3) regulation by FINRA (formerly the NASD/NYSE regulatory arms).
While I don’t generally get involved in public affairs, I feel it is incumbent upon me to weigh in on this issue. I have been in the financial services field for 32 years, and I have been regulated by either the NASD, NYSE, or the SEC, or both, during this entire time. In addition, I have served as a securities arbitrator for the American Arbitration Association. I have been a CFP since 1984, I am a graduate of [The University of California at Irvine, and I hold an MBA in international business. I am the president of Hokanson Associates, an independent advisory firm celebrating its 25th year.
I’m sure you are a busy man, so I will cut to the chase: Continued regulation by the SEC, or by a yet-to-be established SRO, is acceptable to the great majority of investment advisors — in fact, by a ratio of 4 to 1. Regulation by FINRA, however, is not an acceptable alternative.
The reasons are essentially twofold. One is that FINRA as an organization does not meet a professional standard acceptable to ethical advisors, while the second is that U.S. consumers would be poorly served by having the broker-dealer community regulate their primary competitor — independent advisors.
Allow me to start by addressing the first of these two issues. As most Americans will appreciate, transparency is essential to good governance. FINRA, a private organization, is not subject to the Freedom of Information Act, nor is it subject to the Administrative Procedures Act, nor is it subject to the Sunshine Act 2. lts board meetings are not open to the public. We are in the year 2012, and FINRA — charged with regulating stockbrokers who advise millions of Americans — behaves like a background shadow organization from a bygone era.
This is not just my opinion. In August 2010, FINRA’s own members passed a resolution calling for an independent investigation of FINRA’s directors’ and officers’ potential ties to Bernie Madoff. (As you know, Mr. Madoff’s brother Peter was a vice chairman of FINRA’s predecessor, the NASD. The FINRA board rejected the proposal.)
The SEC has weighed in as well, issuing charges in October of last year charging FINRA with securities violations. This marks the third time in eight years that FINRA employees have given the SEC altered or misleading documents.
FINRA provides very little transparency with respect to its budget and pay practices. The U.S. Chamber of Commerce observed that FINRA does not observe “the traditional checks and balances placed on government agencies”. Compensation for FINRA’s top 10 executives exceeded $11 million in 2009, while the SEC chairman’s earnings were about $175,000, the FINRA chairman earns over $2.5 million. Really? For what?
FINRA not only missed Ponzi scammers Madoff and [R. Allen] Stanford (the SEC shares blame here), but it failed with respect to regulating firms in what should be its area of core competency, such as Bear Stearns, Lehman Brothers and Merrill Lynch.
Rife with conflicts
I would now like to address the second main point that I made for rejecting FINRA as a regulator of independent investment advisors — a subject dear to my heart. I left a traditional broker-dealer, Dean Witter Reynolds (now Morgan Stanley), for the same reason thousands of financial professionals and millions of investors have. The broker-dealer model — not unlike FINRA itself — is rife with conflicts of interest and lack of clear disclosure of conflicts and fees faced by American consumers of financial advice.
Over the years, a better-informed American public has made a clear choice towards greater transparency and more consumer-friendly alternatives. Vanguard — a low-cost no-load mutual fund company, is now the nation’s largest. Charles Schwab — a small broker-dealer when I left the firm that became Morgan Stanley — now roughly equals the latter in total assets, despite the recent addition of the assets of Smith Barney to Morgan Stanley. Much of Schwab’s growth is the result of its commitment to serve independent registered investment advisors such as my firm, Hokanson Associates.
Industry analyst Cerulli Associates [Inc.] confirms this trend. While the independent advisor community is growing rapidly, the institutional advisor community is shrinking. From 2007 to 2010, assets in the financial advisory industry grew to $11.2 trillion from $11 trillion, while “wirehouse” assets declined from $5.5 trillion to $4.8 trillion. In fact, Cerulli projects that wirehouse market share will decline from 43% in 2010 to 35% in 2013 .Frankly, this is a rout. In the first quarter of 2012, at least 50 advisors managing nearly $12 billion in assets have left Merrill Lynch alone. We run into “breakaway brokers” on a regular basis now, and they uniformly cite the need for independence and objectivity as their primary reason for becoming independent.
In summary, not only is FINRA an anachronistic organization doing a poor job of serving the public welfare, but allowing FINRA to regulate its primary competitor industry — which has grown so rapidly on the basis of greater transparency, lower fees, more disclosure and fiduciary standards absent in the broker-dealer world — would result in a huge step backward for the U.S. consumer and for our country.
Neil C . Hokanson, President
201 Lomas Santa Fe Drive, Suite 360 Solana Beach, CA
92075 Tel. 858 755 8899 Fax: 858 7554449
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