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Why keeping FINRA from ruling RIAs is critical to these firms, the investor -- and even the U.S. economy

In Part 1 of a four-part series, our One Man Think Tank pulls back the lens to look at how the resolution of the fiduciary furor could reverberate nationwide

Monday, June 24, 2013 – 4:03 AM by Guest Columnist Ron Rhoades
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Ron Rhoades: Wall Street and the large U.S. banks have captured our regulatory bodies and Congress, to the detriment of individual American investors.

Dina’s Note: Ron Rhoades returns to RIABiz with a four-part series that updates and expands An in-depth analysis of FINRA’s attempted takeover of RIAs and why the group should be disbanded, Part 2, originally published by RIABiz on May 31, 2012. In this first installment, Rhoades explores the effect lack of trust will have on the capital markets and our economy. In future installments, Rhoades will delve into the history of the regulation of brokers; FINRA’s early — and more recent — failures to protect the investing public; and, finally, discuss options for reform, including the creation of a true profession for financial and investment advisors.

Brooke’s Note: The free enterprise system is no more compartmentalized than any other system. If one part is sick, damaged or tainted, it is only a matter of time before it affects the body whole. The recognition of that immutable natural law is, in effect, what Ron Rhoades draws our attention to in this column. Is it farfetched to think that a kink in the economic hose in as critical a point as the one where capital flows back from the consumers to companies and governments — i.e. though financial advisors as guided by their regulators — would be like a low-level virus for the grander economy? A good think tank made up of of several cross-disciplinary academics could work that one out. Fortunately for us, Ron is it. See: Part One: Investment Advisers: Is our path toward, or away, from a true profession?.

FINRA is hungry

That big gorilla called FINRA — facing a continued decline in its membership (consisting of all broker-dealer firms conducting business with the public) — is hungry. Sitting nearby are registered investment advisor firms — appearing to FINRA as juicy, growing bananas and a perfect treat to be consumed, chewed up and digested.

Yet, we must ask – if you are a consumer, or if you are a registered investment advisor or an investment advisor representative, would FINRA’s desired takeover of RIAs be a good thing? Not on your life. Permit me to explain why.

In this series of four articles, I propose that, for long-lasting reforms, FINRA possesses fatal flaws and must be dismantled. In its place should arise a true professional regulatory organization bound to a bona fide fiduciary standard of conduct and to promoting the best interests of clients at all times and without exception. Only then will our fellow Americans receive the ongoing certainty of the substantial protections of the fiduciary standard that they so justly deserve. See: Analysis: Beware of a FINRA bearing gifts for RIAs.

I first explore the diminished trust in financial intermediaries, and its dire consequences for the future economic prosperity of all Americans.

FINRA keeps the U.S. economy struggling

In more than seven decades of existence, the Financial Industry Regulatory Authority Inc. (formerly known as the National Association of Securities Dealers, or NASD) has failed to provide the essential safeguards necessary to limit its large Wall Street member firms’ ability to underwrite or sell investment products with exorbitantly high fees and costs.

The result has been the preservation of an oligopoly of investment banks, as well as the preservation of conflicted broker-dealer business models long overdue for an extinction event. More importantly, FINRA’s long-standing protection of its members’ excessive rent-taking has led to a crisis in American capitalism, negative implications for U.S. economic growth, and a dismal personal financial outcome in retirement for tens of millions of Americans. See: Why FINRA’s power grab for RIAs needs to be stopped to avert the death of the profession, Part 1.

By way of explanation, American business is the robust engine that drives the growth of our economy and delivers prosperity for all. An important component of the fuel for this engine is monetary capital. Yet, this monetary capital is not efficiently delivered to the engine of business. It’s as if the engine is stuck using an outdated, clogged carburetor, in the form of substantial intermediation costs by current investment banking firm practices.

More importantly, the transmission system of our economic vehicle is failing, leading to far less progress in our path toward personal and U.S. economic growth. The transmission system is large, heavy and unwieldy; its sheer weight slows down our vehicle’s progress. Through costly investment products and hidden fees and costs, this transmission system unnecessarily diverts much of the power delivered by American business’ economic engine to Wall Street, rather than deliver it to the investors (our fellow Americans) who provide the monetary capital.

The ramifications of this inefficient vehicle, with its clogged carburetor and faulty transmission, are both numerous and severe. The cost of capital to business is much higher than it should be, due to the exorbitant intermediation costs Wall Street imposes during the raising of capital and its diversion of the returns of capital away from individual investors.

In fact, Wall Street currently diverts away from investors a third or more of the profits generated by American publicly traded companies. As Simon Johnson, former chief economist of the International Monetary Fund, observed in his seminal May 2009 article “The Quiet Coup,” appearing in The Atlantic, wrote: “From 1973 to 1985, the financial sector never earned more than 16% of domestic corporate profits … In 1986, that figure reached 19%. In the 1990s, it oscillated between 21% and 30%, higher than it had ever been in the postwar period. This decade, it reached 41%” More recently the financial services sector’s bite into corporate profits has been estimated at one-third or higher.

Investor distrust = Less capital

The siphoning of profits by Wall Street, away from the hands of individual investors, has led to a high level of individual-investor distrust in our system of financial services and in our capital markets. In fact, many individual investors, upset after finally discovering the high intermediation costs present, flee the capital markets altogether. (Many more would flee if they discovered all of the fees and costs they were paying, and realized the substantial effect such had on the growth or preservations of their nest eggs. See: A cap on 12b(1) fees is going to have one predictable result. Think carnival games..)

The effects of greed in the financial services industry can be profound and extremely harmful to America and its citizens. Participation in the capital markets fails when consumers deal with financial intermediaries who cannot be trusted.

As a result of the growth of investor distrust in financial intermediaries, the capital markets are further deprived of the capital that fuels American business and economic expansion, and the cost of capital rises yet again. Indeed, as high levels of distrust of financial services continue, the long-term viability of adequate capital formation within the United States is threatened, leading to greater reliance on infusions of capital from abroad. In essence, by not investing ourselves in our own economy, we are selling our bonds, corporate and other assets to investors abroad. See: This $9-billion Philly RIA is launching an ETF company financed by Chinese private equity.

h2 Less capital formation = Reduced economic growth

It is well documented that public trust is positively correlated with economic growth.

Moreover, public trust is also correlated with participation by individual investors in the stock market. This is especially true for individual investors with low financial capabilities — those who in our society are in most need of financial advice; policies that affect trust in financial advice seem to be particularly effective for these investors. See: A $2.5 billion RIA makes its mass-market bid for thousands of new clients.

The lack of trust in our financial system has potential long-range and severe adverse consequences for our capital markets and our economy. As stated by Ronald J. Columbo in a recent law review article: “Trust is a critical, if not the critical, ingredient to the success of the capital markets (and of the free market economy in general). As Alan Greenspan once remarked: ''Our market system depends critically on trust — trust in the word of our colleagues and trust in the word of those with whom we do business.’”

From the inception of federal securities legislation in the 1930s, to the Sarbanes-Oxley Act of 2002, to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, it has long been understood that in the face of economic calamity, the restoration and/or preservation of trust — especially investor trust — is paramount in our financial institutions and markets. See: Barney Frank puzzles crowd on his fiduciary stance at TD summit — as questions from Skip Schweiss and advisors expose his haziness on the RIA structure and soul.

Less trust = Less use of financial advisors

The issue of investor trust in financial intermediaries does not just concern asset managers and Wall Street’s broker-dealer firms; it affects all investment advisors and financial advisors to individual clients. As Tamar Frankel, a leading scholar on U.S. fiduciary law, once observed: “I doubt whether investors will commit their valuable attention and time to judge the difference between honest and dishonest … financial intermediaries. I doubt whether investors will rely on advisors to make the distinction, once investors lose their trust in the market intermediaries. From the investor’s point of view, it is more efficient to withdraw their savings from the market.”

Harmful impact on Americans’ retirement security

Even more severe are the long-term impacts of the high intermediation costs imposed by Wall Street firms on individual investors themselves. Individual investors, now largely charged with saving and investing for their own financial futures through 401(k) and other defined-contribution retirement plans and individual retirement accounts, reap far less a portion of the returns of the capital markets than they should. See: 10 essential steps that 401(k) plan sponsors need to take in 2013 to put clients on the right road to retirement.

These substantially lower returns from the capital invested, due to Wall Street’s diversion of profits, result in lower reinvestment of the returns by individual investors; this in turn also leads to even lower levels of capital formation for American business. See: Why the industry needs to accept some blame for 'flaws’ in PBS Frontline’s 'Retirement Gamble’.

It must be remembered that, fundamentally, an economy is based upon trust and faith. Continued betrayal of that trust by those who profess to “advise” upon qualified retirement plans and IRA accounts, while doing so under an inherently weak standard of conduct, only serves to destroy the essential trust required for capital formation, thereby undermining the very foundations of our modern economy.

Burdens placed upon governments — and taxpayers

As individual Americans’ retirement security is not adequately provided through their own investment portfolios, saddled with such high intermediation costs, burdens will shift to governments — federal, state and local — to provide for the essential needs of our senior citizens in future years.

These burdens will likely become extraordinary, resulting in far greater government expenditures on social services than would otherwise be necessary, precisely at the time when our governments can ill afford further burdens and cannot solve these burdens through the issuance of debt.

Consequentially, higher tax rates become inevitable, for both American business and individual citizens alike. This, in turn, consumes a greater share of our economy, leading to further economic stagnation, and perhaps to the permanent decline of America in the 21st century and beyond.

We, the People: Servants of Wall Street

In essence, American business has become Wall Street’s servant, rather than its master. The excessive rents extracted at multiple levels by Wall Street fuels excessive bonuses paid, in large part, to young investment bankers. See: One-Man Think Tank: When Wall Street has investors’ 'best interests’ at heart, watch out.

Wall Street also drains some of the best talent away from productive businesses, as well. Far too many of our graduates of math and engineering programs make their way to Wall Street, and even more pursue finance majors rather than pursue studies in the STEM (science, technology, engineering and mathematics) disciplines. This further distorts the labor market, as shortages of talent in our important information technology and engineering sectors continue.

Consequently, Wall Street has become a huge drain on American business and the U.S. economy. It derives excessive rents at the expense of corporations and individuals. The financial services sector, rather than providing the grease for American’s economic engine, instead has become a very thick sludge.

Wall Street’s control of our government

Wall Street and the large U.S. banks have captured our regulatory bodies and Congress, to the detriment of individual American investors.

As economist Simon Johnson also observed: “The (2008-9) crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: Recovery will fail unless we break the financial oligarchy that is blocking essential reform … we’re running out of time.”

The solution

There is but one solution to fix the affliction affecting our country’s capital markets, and the resulting lower levels of capital formation and economic growth. The compelling reply to the current state of affairs lies in the application of a bona fide fiduciary standard of conduct to all providers of personalized investment advice.

Simply put, this broad-based fiduciary standard requires that financial advisors act in the best interests of their clients, and to subordinate their own interests (and those of their firms) in order to keep the best interests of the client paramount at all times.

Instead of preserving the economic interests of conflict-ridden investment banks, the best interests of individual American investors would be advanced under the fiduciary standard. This in turn would free America from the grip of Wall Street, and free individual Americans from personal financial prospects that are far too often dismal and bleak.

Ron Rhoades, JD, CFP® serves as chairman of the steering committee of The Committee for the Fiduciary Standard. He is an assistant professor of business law and financial planning at Alfred (N.Y.) State College.

Stephen Winks

Stephen Winks

June 26, 2013 — 2:12 AM

Very incisive assessment, the veracity of which is readily documented and widely shared by all who have an indepth knowledge of the industry.

The challenge here is the industry controls its regulators as well as Congressional legislative procedure as demonstrated by the agonizingly slow ongoing fiduciary debate holding brokers to fiduciary duty which is unambiguously in the consumer’s best interest—the literal definition of public policy—the very purpose of Congress..

The question is how does the best interest of the consumer prevail in such a compromised environment, even when the fiduciary standing of brokers was required by statute and an Act of Congress two long years ago. The industry wants to negotiate away consumer protections afforded to all investors except retail investors—those most in need of advice. Presently brokers are not accountable for their recommendations and have no ongoing fiduciary duties to act in the consumer’s best interest.

The abuse of consumer protections is so obvious, it begs immediate resolution—but is thwarted by industry interests. Scandalous behavior acknowledged even by the most ardent brokerage industry chroniclers, who fear a loss in advertising revenues if they speak out. The power of the brokerage industry is literally unchecked.

The role of the press is very important in reconciling brokerage industry policy that brokers do neither render advice nor has any ongoing duties with their recommendations which is clearly counter to the consumer’s best interest.

Ron Rhoades goes a long way in building an irrefutable case for regulatory reform as our leading institutions and regulators have failed to preserve and protect the public trust—which is very dangerous to the well being of all Americans.

Every publication and media outlet should be singing this song of the abuse of consumer protections to the retail investor, which destroys the trust and confidence of the investing public undermining our economic well being as a country.


Brooke Southall

Brooke Southall

July 2, 2013 — 11:33 PM


Thanks for both thoughtful comments.




June 26, 2014 — 11:23 AM

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June 26, 2014 — 12:49 PM

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Mike McDaniel

Mike McDaniel

July 2, 2013 — 11:13 PM

Excellent piece. Well done. I just gave up my registrations with FINRA (and the revenue associated with it) to improve my (and client’s) quality of life. Knowing that FINRA is going after the RIA model keeps me up at night.

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