In a letter dated February 17, 2006 to Congressmen Markey and Miller the GAO agreed to undertake a study on how pension consultant conflicts of interest and undisclosed financial arrangements may have adversely affected the solvency of some pension plans, particularly those that have been assumed by the PBGC. The GAO will also determine which agencies are responsible for overseeing and investigating potential conflicts and what is the PBGC’s role in this process.
To date the PBGC has failed to undertake investigations of the over 4,000 failed pensions as to which it serves as Trustee. The agency lacks the staff, expertise and information required to undertake such investigations. No other agency has undertaken such investigations. We are confident GOA will conclude PBGC has failed in its fiduciary duty to investigate any potential wrongdoing related to terminated pensions and look forward to an answer to the question of which agencies are responsible.
Why the SEC Is In Danger of Becoming Irrelevant
While it hasn’t been easy, as a result of political pressures, compromises with the industries it is charged with regulating and failure to comprehend rapid changes in information technology, the Securities and Exchange Commission, the federal agency charged with protection of investors, is on the verge of becoming virtually irrelevant.
Simply put, the good news is that the day is rapidly approaching when the private sector may be capable of doing a better job of providing investors with the information they need to make informed investment decisions than the SEC. The bad news is that less-fortunate investors forced to rely upon information provided by the SEC and self-regulators such as the NASD are far more likely to be victimized and unsuccessful in their investing.
The political pressures brought to bear upon the SEC are widely known but rarely is the extent to which these political factors undermine the overall effectiveness of the Commission openly discussed. Obviously, political leanings play a formidable role in the selection of SEC Commissioners. For example, it is unheard of for an individual, Republican or Democrat, with a record for fighting on behalf of investors and opposing the financial services industry to be selected as a Commissioner. Don’t expect to see Ralph Nader appointed as an SEC Commissioner in your lifetime. Persons whose careers have involved representing financial services firms or employment with such firms are the usual suspects. Below the Commissioner level, the selection of Directors of Divisions within the agency, such as Market Regulation and Investment Management, is also influenced by candidates’ acceptance with the regulated. The Investment Company Institute, the mutual fund industry’s lobby group, and the Securities Industry Association, the brokerage industry’s lobby group, influence the selection of Directors for these Divisions. In summary, selection of senior management at the SEC is not determined by merit using accomplishment in investor protection matters as the yardstick; rather, a favorable reputation with the regulated is of greater significance. The speed with which these government managers find comfortable quarters within the industry after their period of “government service” is powerful evidence of how seldom they seriously oppose the regulated.
Self-Regulation of the Brokerage Industry
There is no better example of compromises with the regulated that have undermined investor protection than the SEC’s continued willingness to allow the brokerage industry to self-regulate, self-insure, self- adjudicate (through mandatory arbitration), and even control public access to the brokerage industry’s criminal and disciplinary histories.
While there is limited oversight of brokerages by the SEC, it is certain that investor protection could be significantly enhanced through ending self-regulation of this industry. Self-regulation involves an insurmountable conflict of interest. That’s why the rest of us (who are presumably at least as trustworthy as stockbrokers) are not allowed to regulate ourselves. The National Association of Securities Dealers (the brokerage industry’s so-called self-regulator) pretending to be a true regulator is as believable as the actresses playing virgins in porn movies. Why is it that the head of NASD Regulation’s compensation is exponentially greater than the Director of the SEC’s Division of Market Regulation? Answer: Because the NASD self-regulator is paid for value provided to the industry. In other words, the head of NASD Regulation is not perceived by the industry as merely a cost center—that person contributes to the profitability of the industry by serving as a friendly regulator and is compensated accordingly.
NASD Systems of Mass Deception versus Systems of Enhanced Disclosure
Every year thousands of investors fall victim to avoidable fraud by brokers. As we detailed in our 2002 publication, The Siedle Directory of Securities Dealers, permitting the brokerage industry to control public access to its misdeeds has resulted in 85% of industry wrongdoing being unreported. In the Directory we showed that the NASD’s Public Disclosure Program (PDP) significantly understates the risks of dealing with brokers and brokerages. That is why we refer to the PDP as a System of Mass Deception. Neither the SEC nor the NASD ever disputed our findings. Yet the SEC allows the NASD to offer its misleading PDP for investors to rely upon. The private sector can develop Systems of Enhanced Disclosure that will be superior to and correct the deficiencies within the NASD Public Disclosure Program.
How faulted is the NASD’s Public Disclosure Program? Would you believe that it does not permit a broker or firm to respond “yes” to the question of whether the broker or firm has any disciplinary matters in his or its past? Only two answers are permitted by the NASD’s Public Disclosure Program—“no” and, get this—“maybe.” That’s what we call industry friendly.
When we published our Directory, the NASD threatened suit against us. The SEC refused to intervene in this first meaningful challenge to the NASD’s right to control public access to industry disciplinary data. So we went to court to establish our right to publish the industry’s history of misdeeds. Ultimately, a federal court judge in Tampa, Florida decided that the NASD could limit public access to the disciplinary histories of its members. While the NASD won this critical challenge to its right to control public access, we proved that in less than one year and with a limited budget a private company could devise a system that would provide investors with better information about the industry’s transgressions than the industry has been able to devise over the decades.
If all the ugliness of the brokerage industry were properly disclosed, how many investors would be saved from ruin? We may never know because the brokerage industry will never allow an end to self-regulation. The industry argues that self-regulation works. If self-regulation were truly comparable to regulation by the SEC, presumably the brokerage industry would have no reason to oppose an end to self-regulation. Yet, for some reason, the brokerage industry believes government regulation is a bad idea.
The SEC has allowed the brokerage industry to control the content and timeliness of other disclosures to the public. For example, there is no reason why Form BD, the registration form brokerages must file and keep current with the SEC should not be made publicly available on-line. Form BD contains some information that is important to investors and cannot be obtained elsewhere, such as the ownership structure of a firm. As discussed below, a few years ago the SEC implemented a disclosure program for investment advisers which provides money manager registration statements online for public view. Brokerages are treated differently. Could it be because they are allowed to self-regulate?
The Mutual Fund Industry
The nation was surprised (as was the SEC) when the Attorney General for the State of New York demonstrated that the mutual fund industry had been skimming money out of investor accounts for decades. How is it possible that the SEC was caught so completely unaware of mutual fund wrongdoing? The Investment Company Institute (ICI), the mutual fund industry’s powerful lobby group, had been leading the SEC by the nose for decades. The ICI was the primary source for information about the mutual fund industry that the SEC relied upon over the years. The SEC looked the other way as the ICI stated publicly in its materials that it represented the nation’s millions of mutual fund investors. The SEC allowed mutual fund money managers to pay their ICI lobbyist dues with investor funds. No piece of mutual fund regulation was ever implemented by the Commission without significant ICI input.
Further, most of the information mutual fund companies are required by law to maintain for SEC staff review during regularly scheduled inspections, records that are required for the protection of investors, is never made available to the public. For example, records of violations of the Codes of Ethics mutual fund advisers are required to adopt, advisers are permitted to keep secret. Investors never know whether their portfolio managers are engaged in personal trading which might undermine the performance of the funds in which they invest. Why should this information, gathered in the name of investor protection be kept from investors?
Eliot Spitzer showed that by welcoming mutual fund whistleblowers a state regulator with the political will to take action armed with a small staff lacking industry expertise could have greater impact than a federal regulator with a huge staff that had grown too close to the regulated industry. The SEC’s Division of Investment Management had heard from credible industry insiders about trading abuses and unsavory marketing practices but had chosen to ignore those dire warnings. Input from whistleblowers and others that conflicted with the message the mutual fund industry was spreading to the public, was unwelcome.
No Freedom of Information
Furthermore, the SEC argued in court that the findings of its investigations into money management wrongdoing should not be subject to the Freedom of Information Act. Investors who lose everything at a money management firm that the SEC subsequently investigates or even shuts down, today are denied access to SEC reports that might enlighten them as to the causes of their losses. Results of the SEC’s ongoing money manager inspection program, what are referred to as “deficiency letters” have never been made public, despite the fact that these letters contain valuable information regarding money managers’ operations and industry norms. Since 95% of all money manager inspections result in deficiency letters, access to this library of letters would provide investors with a far more complete picture of the industry. Investors would learn that the reputation of the money management industry is largely undeserved.
Loopholes in the Investment Advisers Public Disclosure Program In 1996 Congress amended the Investment Advisers Act to require that the SEC establish a readily accessible electronic process to respond to public inquiries about investment advisers and their disciplinary information. The SEC created the Investment Adviser Public Disclosure (IAPD) program to satisfy Congress’ mandate. No longer would investment advisers be required to make paper filings of their registration statements (Forms ADV) with the SEC, copies of which investors had to order from the SEC’s public reference room. Advisers’ Forms ADV, containing information about these companies and business operations, as well as certain disciplinary events involving advisers and key personnel, would be available online. Firms would file electronically their Forms ADV and investors could access the information immediately. Unfortunately all has not gone according to plan. Currently, you can only search for investment advisory firms on the IAPD website, not for individual investment adviser representatives. Also, while Part I of Form ADV is available online, Part II, which has additional sensitive information has yet to be brought online. Today even the SEC does not have copies of money managers’ Part IIs since the SEC eliminated the requirement that they be filed in paper form with the agency when the online program began. You can’t get Part IIs from the SEC Public Reference Room. The only source for Part II information is the firms themselves and they aren’t required to give it to persons (such as lawyers, investigators and reporters) who may be asking difficult questions—only to potential investors. Furthermore, investors often have misplaced the original Form ADV Part I and II documents they received from a money manager (at the inception of the relationship) by the time they realize they’ve been fleeced and seek to sue. By then the Part II information may have been amended numerous times and determining what Part II said at the time the investor invested can be impossible. There is no paper trail. The net result is that investors have less information than ever about the nation’s investment advisers. Isn’t this a problem someone at the SEC could fix?
Maybe, but the SEC is not running the program. When you call the number on the sec.gov website with questions, the NASD answers the phone. The NASD ultimately is managing the investment adviser disclosure program for the SEC and so it should be no surprise that the result is substantially less investor protection than is possible. Since 1996, the NASD hasn’t figured out how to provide investors all of the information that is contained in money managers’ registration statements (Form ADV Parts I and II). The private sector could accomplish this task in less than a year at minimal expense. Why is the SEC subcontracting its regulatory responsibilities regarding money managers to a self-regulatory organization it has sued repeatedly over the years for failing to adequately enforce the securities laws? Pension Industry Conflicts
In May 2005 the SEC Staff issued a report on conflicts of interest in the pension consulting industry. The report summarized the findings of a sweep investigation of many of the leading consulting firms, which included an examination into the divergent sources of compensation these firms collect and the related conflicts. The Staff concluded that the industry was subject to rampant conflicts and disclosure was abysmal. Were pensions that may have suffered harm ever made privy to the financial information the pension consulting industry provided to the SEC? Of course not. Armed with that information, i.e., full disclosure (as made to the SEC), pension victims could have sought recoveries. The ensuing private litigation might have forced the pension consulting industry to clean up its act and strengthened the retirement security of the nation’s pension participants. Instead the SEC chose to issue a vague warning to pensions to more carefully scrutinize the investment consultants they hire. A list of questions to ask was offered to pensions by the Department of Labor.
The investment consulting industry was let off the hook. Information collected by the SEC, in the name of investor protection, was withheld from investors. Again, the SEC asserted its right to unilaterally determine the information investors were entitled to receive.
The SEC’s Failed “Closed Door” Policy
In summary, both with respect to receiving information from outsiders and sharing information with the public, the SEC has followed a failed closed-door policy. The SEC rejects the notion that, generally speaking, information gathered to protect investors should be provided to investors. Instead the SEC has taken the position that the agency and it alone should be allowed to decide how much of the information companies are required to submit to the SEC, it will provide to investors. The SEC has also failed to realize that its secrecy policies deprive the agency of dialogue with parties who may be capable of supplementing its regulatory efforts.
At Benchmark today we are in possession of a significant and growing body of non-public information about money managers, brokers and other financial service providers. This non-public information is information the SEC either already has and chooses to ignore or does not possess. Due to legal considerations, we cannot broadly disseminate this information to the general public. A government regulatory agency can provide such information to the public without the constant threat of litigation. Yet the SEC is not stepping to the plate.
A Shift from Compelling to Thwarting Disclosure
Over the years, the SEC has subtly shifted from its traditional role of compelling disclosure to obstructing efforts to speed and broaden the flow of material information to investors. Today certain industries hide behind the limited disclosure requirements of the federal securities laws as a defense against greater disclosure. They provide the public all the SEC requires, nothing more, even though vastly superior disclosure is possible.
The Commission is largely irrelevant to institutional investors today and is of limited utility to retail investors. It is plummeting to the status of the Better Business Bureau, i.e., an organization only the most naïve believe protects their interests from unscrupulous corporations.
The Commission has lost its sense of purpose as its organizational structure and traditional manner of operating have become increasingly inappropriate to pursuing its stated mission, i.e., the protection of investors, in today’s world. It’s not too late for the Commission to reevaluate its tactics and implement strategic changes. The big question is whether anyone in Washington or on Wall Street wants that to happen. Chattanooga ends Pension Fight