Financial Reform Watch

Published — October 12, 2010 Updated — May 19, 2014 at 12:19 pm ET

Small investors to get bigger megaphone at SEC

Introduction

For the average Main Street investor, the roots of the 2008 financial collapse remain murky. The impact, though, was not: houses foreclosed, banks shuttered, pension funds depleted and investment and retirement plans that went the way of a market in freefall.

And while the Dodd-Frank financial reform law focuses largely on Wall Street and gaps in regulatory oversight, it also includes provisions to help ordinary American who are trying to save money for retirement, buying a home, or paying for kids’ college education.

Among the changes: Creating an Office of Investor Advocate to give small investors a bigger megaphone within the Securities and Exchange Commission.

The SEC has begun searching for a pro-investor expert to fill the job, said Lori Schock, director of the SEC’s investor education office. The investor advocate, to be appointed in November or December, according to the SEC’s timeline, will act as an ombudsman to handle investor complaints and report to Congress on how well the agency is policing the markets from that perspective. The first report is due in the middle of 2011.

While there is not yet a short list of names for the job, Barbara Roper of the Consumer Federation of America says the SEC must choose someone who is credible and not a “fake investor advocate” to fill the job. For example, Rich Ferlauto would have been a good choice, Roper said, if he had not been recently hired as a senior official at the SEC’s office of investor education. “If they are really interested in getting something done, it [the office] has the potential to be influential,” Roper said.

Dodd-Frank expressly prohibits filling the investor advocate job with an SEC employee or someone who has worked at the agency within the past two years.

New pro-investor committee at SEC

The investor advocate will sit on a new Investment Advisory Committee created by the Dodd-Frank law to advise the SEC on concerns of individual investors. The idea isn’t a new one – SEC Chairman Mary Schapiro created a similar panel soon after taking the agency’s top job last year. But because the new Investment Advisory Committee has been mandated by Congress, it will be more powerful and have a bigger platform for change, advocates and an SEC official said.

Lawmakers insisted on legislating the committee partly in response to the $65 billion Bernie Madoff investment fraud scheme, which was flagged to the SEC’s attention several times over the years by a whistleblower. The tips, however, were ignored by SEC employees, in part because of Madoff’s clout on Wall Street,

The new investor committee at the SEC “can’t be watered down in the future, so that’s a good thing,” said the SEC’s Schock. “It is hard finding the voices of (small) retail investors, and there are a whole slew of financial institutions,” she added.

Damon Silvers, policy director at AFL-CIO, a federation of labor unions, said that having a permanent committee is the key to long-term change in Washington. “This is a huge deal in terms of the way Washington actually functions,” said Silvers, who sits on the SEC’s existing investor committee and is also a member of the Congressional Oversight Panel created to oversee bailout spending. “Presidents, congress people come and go … [the committee] will be a steadying influence.”

The rest of the committee, which must include a state securities regulator and a representative for elderly investors, will be appointed after the investor advocate is chosen, Schock said.

Fiduciary standards, arbitration

The SEC is required to carry out other changes on behalf of small investors, under the Dodd-Frank law. The law “is a broad sword in some areas and a scalpel in others,” Schock said.

One of the most controversial is a study examining whether ordinary investors understand the different legal obligations that investment advisors and stockbrokers now have to their clients. While investment advisors are required to register with the SEC and has a fiduciary responsibility to help clients choose the best investment products for their needs, brokers are often salesman for a particular product, unbeknownst to investors, and are not obligated to act in the best financial interests of their clients.

A survey released last month, conducted by the Consumer Federation of America and other groups, showed that Americans usually don’t know the difference between brokers and investment advisors. The SEC must report to Congress in January with recommendations on whether the fiduciary obligation should be expanded to other investment professionals – an issue that brokers’ groups are fighting.

Another “scalpel” provision involves binding arbitration that many small investors are now required to accept when they hire an advisor. The SEC is going to take a closer look at the contracts that investors sign with investment advisors, most of which require any complaints to be mediated by an arbitrator and prohibit the client from filing a lawsuit. The SEC is now empowered to make rules limiting binding arbitration clauses. The agency also has the power to improve or amend the often daunting financial disclosures investors receive.

Silvers said the Dodd-Frank law is stronger than most realize for individual investors. If the law’s goals are achieved, resulting in a more transparent system that is less prone to boom and bust cycles, a small investor relying on the market to retire or save would see a huge benefit.

“The potential of Dodd-Frank is to create a system that is less vulnerable to bubbles,” Silvers said. “A marketplace full of tricks and traps and opaque forces is a market the individual investor is not likely to do well in.”

But Silvers said how effective the act is for investors will ultimately be up to how the SEC establishes rules to carry out the law. “Are those rules robust and is the authority used widely?” he asked.

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