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The Case against Wall Street

December 22, 2015

by Bob Veres

We are currently in round four of this battle to distinguish (or not) sales agents from fiduciary advisors, and this time the war is over the term “fiduciary,” loosely defined as giving advice solely for the benefit of the customer. This somewhat esoteric distinction served as a bright line for those consumers who understood the concept, until the brokerage industry proposed to “harmonize” the fiduciary standard with the brokerage sales model. It is unclear whether this initiative will succeed, but it has already managed to confuse the issue. And, as we will see shortly, ladies and gentlemen of the jury, the defendant’s stranglehold on legislative and regulatory initiatives suggests a preordained outcome.

I would suggest that even this bare-bones recital of the battles in this war would lead you to three simple conclusions:

  1. There is no obvious end to this succession of efforts to obscure the line between professionals and Wall Street agents;
  1. The Wall Street firms are very good at these battles, sometimes winning so quickly and easily that their effort seems perfunctory; and
  1. Each time Wall Street wins, the consuming public is returned to a state of confusion, uncertainty and the kind of disempowerment that accompanies a lack of information.

I invite you to conclude that here, once again, Wall Street’s net effect is not only harmful to society, but anti-consumerist by any definition you would want to apply.

Undue influence

It is time to ask ourselves: How does the brokerage industry get away with exempting itself from SEC registration, openly flouting the law of the land by marketing its advice and using terminology to describe its brokers that was supposedly reserved for professionals who sat on the same side of the table as their clients?

We can start with Congress, which makes the laws of the land, but even more usefully, also holds hearings that can be used to intimidate regulators, and also controls the funding for our regulatory organizations, including the SEC.

Figure one shows the largest 25 donors to Congressional campaigns, and Figure two shows the next 25. Ladies and gentlemen of the jury, if you scan this list, you might notice the Vanguard Group at number 11, and TIAA-CREF at number 15 are generally on the fiduciary professional side of the lobbying effort. But you will not find another supporter of consumer protection, or of clearly distinguishing professional investment advisors, anywhere on that list. The millions of dollars on the brokerage side of the ledger are balanced by a small $370,000 total contribution amount by TD Ameritrade (number 58 on the list) and an independent RIA called Fisher Investments at number 86 ($220,000 in contributions). The Financial Planning Association comes in at number 134 on this list, with $110,000 in total contributions.

Ladies and gentlemen of the jury, who do you think has the greater influence on Capitol Hill: the industry and its multimillion dollar contributions, or the profession with its mere thousands?

Of course, these amounts don’t add in the total number of dollars spent on armies of lobbyists. A recent graph compiled by the Huffington Post charted the number of meetings with regulators during the debate over the Dodd-Frank legislation, and found 1,793 meetings by representatives of the financial industry, plus 609 by legal professionals lobbying on behalf of Wall Street.

Pro-reform meetings, in total, came to 153.

A quick look at the regulators shows that they are largely led by people pulled from, and approved by, the brokerage industry. Among recent Treasury secretaries, we have Jack Lew, former COO of Citigroup. He was preceded by Tim Geithner, former president of the New York Fed, who famously was offered the COO job as Citigroup’s top executive. Mr. Geithner was preceded by Henry Paulson, former CEO of Goldman Sachs, and before that, John Snow, ex-CEO of CSX Corp. and a rare non-Wall Streeter in that post. Before that, Paul O’Neill, former chair of Alcoa Aluminum (another non-Wall Streeter) who succeeded Larry Summers, who earned $2.8 million as a consultant to Goldman, JP Morgan Chase, Citigroup, Merrill Lynch and Lehman Brothers. Before that: Robert Rubin, former co-chair of Goldman Sachs. Ladies and gentlemen, Wall Street insiders have clearly dominated White House regulatory and economic policy for the past 20 years.

The SEC, meanwhile, is currently chaired by Mary Jo White, formerly an attorney at Debevoise & Plimpton, which famously represented JPMorgan Chase in a variety of civil lawsuits – and she is by far the most independent-of-the-brokerage-industry chair we will encounter in our trip through recent history. She succeeded Elisse Walter, a former senior official of the NASD and FINRA, who succeeded Mary Schapiro, a former chairperson of the NASD and FINRA. Before Schapiro, the SEC was chaired by Christopher Cox, a former member of Congress who was known to be a champion of financial services deregulation. Before him: William Donaldson, founder of DLJ Securities, who succeeded Harvey Pitt, who had previously served as a securities attorney who specialized in representing Wall Street firms.

It would be hard not to notice the cozy relationship between Wall Street firms and the top securities regulator and policymaker in Washington, D.C. But the relationship goes further, deep into the staff at the SEC. Regulatory capture on 100 F Street, NE takes the form of an unwritten but visible offer: “If you [the staff person] play ball with your decisions and regulatory proposals, you will receive a reward when you leave in the form of a seven-figure salary for lobbying and legal work.” This practice is so common that it has a colloquial name in Washington circles; it is called “the revolving door.”

There have been various efforts to measure the extent to which this particular door revolves, but perhaps the most comprehensive is the 2013 report by the Project on Government Oversight, which found that from 2001 through 2010, 419 ex-SEC staffers filed 1,949 disclosure statements, disclosing that they planned to represent their new employers (or, in many cases, Wall Street clients of the law firms they joined) in matters pending before the SEC. One wonders how there can be that many “pending matters” (a delicate euphemism for regulatory infractions) over that short a time period, much less that ex-staffers would be addressing so many.

But here’s the punch line: These statements only have to be filed for the first two years after a staffer leaves the SEC, and it is not a requirement for all ex-staff members. To the extent that the filings don’t cover representation in matters two years after the staffer leaves office, or activities of staffers who are exempt from the filing requirement, the nearly 2,000 manifest conflicts of interest among current and former regulators represent an undercount of the actual impact of the revolving door.

In all 1,949 representations (plus others undisclosed), the dynamic is roughly the same: the staffer talks with people he or she has worked alongside for years, unruffling feathers, using friendship and camaraderie built up over years to mitigate the normal, logical impulse to apply the rules fairly and appropriately to the infractions. The revolving door is a forgiving door for an industry that routinely transgresses the regulatory boundaries – and that almost certainly means that our defendant is systematically creating lighter consumer protections for its own benefit.

Ladies and gentlemen of the jury, would you say that the ability to purchase lighter consequences for harming the public is in the best interests of the public and the American economic system? Or not?

What is FINRA?

But the organization that most closely “regulates” the Wall Street firms is FINRA, the Financial Industry Regulatory Authority. FINRA bills itself as a self-regulatory organization of the brokerage and broker-dealer world, and it has famously applied for the job of inspecting RIA offices on behalf of the SEC.

But is FINRA what it says it is? Or is FINRA, instead, an advocate of the brokerage industry masquerading as a regulatory body, which imposes its rules primarily to make sure that a predatory business model doesn’t go so far that it sparks outrage and a backlash in the public and Congress? That, ladies and gentlemen, is for you to decide. Let’s examine the evidence.

In a particularly well-researched column, attorney and college professor Ron Rhoades notes several instances where FINRA (and the NASD, its predecessor organization) seemed to act as an abettor rather than regulator of Wall Street activities later considered nefarious. One example is the price-fixing policies of the market-making member firms in the mid-1990s. Rhoades quotes then-SEC chair Arthur Levitt stating that the evidence showed that the NASD “did not fulfill its most basic responsibilities,” and “simply looked the other way” as these profitable, illegal activities mounted. The same column notes that FINRA failed to take any regulatory action at all regarding the derivatives scandal and the massive, costly failure of packaged securities like CMOs that led to the 2008-9 Great Recession – before or after the crisis. This led the Alliance for Economic Security to bluntly conclude, in its January 4, 2010 proposal for new rules, that “FINRA is not a reliable regulatory authority.”

Other examples cited include failure to regulate the conflicts of interest where securities analysts at the large Wall Street firms were issuing reports that were more in the interests of the investment banking department’s sales activities than in strict accuracy, where the analysts (famously including Henry Blodget) contradicted their own reports in emails to some of their customers. In fact, FINRA never took action in those cases; they were brought to light and ultimately prosecuted in a landmark settlement by the state securities regulators and the SEC.

And, of course, the most famous example of FINRA’s regulatory talent for looking the other way is the Bernard Madoff scandal, where the former non-executive chairman of the NASDAQ stock exchange conducted the largest Ponzi fraud in American history right under the noses of FINRA’s regulatory supervision for at least 28 years.

Finally, FINRA is also a lobbying organization, landing at number 29 on the aforementioned 2014 campaign contributions list, with $870,000 spent to promote the securities industry. When brokerage firms are caught in transgressions and fined by FINRA, they are obligated to pay fines to the same organization that lobbies on its behalf. What other industry in America gets to make a lobbying donation whenever they’re forced to disgorge ill-gotten profits?

In hearings, FINRA touts its independence from the brokerage industry, and points to the fact that its board consists of 10 “industry” members and 12 “public” ones. So the industry is outnumbered and outvoted whenever the board meets to decide how to regulate (and lobby for) the wirehouse community. Right?