Financial Regulations Protect Consumers – Sometimes

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The financial services field is one of the most regulated in the United States. I'm told that our regulations are as complex as those in the medical field. This makes sense; our health and our money are two important pillars of wellbeing. Preventing harm to either can be a matter of life and death.

Regulations are intended to protect patients and financial consumers from negligent, unethical, or fraudulent providers. While they do offer some protection to the public, they are not completely effective. An Internet search for "financial fraud" will give you a horrifying number of cases. Remember Bernie Madoff, who pled guilty in 2009 to scamming his clients out of $65 billion. In the three years following, there was a 62% increase in financial fraud.

The cost of preventing fraud is significant to financial companies. According to LexisNexis Risk Solutions 2020 Survey, "The cost of fraud pre-COVID-19 among U.S. financial services and lending firms rose 12.8% over the previous reporting period, which covered the first halves of 2018 and 2019 respectively. For every dollar of fraud lost in the pre-COVID period, U.S. financial services and lending companies incurred an average of $3.78 in costs, up from $3.35 since the last edition of the survey."

It's not unusual for regulations to reduce service to clients. For example, my firm used to help clients with managing and trading their employer 401(k) plans. This required us having the passwords to their accounts. About a decade ago the SEC decided we could not have client passwords in our possession. It violated the rules meant to protect against financial advisors absconding with clients' money. Never mind that the millions of dollars clients may have placed with the same advisor in accounts over which they had direct access were perfectly okay.

Another instance recently ended up in one advisor known to me abandoning a weekly video to all her clients updating the recent market effects on model portfolios. She was highlighting how one anonymous actual client portfolio was performing as compared to how hypothetical (“back-tested”) portfolios were doing. Reporting on an actual rather than a hypothetical portfolio is a much better indication of true performance. Many advisors don’t report on actual portfolio performance, however, because it’s almost always worse than the hypothetical.