(The following question and answer session was posted to Prodigy’s Focus On Funds investment web site on September 5, 1997. Questions were posed by Marsha Meyer and answered by Mark Griffin, Utah Securities Commissioner and president of the North American Securities Administrators Association.)
Q: I read that small investment advisers will now be regulated by the states. It said that the SEC used to regulate them, but now the states will be responsible. But just what does or will the states regulate? How do they get involved, or do they only conduct a review after there are complaints that surface?
A: Under a change in the law, states now have the exclusive responsibility to regulate smaller investment advisers, defined as those having fewer than $25 million in assets under management. Prior to this change, all but four states already regulated investment advisers, regardless of the size of the adviser. The change will mean only that the states’ focus will be on the smaller advisers for any routine audits. Of course, the states will always look into any allegations of fraud, no matter if the adviser is large or small.
Q: What is the public getting by having the state governments involved in the investment business except for more bureaucrats, red tape and ultimately higher fees to the public?
A: Few of the people we have assisted to recover money lost in some fraud regard our activities as bureaucratic. You may as well ask the question of whether states ought to have any local laws. State authorities accounted for some 6,700 cases opened and investigated in 1995. The federal authority brings fewer cases, but has a focus on the national markets. Our focus is on state citizens. Additionally, licensure is a traditional function of local governments; just as all states license attorneys, medical doctors, and general contractors, states license securities professionals as well and have a say in the methods and standards by which they conduct business. And the fees involved are microscopic — a mere fly speck — in the overall economic picture.
Q: How will states without a securities commission (I read last week that 20 states are like this) oversee the advisers with less than the $25 million under management? Are they being forced by the new federal regs to create a regulatory department?
A: Your information is incorrect. All states have securities regulatory agencies and only four of those do not regulate investment advisers. These four are Colorado, Ohio, Wyoming and Iowa. Their legislatures have or are currently examining the question of creating that authority. However, this new law provides that the SEC will continue to register and regulate small advisers in states where no investment adviser laws exist. In other words, there are no gaps in the regulation of advisers; each will look to either a local or national authority.
Q: Is buying stocks and mutual funds on the Internet safe? Who, if anybody, regulates the Internet?
A: I’ll answer the last question first: No one regulates the Internet. However, securities professionals who use the Internet are regulated. And in that context, the medium of communication is not important; securities professionals are subject to the same rules using the Internet as they would be using the telephone or in their letter correspondence. Now, is it safe to purchase traditional investments from reputable firms on the Internet? Yes, I think so. However, the Internet is no place to be exploring exotic investments. And anyone participating or reading traffic from chat rooms discussing stock or rumors of public companies should know that these present grand opportunities for manipulation and fraud. All unofficial information on public companies and their stock should be regarded with a great deal of skepticism.
Q: How can I check up on the advice of my broker to see if it’s in my best interests? I’m a widow, and my husband always handled our finances.
A: Well, I’m a little concerned for you, and I am glad you asked the question. People who are in your situation should get a little objective help. Sometimes, a reputable broker can provide that help. However, brokers usually make their money on transaction-based fees. Accordingly, a broker can profit handsomely from the transactions he or she recommends even when these recommendations may not be the best for you.
In your situation, I would look for an reputable investment adviser who would charge a modest fee to examine your portfolio and advise you. There are plenty of investment advisers or financial planners who are “fee-only” and don’t take commissions. If you are an elderly widow, it will be clear the type of investments that are appropriate for you and those that are not. The advice you get is usually well worth the small fee.
On the other hand, if you decide to continue with your broker, you can check that person’s disciplinary background with your state securities agency to see if there are any significant complaints about conduct or if a regulatory agency has sanctioned him or her. If you don’t know the number of your state agency, visit the North American Securities Administrators Association web site (www.nasaa.org). There you’ll learn how to contact your local regulator to get this information.
Finally, if you are not using an investment adviser or planner, at least get yourself educated. The best way to assure you’re getting good service from a broker is to know something about proper investment. Take an adult ed course on personal finance. Discipline yourself to read the financial page of your local paper or subscribe to a national financial journal. You can also watch the Nightly Business Report on PBS and other TV financial news journals. You’d be amazed at how easy it is to pick up a financial education from just investing a little of your time.
Q: What are some of the most popular scams currently being promoted on the Internet and through telemarketing?
A: Well, if I told you the most “popular” you might avoid those and get snared by one I don’t know of. Currently, with the markets running at nose-bleed levels and with investor demand at an all time high, the scams are abundant and highly creative. It’s kind of like a huge picnic with loads of food — you’ll always attract armies of ants. Better to learn to identify the common features of a scam, rather than what the scam “de jour” is. A sure sign of a fraud is pressure to buy now — today, this instant. In reality, sound investments are usually like subway trains, they come one right after another, and if you don’t get on this one, there’ll be another along shortly. Another sign of fraud is any promise of high return combined with a guarantee of low risk. Return levels and risk levels are mirror images of one another: high return is high risk; low return, low risk. It’s a market law that is immutable. Investments pitched as high return, low risk are pure frauds 99.9 percent of the time. If you’re still curious about the scams de jour, check out www.nasaa.org, open the Investor Education section, and look for the Investor Alert entitled “Field of Schemes.”
Q: My financial planner is out of state. Does that mean she won’t be regulated by my state under the Securities Markets Improvement Act?
A: No, the residence of your planner is not determinative. Your own state securities regulator has jurisdiction over your planner’s activities in your state regardless of domicile and will require your planner to have a local license and obey local securities laws.
Q: I was told that variable annuities are not covered by securities regulations because they are an insurance product. Is that true?
A: Under most state laws this is true; however the SEC and the NASD treat variable annuities as securities, and they are covered by federal securities regulation and NASD rules.
Q: Is my broker obligated to tell how much money she makes on the investment products she recommends? Are financial planners required to provide this information? Don’t you think it would be a good idea?
A: Currently brokers and planners are required to disclose compensation in a variety of ways. A brokerage commission is required to be disclosed and customers see commission amounts on the confirmation notices they receive in the mail for a given transaction. However, mark-ups on the transaction are not disclosed, and some brokers share in the profits on mark-ups. On the back of the customer confirmation notices, customers may check a box to require disclosure of mark-ups, but it must be done for each transaction.
Investment advisers/financial planners, on the other hand, disclose their compensation structure in a brochure they provide to customers and in their regulatory filings with the SEC and states. However some planners accept compensation in the form of “soft dollars” from brokers to whom they refer business. Originally these were payments from the brokers to cover research expenditures; however “soft dollar” payment systems have evolved to cover items that are clearly not research. The SEC is now exploring tightening up the rules governing this and disclosure might be the best alternative.
To answer your last question, I think hidden compensation systems do the market and the customer no good. A large share of the cases we deal with involve flawed compensation systems that fail to align the broker’s and the customer’s interests. Disclosure of all compensation is the first step in that alignment. So, yes, it’s a good idea.
Q: What are some good ways to tell whether a cold caller is a legitimate securities dealer or a scam artist? Are there some telltale characteristics?
A: I tell people not to do business with cold callers. It is simply too dangerous to do business over the phone with someone you don’t know. I tell people to pick their financial professionals; don’t let them pick you. But, for the curious, here are a few telltale scam artist characteristics:
Q: What are the biggest mistakes you see investors make in terms of not looking out for their best interests?
A: We are a convenience society. What we want, we want now--and we want it without a lot of trouble. I think one of the biggest mistakes we make is “Convenience Investing,” that is, investing on a hunch, investing with the first person who gets you on the phone, or because your Aunt Louise made a bundle in this or that investment product.
But investing is not like deciding where to have lunch. So the first mistake to avoid is the practice of “convenience investing.” Think of investing as a part-time job: it takes a little education and a little time to earn your pay.
Second, don’t be greedy. Greed is the bait that usually hooks investment victims. Invest for the long term, and don’t try to make a killing.
Third, most people fail to check our their investment professional with their state securities agency and ask for references.
Fourth, many people, when they decide to invest, bet the farm, instead of just the south forty. And they usually bet the farm with someone they don’t know, whom they met over the phone. Go slow. Experiment with a portion of your savings in legitimate, traditional investments. Diversify. Hold something back until a time when your knowledge of markets and investing has grown and given you more confidence. But still, diversify.
Issued September 1997
This publication was compiled by the North American Securities Administrators Association and the Better Business Bureau and is furnished to you by the Texas State Securities Board.
