VIEWPOINTS : Should the State Regulate Financial Advisers? : <i> Legislation Needed to Curb Abuses in This Rapidly Expanding Field </i>

Joseph P. Montoya (D-Whittier) is chairman of the state Senate Business and Professions Committee

Late last week, the nation’s largest association of financial planners formally proposed the establishment of a self-regulatory organization to police the rapidly growing industry. Why would the 22,000-member International Assn. for Financial Planning take such a step now?

During the past year, California has been rocked by several enormous consumer fraud cases involving financial planners and investment advisers. The names J. David Dominelli in San Diego (real estate investment) or Ronn Morrow in Sacramento (financial planning) evoke anger and frustration among duped clients, all of whom lost money and many of whom expected protection from federal securities laws or professional organizations.

And just more than a week ago, the Securities and Exchange Commission disclosed a complaint against a Reno securities trading firm in which $55 million was allegedly swindled from clients in 41 states.

There is an obvious need to provide stronger regulation, and California is among a handful of states that are attempting to do that on a local level.


Legislation Proposed

I have proposed legislation (SB 315) that requires those calling themselves financial planners, advisers, analysts or counselors or investment advisers to disclose 1) their ownership interest in entities and products that they are offering, 2) the sales fees and commissions that they will receive for recommending particular products, 3) the nature and cost of the services that they are providing and 4) information relative to their background and business practices. Passage of this bill is not certain, but there is sufficient support for it among financial planners and consumers.

It is clear that criminal fraud cannot be totally prevented without severely encumbering our financial markets. Adam Smith wrote in “The Wealth of Nations”: “The real and effectual discipline which is exercised over a workman, is not that of his corporation, but that of his customers. It is the fear of losing their employment which restrains his frauds and corrects his negligence.” So how can unscrupulous financial advisers be exposed to the public? How do you bring consumer discipline to bear? My recommendation is disclosure.

Information is the consumer’s strongest weapon against abuse and fraud. Knowledge of the adviser, the products and the terms of the transaction allows the consumer to make better choices.


An array of professionals is competing to give financial advice. Accountants, lawyers, bankers, brokers, realtors, insurers and independent financial planners and investment advisers are all holding themselves out as financial experts.

Bankers Lobbying for Exemption

Bankers have lobbied quite hard for an exemption from the bill because of other licensing or regulation that applies to their principal profession. Should the public interpret this position to mean that reliable financial advice cannot be received at their neighborhood bank? Banks, once a societal citadel to be as trusted as church and family, now want to refuse the minimal courtesy of disclosing information to consumers.

Often a banker, insurer, broker or other professional works for a company that offers financial “products” such as insurance policies, mutual funds or securities as well as financial advice. This often creates a conflict of interest for advisers: Do they represent the client, who has acquired their services to give impartial investment advice? Or, do they represent the company, which pays a salary or commission for promoting specific products?


Or, should the ethical judgment be left to the advisers? SB 315 makes it clear that the primary responsibility should be to the consumer. Neither bankers nor other financial advisers should be placed above consumers to satisfy a need to enter a new market or expand an existing one.

Financial advisers are currently required to pass an examination to practice under existing state law. However, since the array of financial services has become more vast, this testing, directed at knowledge of securities, can be inappropriate for the insurer, realtor, accountant or other professional whose advice is often based on products other than securities. SB 315 provides for more appropriate specific testing as determined by the agency overseeing each of the affected professions.

Again, banks wish to avoid this requirement. They are breaching the understanding of the “level playing field,” meaning that they think the rules should apply only to some. I believe in fairness, and in the simple test, “If you waddle and quack like a duck, then you are a duck.” If a professional gives financial advice, then he or she would be covered by SB 315--no exceptions.

Cost of Programs


I realize that the cost of administering regulatory programs is expensive and cumbersome to those being regulated as well as to those supposedly being protected. The state Department of Corporations does a commendable job in trying to curtail financial fraud. But there is a limit to the amount of money that the public is willing to spend on enforcement efforts, especially those that could be created to place the consumer as watchdog. SB 315 is designed to provide consumers with tools for their own vigilance, which is better than building a dependence upon a government protector, often underfunded, which has little personal stake in the outcome.

Interestingly, the support and sponsorship of SB 315 is coming from financial planners and advisers who have seen the credibility and integrity of their profession placed in question.

California has some very competent and conscientious financial professionals who recognize that consumers have the judgment and wisdom to hire the cream of investment talent once they are given reasonable information.

While SB 315 won’t prevent the most calculating fraud, it will, in Adam Smith’s words, provide “the fear of losing their employment” for advisers who fail to put their client’s interests before their own.