VIEWPOINTS : <i> Disclosure Requirement Is a Good First Step; Nevertheless, Buyer Beware</i>

I recently had a new home built. For many American consumers their home is the largest single investment they will ever make. I was dismayed during my investment how, despite the fact that the builder was licensed, the subcontractor bonded and the carpenters experienced, so many things went wrong. Let the buyer beware!

Within my development, a kitchen wall caved in, two foundations cracked, a wood-slat fence fell down, an installed sprinkler system doesn’t work and many toilets didn’t flush.

You get the picture.

The experience made me wonder, however, just how much good all that licensing did. Once all those problems surfaced, did I have recourse to solve them?

The situation is not unique to building, of course. Within the booming financial-services industry, problems abound. There is a bill circulating in Sacramento (SB 315) designed primarily to give teeth to the regulation of the blossoming financial-planning industry because too many charlatans have been posing as advisers. Entrepreneurs from all walks of life were holding themselves out to be knowledgeable in the assorted disciplines necessary in financial planning.

To the credit of the California senators, they interviewed the various sub-sections of the financial-planning community, asking what should be included and who might be excluded from provisions requiring disclosure. Needless to say, attorneys, certified public accountants and bankers with large lobbying efforts fought to be excluded. Let’s look at the result and then tell a story.

The bill has three areas of focus: who is included and who is excluded; what the included should disclose about themselves and what the “plan” should include.

The plan, which typically covers the various aspects of the client’s financial needs, risk, investment, tax planning and estate planning, should, according to the bill, also include a description of all recommendations and of the client’s goals, disclosure of fees, an alternative solution statement, a timetable and written promises, guarantees and disclaimers made by the financial adviser.

What does the financial adviser need to disclose? According to SB 315, that disclosure would cover the types of clients served by the financial adviser, the nature and cost of services provided, the methods of analysis, sources of information and investment strategies utilized, the educational background of the financial planner, possible conflicts of interest and the amount of any sales fees an adviser may receive for recommending particular financial products.

Savings and loans and credit unions would be subject to the regulation unless the services are provided in the usual course and scope of business as depository institutions. So would attorneys and accountants rendering financial advice outside the usual scope of their services. In other words, anyone who calls him or herself a financial planner or investment adviser would be subject to the regulation.

Now, back to my story:

I drove to the builder’s headquarters to determine his qualifications on my new home. I told him what I wanted in terms of design, size, lot orientation and amenities.

“What kinds of homes have you built?” I asked.

“Pretty much all kinds,” he answered, “including custom and tract houses.”

“How much of the actual house do you build and how much will it cost?” I inquired.

“We build most all of the house, except we subcontract the plumbing and electrical to top-notch firms. Your house should run about $100,000,” he told me.

“Tell me about your educational background.”

“Well,” the builder said, “I graduated from San Diego State University in industrial arts and began building homes when I was 22. I’ve built over 500 homes. In addition I subscribe to Professional Builder, Building Design & Construction and California Builder.”

Finally, I asked him, “What conflicts of interest do you have in building this home?”

“Nothing unusual,” he said. “I own the lumber company that supplies the wood for the project. Our prices and mark-up are competitive and it helps me control your cost. I’ll make $10,000 on your house, but I don’t think you begrudge me that.”

“Thanks for your time. Draw up a blueprint based on my thoughts and have it back to me as soon as possible.”

In subsequent conversations with the builder, he told me he felt the wood in the kitchen was bad, not the design. No one is really sure why the toilets don’t flush and the fence is falling. That can happen to anyone. And besides, he gave me his background and disclosed his conflicts of interest. Since he had made a full disclosure, he was off the hook.

Disclosure for financial planners is at the heart of SB 315, but if the example of my home is a lesson, the bill does not go far enough. Some obvious faults in the bill center around the halfheartened inclusion of attorneys and certified public accountants, the complete exclusion of banks and the lack of educational guidelines and performance guarantees.

A financial planner sitting in a bank office isn’t regulated. And even with disclosure, few clients will know whether the disclosed education of the planner is suitable. There should be testing and ongoing educational requirements. After all, a stockbroker must pass a test to deal in stocks, and an insurance agent must pass a test and keep a license current to sell insurance.

Education of the planner is the key. The bill should require the adviser to pass an industry test and remain current with changes in the financial framework. Without this requirement the bill doesn’t go far enough.

And what if the adviser’s financial plan is simply no good? There is no recourse to remove the member from the financial advising community, as long as the adviser--like my builder--disclosed certain facts. Shouldn’t the goal be to train good planners and remove poor advisers? Only a very small segment of the consuming public will be able to ascertain the pertinent education, performance and personal qualities necessary for a planner from this bill.

The proposed legislation is a small step in the right direction. Nevertheless, caveat emptor.