Just a Regulatory Guy

Arthur Levitt has been chairman of the Securities and Exchange Commission since July 1993, following a long career as a Wall Street executive and chairman of the American Stock Exchange.

Throughout his tenure, the SEC has focused its regulatory efforts on initiatives aimed at protecting the interests of small investors; these include actions against the Nasdaq Stock Market, where brokers were accused of manipulating “buy” and “sell” prices for their own benefit. The commission has also grappled with an explosion of financial services offered to the public, ranging from mutual funds to professional investment advisors, who have proliferated at a rate that makes it difficult for the SEC staff to keep pace.

Levitt will appear at 11:30 a.m. Sunday in the California Ballroom at the Westin Bonaventure hotel in Los Angeles as keynote speaker at the Los Angeles Times Investment Strategies Conference. The event is sold out, but attendance at Levitt’s speech is free, on a space-available basis.

Question: Equity investing has mushroomed in recent years, driven both by the expansion of 401(k) and other defined-contribution plans, and by the attractions of the “exuberant” market. What pitfalls should investors look for in this environment?

Levitt: I guess what I’m concerned most about is that there are millions of new investors who are relatively unsophisticated, who have not lived through the experience of a down market. And my concern is to make sure they understand that markets, by definition, have volatility. I think their level of understanding of investment styles, investment products, investment advisors is critically important to their success.

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Q: What should the brokerage industry do to ensure that customers are more aware that stocks can fluctuate--and that bonds, which used to be symbols of price stability, can also show unusual volatility?

Levitt: I came from the securities industry, so I have an understanding of how products are sold, how brokers are compensated, how customers very often need guidance in terms of handling investments and adapting themselves to volatile markets. I think the industry has to see to it that brokers totally understand a customer’s tolerance for risk and adapt an investment portfolio specifically to that tolerance. My definition of a good broker is one who can most accurately come up with such a portfolio. If you have a 65-year-old customer who is receiving Social Security and has $300,000 in the bank, you would not be buying IPOs [initial public offerings] or relatively unseasoned companies that pay no dividends. You would be more concerned about preservation of capital with the highest level of income.

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Q: Doesn’t the brokerage industry’s very compensation structure encourage abuses? Commissions, after all, encourage brokers to sell not the most suitable products to a given customer, but the most profitable ones.

Levitt: Yes. The industry can do a better job of explaining how brokers are compensated in terms of commissions, giving customers an opportunity to pay a fee rather than a commission, explaining exactly how mutual fund expenses can eat into mutual fund returns. In other words, I think the industry can do a better job of communicating bottom-line costs and results to customers.

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Q: One issue raising a lot of concern lately is whether the SEC has the resources to oversee a mutual fund industry that has grown tremendously. (In 1961 there were 161 mutual funds; today there are more than 5,350.) Can you oversee thousands of mutual funds with the staff you’ve got?

Levitt: Clearly, this is one division of the commission that is being really overextended. We have kind of accommodated to that by inspecting the largest funds more frequently and more intensively. This works because the problems that funds have rarely tend to be unique. They tend to be general problems--so if we’re concerned about a practice of portfolio managers trading for their own account, if we bring a case against one or two managers, that will resonate throughout the industry. That’s true of almost any of our enforcement activities. We can’t possibly cover the total waterfront, but we’re selective about the cases that we bring as a kind of lesson to the industry. I can’t say to you that we or any other commission can totally oversee and eliminate all fraud in America, but by aggressively bringing “message” cases we tend to get that notion out.

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Q: Another area that’s caused a lot of concern is the growth of the investment advisory business. Stories are already legion about investors being taken advantage of by so-called advisors who entice them into unsuitable investments.

Levitt: I’m more concerned about investment advisors’ proliferation than I am about mutual funds because almost anybody can lay out a shingle and say, “I’m an investment advisor,” and do great harm to individual clients.

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Q: The problem there is that investment advisors are regulated by the individual states, which have conflicting standards. Can the commission take steps to promulgate nationwide professional standards?

Levitt: That’s one of the things we’re looking at. We took a step forward last year with a bill that was passed in Congress calling for the states to handle the inspection of the smaller investment advisors, freeing the commission to spend more time examining the larger advisors. And we are considering the notion of licensing standards that are more comprehensive than anything that exists right now.