Regulator Seeks to Fill Gaps in Securities Law
The Hunt brothers’ attempt to corner the silver market was just being discovered in 1980 when Mary Schapiro was graduating from law school. The scandal changed her life.
Nelson Bunker Hunt and William Herbert Hunt lost about $2 billion when silver prices collapsed, and they eventually filed for bankruptcy and paid millions in fines to regulators and tax authorities. Schapiro, fascinated by the bold securities manipulation, turned down jobs at law firms to go work for the Commodity Futures Trading Commission, the national regulator that helped nab the Hunts.
Schapiro has been defining and fighting financial crimes ever since, bouncing between the Securities and Exchange Commission and the Commodity Futures Trading Commission before landing in 1996 as vice chairwoman of the National Assn. of Securities Dealers, now known as NASD, which regulates the nation’s 660,000 securities brokers and dealers.
The last five years, plagued with scandals affecting virtually every aspect of the U.S. securities market, have been especially tumultuous for Schapiro and her fellow regulators.
First it was discovered that securities analysts frequently had altered stock recommendations to help their investment banking departments and retail sales staffs. Later it emerged that mutual fund companies had allowed certain favored customers to manipulate when they bought and sold fund shares. And several corporate executives falsified financial reports to boost company share prices and executive paychecks -- sometimes with the help of their accountants.
The individual investor took it on the chin as scandal after scandal helped send stock prices crashing nearly 40% from their 2000 highs.
The market has recovered some of its losses, and many of the analysts, accountants and executives involved in the wrongdoing have been fired or have gone to prison. Meanwhile, regulators have orchestrated an unprecedented crackdown, filing suits to enforce existing laws and initiating dozens of new rules and regulations aimed at better protecting investors. But challenges remain for individual investors.
Schapiro was in Los Angeles recently, and I had a chance to talk to her about what led to the scandals and what is being done to prevent them in the future.
*
Question: Were there holes in either securities regulation or enforcement that led to all the scandals we’ve experienced over the last five years?
Answer: I think there were clearly some areas where regulations needed to be tightened up to keep up with the way the business had changed in the last few years. As a result, there were some gaps.
If you think about how the lines between investment banking and analysts had blurred, for instance, you’d realize that analysts had become cheerleaders for investment banking. I don’t think regulators fully grasped that before all this happened. That’s an area where it was very important to shore up the rules.
Q: What are you doing to try to head off the next investor disaster?
A: We have this ‘ahead of the curve’ initiative where we try to anticipate future problems. We gather all sorts of data and give it to a task force that uses that information to help them determine where problem areas are forming. We also talk to research analysts to learn about the trends they’re seeing. And we’re creating a think tank of academic experts. We have had pretty good results so far.
Q: What are some of the problems they’ve come up with?
A: We’ve seen some brokers suggesting that people refinance their homes and take cash out to invest in the stock market. Some of these homeowners don’t have other assets. They are depending on the income from the investments they buy to repay the mortgage. We’ve seen a few people lose their houses over this.
Q: Is this a widespread problem?
A: We don’t think it’s pervasive, but when it happens, the impact is so great that we’ve put out an advisory on it. We want investors to realize that they may be risking an asset that should never be put at risk.
Q: What other issues are you concerned about?
A: We are looking at a lot of structured products, where the risks may not be clear to investors. We are concerned about hedge fund sales to individual investors and about equity indexed annuities. These products are extremely complex. Sometimes the brokers don’t even know what they’re selling.
Q: What is your main concern about equity indexed annuities?
A: People think that these are securities products because they’re linked to a stock market return, but they’re not necessarily. They are extremely complicated. They have very high commissions, and only about 10% of them are sold by broker-dealers. Those that are sold by insurance agents may not be subject to the rules and protections that apply to securities sales.
Q: So an equity indexed annuity looks like a security and sounds like a security, but investors who buy it are not necessarily protected by securities laws?
A: When it’s sold as an insurance product -- and some of these are -- none of the securities rules applies. We don’t have jurisdiction.
Q: What are you doing to protect investors from these and other securities violations?
A: We’ve got a three-part approach: new rules, enforcement and investor education.
Q: What have you done in the realm of investor education?
A: We have added a number of tutorials and interactive tools to our website [www.nasd.org]. I think one of the best ones we’ve done is a smart bond-investing program. I shouldn’t say this, but I even learned from it.
We’ve got a 401(k) learning center, tutorials on college savings, and we have expense analyzers so that investors can figure the impact of investing in [mutual fund] A, B or C shares. [Each share class has a different fee structure.]
Q: Aren’t the brokers and investment advisors that you regulate supposed to be advising their customers about which type of mutual fund fee structure is most advantageous to them, as well as explaining some of the other issues that are the subject of your tutorials?
A: A lot of consumers use online firms, so they don’t have a broker. We’ve also found that a lot of people want the education so that they can ask their brokers the right questions. They very much wanted to be more knowledgeable so they wouldn’t have to totally place their lives in a broker’s hands.
Q: What’s next on your agenda?
A: I think it’s important for regulators to step back now and look at disclosure. Whether the investor is buying a bond, a variable annuity or any other security, we need to look at what information investors need to get, when do they need to get it and how can we best provide the disclosure so that they can best understand it.
We now have a jumble of disclosures, and the tendency of regulators is just to add more. But that doesn’t necessarily improve the information that’s going out to investors.
*
Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For previous columns, visit latimes.com/kristof.
