Without Broker Education Clause, Reform Bill Falls Short

by: Jake Zamansky

Late last week, the House of Representatives narrowly passed a bill intended to rein in Wall Street’s worst excesses. The bill is designed to protect the rest of the economy from the big banks’ enormous appetite for risk. Some of the proposed changes are systemic, and the banks are now furiously lobbying to defeat those measures.

In addition, the bill has some provisions aimed at helping retail investors. For example, the bill would impose a fiduciary duty on brokers, requiring them to recommend only suitable investments and to put their clients’ interests ahead of their own. This step is long overdue since brokers, just like their investment advisor counterparts, typically offer products and services that go well beyond the simple purchase and sale of stocks and bonds-giving advice on mortgages, insurance, college tuition and retirement planning. In light of these wide-ranging responsibilities, many of which go to the heart of investors’ financial well-being, it only makes sense that brokers should be held to this higher standard.

The fiduciary-standard provision of the bill, while welcome, will not by itself protect investors. In fact, another fundamental problem remains unaddressed: every day of the week, under intense pressure to produce, brokers sell to their retail customers complex and opaque products that not even the brokers themselves truly understand. I’m talking about so-called “structured products.”

Brokers have pushed billions of dollars worth of these derivatives on their retail customers in recent years, many of them with snappy names like ELKs, LYONs and SPARQS. Behind the hollow promises of principal protection and the downplaying of risk lie two factors that-- when combined-- can lead to ruin. First, in an effort to shore up their balance sheets amid rocky economic times, banks pushed their brokers to step up their sales of these structured products. The brokers in turn targeted their otherwise conservative and unsophisticated customers looking to combine safety with some upside. And second, the banks failed to educate their brokers on the workings and risks of the products. In the current era of rapid financial innovation, that failure has had terrible consequences.

I am hearing from brokers coast-to-coast that the so-called training they received to sell these products was laughably weak: A couple of blast voicemails, the occasional webinar, maybe a lunch session. I have come to learn that the focus of these “training” sessions was actually on selling rather than on genuine education. So when brokers claimed the products were “like CDs,” “risk-free” or “guaranteed,” some may not have been knowingly deceiving their customers. Instead, they may have been earnestly-and mistakenly-passing on the assurances they received from above. Both brokers and their customers deserve better.

Back in 2005, FINRA put its members on notice that they should be careful in selling structured products to their retail customers. They were urged to educate their brokers on how the products work, on their risks and benefits, so the brokers could fairly discuss the products with their customers. It is now clear that some of the top brokerage firms chose to ignore that warning, putting profits ahead of people. That’s why the Wall Street reform bill and the fiduciary-standard provision will fail without an education clause and an enforcement mechanism to make sure firms follow through. Short of that, despite Congress’s best intentions, we will continue to see woefully undertrained brokers pitching the “product of the week” to their customers, and everyone will pay a steep price.

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