Reuters Money

Is it time to clamp down on money funds?

Money market mutual funds are an institution “vulnerable to a crisis…(with) no backstop … no capital … (and) no official liquidity support,“ Paul A. Volcker, former Federal Reserve Board chairman who had recently served a 2-year term as chairman of President Barack Obama’s Economic Recovery Advisory Board, said last month.

“What is the public good that this institution is providing that makes it worthwhile to run a big risk: vulnerability to a crisis?”

He was speaking at a Securities and Exchange Commission discussion of another truckload of proposed regulations — intended, like a now-effective 2010 set, to prevent a recurrence of the September 2008 “run” on such funds — after joking about his long service to the country by identifying himself as having been “once in a while with the Federal Reserve.” The SEC is considering further regulations on money market mutual funds but there are no indications that any formal proposals will be made soon.

It seems like we’ve seen this film before.

It was way back in 1981 that Volcker said “money market funds] are becoming … more like banks … but they do not operate under the disabilities that banks and thrift institutions do.”  He said “the question, obviously, is whether (the same constraints) are appropriate for money market funds, too.”

Back then, as Fed chairman, he was asking Congress for the authority to impose reserve requirements on money market fund accounts from which shareholders could “make withdrawals.” He never got it.

Fast forward 30 years, past the 2008 credit crisis, and he’s still saying that money funds should face bank-like requirements on capital reserves and liquidity.  Maybe, this time, he’ll win. One proposal being considered would regulate money funds as special-purpose banks.

How would you fix money market funds?

When an 849-page Act of Congress was dropped in the country’s lap last July, a brief section buried on Page 513 — telling the SEC to further tighten credit quality regulations limiting how taxable money market mutual funds invest your money — may not have gotten your attention.

When the SEC complied last month by adopting a 21-page release that proposed additional changes and invited the fund industry, shareholders and others to submit comments by next Monday, it may not have gotten your attention either.

It’s, therefore, not yet too late to know what’s involved and to comment, if you wish. (E-mail rule-comments@sec.gov, including File Number S7-07-11 on the subject line.)

The steps leading to this point began when, after months of drafting and redrafting, Congress shoehorned Section 939A, “Review of Reliance on Ratings,” into the Dodd-Frank Act.

It was a reaction to concerns that reliance on credit ratings agencies had become excessive — and costly when agencies’ assessments of some securities’ credit-worthiness were too optimistic — and that this contributed to the financial crisis of 2008.

Aimed at all federal agencies — not only at the SEC — the section:

• Ordered them to remove from their regulations “any reference to, or requirement of, reliance on credit ratings” when discussing “the credit-worthiness of a security or money market instrument…”
• Asked them to substitute “such standard of credit-worthiness as…appropriate.”

Consumer cops: Why we need Mary Schapiro and Elizabeth Warren now

Two women are fending off a vicious man-handling of investor protection.

As Congress pettily wrangles over the debt limit and the next budget, Mary Schapiro and Elizabeth Warren are fighting to protect you against the ravages of Wall Street.

Wall Street and its Republican allies would like to make the Dodd-Frank financial reforms disappear. The money trust has been pouring millions into lobbying to eviscerate the budget of the Securities and Exchange Commission and blocking the formation of the Consumer Financial Protection Bureau.

Mary Schapiro, who chairs the SEC, said she can’t kick start the myriad pro-investor rules of Dodd-Frank without adequate funding. Republicans, lead by Budget Committee Chairman Paul Ryan, want to “starve the beast” in their fiscal year 2012 proposal.

Ryan’s new budget proposal wants to cut off the SEC budget at its knees by giving the SEC $112 million for fiscal year 2012. That effectively freezes the top securities regulator’s funding at 2008 levels. The current budget deal gives the agency a slight increase in funding.

Remember what happened to Wall Street in 2008? The Obama Administration wants $308 million for the SEC to prevent another year like that from happening. The money trust has deliberate amnesia.

While the SEC gathers most of its revenue from fees and fines, it can’t seed key investor protections like an office of investor advocate without the additional funds. Its budget was supposed to double under Dodd-Frank over the next five years. The money trust wants to keep the status quo and de-fund the agency.

Mutual funds: When taxes can hurt

As you’ve gone through the latest annual reports from your mutual funds and considered how to apply what you learned in your investment strategy and tax planning, have you noted that their basic features are not the same? For example, have you noted that some reports have a feature that others don’t: a comparison of pre-tax and after-tax returns?

Have you wondered why?

The answer lies not only in fund decisions to provide these data elsewhere but also in the apparent ambivalence of the Securities and Exchange Commission, an agency of the government whose taxes are at the heart of the matter, about ensuring that people who own mutual funds in taxable accounts know how much of an impact they have.

The SEC knows.

On January 18, 2001, the Commission began a 54-page release, announcing it had just adopted a final rule aimed at improving “disclosure to investors of the effect of taxes on the performance” of mutual funds with this statement: “Taxes are one of the most significant costs of investing in mutual funds through taxable accounts.” Such accounts are of substantial importance among household assets.

Given all the attention paid 401(k) accounts and IRAs by presidents, members of Congress, media and others when the stock market coughs, it may amaze some to read in the release that, according to the Investment Company Institute, almost 40 percent of non-money market accounts held by individuals were held in taxable accounts at the end of 1999. (Ten years later, the ICI reports, it was still 38 percent.)

Noting that many investors are surprised when they learn that “they can owe substantial taxes on their mutual fund investments that appear to be unrelated to the performance of the fund,” the Commission showed it knew why taxes can hurt.

Cheaper financial advice: Will you get what you pay for?

If brokers had to put their clients’ interest ahead of their own, those clients would pay more for financial advice and their investments, an industry group reported recently. A couple with $200,000 in retirement assets would pay roughly $460 more a year in additional fees.

The study was commissioned by the Securities Industry and Financial Markets Association (SIFMA), the group representing  megabrokers and banks, as part of its effort to influence a forthcoming rulemaking from the Securities and Exchange Commission. The SEC is supposed to report to Congress before the end of January 2011 about whether it should require brokers to be fiduciaries – professionals who are legally required to put their clients interests ahead of their own. Currently, fee-only financial advisors are typically fiduciaries, but brokers are required to meet lesser standards: They simply have to recommend suitable investments, and can put their own interests above their clients, say by recommending more expensive investment choices that pay commissions, as long as they are suitable.

Investor advocates criticized the study. ”It’s so incoherent as to defy objective evaluation,” Barbara Roper of the Consumer Federation of America wrote to the SEC. Knut Rostad, chairman of a financial advisors advocacy group, the Committee for the Fiduciary Standard, called the report “a fantastic mythology.” But IRA Hammerman, SIFMA’s general counsel, defended the study, which was performed by Oliver Wyman, a consulting company. “Retail investors deserve strong protections from a new uniform fiduciary standard without sacrificing choice of products and services or facing higher costs,” he said.

The premise of SIFMA’s study and position is that middle-income investors can get more affordable advice if they pay for it indirectly, through mutual fund sales fees and other commissions, for example. SIFMA also said that some investments, such as corporate and municipal bonds, are primarily traded through commission-charging brokers.  It would be hard for savers and investors to buy those products if the SEC came down hard on commissions.

But most observers aren’t expecting that. They believe the SECwill walk a fine line that doesn’t eliminate commissions. The Labor Department recently moved to apply the fiduciary standard to more pension plan advisors, including brokers. Commissions wouldn’t be prohibited, but would have to be collected only if they fit a client-first perspective and were fully disclosed. The SEC is likely to follow the Labor Department’s lead, suggests issue-watcher Ed Lynch, a fee-only retirement plan advisor with Dietz and Lynch Capital.

But a fiduciary standard that leaned on disclosures of potential conflicts isn’t really a fiduciary standard at all, says Rostad.  “If disclosures become the answer to addressing conflicts of interest, the fiduciary standard hasn’t been weakened, it’s been removed,” he said. Roper believes a disclosure-driven rule would offer existing brokerage clients greater protections, but “even if you improve the standard, you’re better off going to someone who is paid exclusively by you to be an advisor.”

No fiduciary for all

The following is a guest post by Tim Kochis, the chairman and former CEO of Aspiriant. Barron’s ranked him fifth in its inaugural listing of the “Top 100 Independent Advisors” in the U.S. in 2007.

As the SEC prepares to begin its six month evaluation of the current rules governing registered investment advisors and brokerage firms, I hope that it takes a nuanced view of reality. Given the array of services, business models and client relationships that need to exist, I strongly believe that imposing a strict fiduciary standard on every firm and individual, in all circumstances, would be a big mistake.

It is important to distinguish sales efforts, the execution of transactions and the brokering of trades from the giving of advice. Imposing a fiduciary duty (putting the client’s interest first) is unrealistic in the sales environment or when brokering an investment between two customers, one a buyer and one a seller. Where both parties are clients, which client’s interest must the financial institution put first?

A non-fiduciary sales environment exists in all economic realms. We rely on consumers’ natural skepticism, access to alternatives, broadly available factual information, and a increasing flood of internet-based opinion to discipline price and quality in virtually everything else we might buy. Why can’t we simply apply caveat emptor to all financial services?

What makes many financial services unique is the industry’s rapid pace of innovation and the unavoidable uncertainty about the future outcomes its services are designed to address, combined with the low level of financial sophistication that afflicts many consumers.

A variable rate, interest-only mortgage, for example, can be a wonderful device for a client with a long horizon on ownership of the property, the discipline to invest (not spend) the cash flow savings, and the financial depth to withstand occasional interest rate spikes. That same device can spell disaster for a client with thin resources, no investment plan, and who must or chooses to sell the property early in the term. The solution, in this example, is certainly not to ban this form of mortgage, or to make any discussion of it be fiduciary in nature, but to make sure that advice about a specific client actually using it be rendered in a fiduciary context.

Disclosure of potential conflicts and “suitability” requirements already exist. Criminal laws and civil remedies for fraud or deceit are already in place. Having to tell the truth is already the law. But, legislating a new regime where all financial services are fiduciary would be impossible to put into practice.

How the fiduciary standard should apply to brokers

The debate over what constitutes financial advice is heading into overdrive.

As part of the pending financial reform legislation, the job of establishing a higher “fiduciary standard” for brokers will rest in the hands of the Securities and Exchange Commission.  On June 25, I sent out an email blast to more than 200 financial advisers (and their press people) to get their opinions about the pending legislation. Overwhelmingly, I heard from independent advisers because the big brokerage firms rarely authorize their advisers to talk to the press directly.

Now the Reuters wealth management team got a chance to sit down with John Taft, head of the Royal Bank of Canada’s U.S. Wealth Management and CEO of RBC Capital Markets Corporation. RBC has more than 800 financial advisers in its stable.

The biggest challenge for the SEC, Taft says, is figuring out how the fiduciary standard will apply to advisers affiliated with brokerage firms, whose breadth of services tends to be much larger than independent financial advisers. “Wealth management firms do much more than just advise clients,” he says. For example, advisers who are attached to a brokerage firm also sell life insurance, offer lines of credit to investors, and trade securities like stocks “on a one-off basis.”

Taft expects the SEC to take a tiered approach when applying the fiduciary standard. “We are not afraid of the fiduciary standard. We act as fiduciaries all of the time,” Taft says. But the fiduciary standard cannot be a “one-size-fits-all solution,” he adds.

Once the legislation is signed into law, the SEC plans to study the issue for six months.

For more of our interview with Taft, check out this Reuters story.