by Cynthia Harrington

The new regime at the Securities and Exchange Commission took on the mission of restoring investor confidence in Wall Street - and auditors and financial managers in public companies felt the impact directly.

Then SEC Chairman William Donaldson took the reformation parade directly to the benefit of shareholders. Buoyed by an agency budget that was roughly twice the size of previous years’, his staff is administering the new proxy disclosure and analyst independence rules, and preparing for massive investor education efforts.

Reforms aimed at helping individual investors don’t always help their financial advisors equally, as independent research will both help and hurt.

According to Peggy Ruhlin, CPA, PFS, CFP, of Budros & Ruhlin, in Columbus, Ohio, independence needs to be protected. “As long as investors think analysts have some expertise, we need to enforce independence or just call them what they are - shills,” she said.

Maintaining that independence comes at a cost. If analysts aren’t compensated by investment banking clients or for the transactions they encourage through trading desks, some new source of revenue must be in the offing.

“We monitor the research costs of our separate account managers,” said Bertram J. Schaeffer, CIMA, national director of investment advisory services in Ernst & Young’s Philadelphia office. “The move to independent research potentially impacts the cost of the research, or it might affect the quality of the decision-making process.”

“Ultimately this move will impact the individual investor because the costs will need to be born by somebody. Ultimately, the investor will pay,” he added.

A lack of independence has already cost Wall Street. Ten firms coughed up $1.4 billion to apologize for the lack of analyst independence. $80 million of the settlement is earmarked as a starter pot for proposed investor education programs.

Whether the programs bring real benefits depends on the content. “I doubt the programs will address the more important issue of asset allocation,” said Glenn Frank, CPA, PFS, CFP, MBA, of Tanager Financial Services in Waltham, Mass. “The general public is better off just buying a series of index funds and leaving them alone.”

Tanager’s clients are not usually among the general public, because its minimums are in the millions. Frank reports that the firm did lose a few impatient 20- and 30-year-olds who had created that sort of wealth in the late 1990s. “Most of our clients are older and have been to the school of hard knocks,” said Frank. “For instance, we don’t have to have that diversification conversation with them more than once, because they have been down the other road themselves.”

Advisors’ work could be made easier with specific investor education. “Investors need to be educated, but not about the technical aspects of the markets,” added Ruhlin. “They need to learn about their emotions and the fear-and-greed syndrome and how not to get caught up in that.”

The SEC has already instituted new rules about the treatment of proxies and votes. Registered investment advisors who manage assets must now send out a written explanation of their policies and procedures for casting their votes.

“This new rule burdens us with increased paperwork, compliance tasks, and hours of work. The problem is that the government requires the same of the little boutique like us as they do of the giants like Merrill Lynch,” said Ruhlin. “We had to mail that stupid thing out to all our clients and it disclosed nothing new.”

New rules about proxy voting cut both ways for advisors. The purpose of telling clients about their procedures is to let the investor evaluate the quality of their advisors’ decisions. Potential conflicts of interest exist where advisors may have relationships with companies or management that could be counter to the best interests of the investors the advisor serves.

“I thought we solved the problem of potential conflicts of interest by becoming fee-only,” Ruhlin said. “We work only on behalf of our clients, we don’t take soft dollars, and we already disclose everything about our business on our ADV [form].”

The disclosure demands are more aggressive for registered investment companies like mutual funds. Mutual fund managers and other asset managers now must disclose not just how they make voting decisions, but actually how they voted the proxies under their care. Ruhlin doesn’t expect any changes in their mutual fund selection process. “We evaluate management teams on many criteria,” she said. “We just wouldn’t place client assets with a team that it wasn’t already obvious they were working in the best interest of the shareholders.”

Following the votes of mutual funds could be useful to them, though. “We know TIAA-CREF, for example, has a reputation as a shareholder advocate. How they vote on certain issues might provide guidance for our decisions,” said Ruhlin.

Most advisors are users of the new proxy disclosure information, not as fiduciaries but as evaluators of asset managers. Ernst’s Schaeffer said that the changes will affect them. “Case law rulings under ERISA already mandate that we review proxy voting records,” he said. “To comply with these rules for qualified plans, we evaluate the voting records of the separate account managers we present to clients to look for potential conflicts of interest.”

But mutual fund companies labor under tighter SEC scrutiny already. Despite this, mutual funds have historically been able to disclose all information on a delayed basis, including which securities they own.

Delayed disclosure of their activities lets the fund company feel assured that they maintain an edge in a marketplace built on their proprietary knowledge. “The new disclosures of proxy voting records allow fiduciaries to evaluate whether the fund manager is really acting in the best interests of the shareholders,” said Schaeffer.

Reforms often come in waves to respond to a crisis.

The SEC itself was established to protect investors from the kind of abuses that led to the Great Crash of 1929. The agency was kept busy in the last decade in response to the S&L crisis and the insider trading scandals. Time will tell whether the new investor protections help or hurt the individual.

“So often, new regulations focus on the minutiae,” said Frank. “We can’t see the forest if they keep throwing trees in our path.”

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