SCOTT REED: Holding financial advisers responsible key to reform

By Scott Reed

With all due respect to John Grisham, his fictional characters, the unlikely situations in which they find themselves and the evil that lurks inside the corporate legal system in his novels, the story of Goldman Sachs is no less compelling.
Its alleged scheme – to create a package of investments that they think will fail, to sell that package to “unsuspecting” investors and then to profit from betting on the failure – is a perfect storyline for a financial thriller.
It’s interesting to me that this happens as I am in the middle of reading the nonfiction book “Too Big to Fail” by Andrew Ross Sorkin.
The book offers a deep look into how our financial industry could have found itself on the brink of destruction. Sorkin interviewed hundreds of key players in the financial world to gain insight into what happened and why, and Goldman Sachs plays a major part in the story he tells.
All the facts have yet to emerge concerning Goldman’s actions in this latest controversy.However, it does seem to be generally agreed upon that Goldman created an investment vehicle to sell to the public and later made a great deal of money by betting against the investments.
It is easy to understand why Congress and the general public would be angry that this sort of thing can happen. At the least it feels that there must have been a breach of ethics in selling something to someone with the expectation that it would rise in price when you constructed the investment from mortgages you thought would most likely fail.
Many think that the Goldman issue will solidify Congress in its attempt to move forward on the Financial Services Bill that will supposedly stop this from ever happening again.
It’s interesting that most people, when caught with their hand in the cookie jar, will admit to trying to get a cookie. However, executives involved in the Goldman Sachs issue testified before Congress with seemingly little remorse for what they had done.
How can that be? How could they have the gall?

Counterparties, not clients
Their argument is that as a market maker they have no fiduciary responsibility to the counterparty.
Notice that they consider their customers as counterparties, not clients. In the role of counterparty, their job is to be fair and try to win, not look out for your best interests.
Lloyd Blankfein, CEO of Goldman, in testimony before the Financial Crisis Inquiry Commission in January, explained it this way: “In our market-making function, we are a principal. We represent the other side of what people want to do. We are not a fiduciary. We are not an agent. Of course, we have an obligation to fully disclose what an instrument is and to be honest in our dealings, but we are not managing somebody else’s money.”
Many members of Congress want to put new regulations in place that will stop companies like Goldman Sachs from creating investments such as those that started this mess.
That sounds good when you say it out loud, and it plays well in the press.
However, the investment world has always relied on the big wire houses and investment banks to create new types of investments for us all to use, and we should be very careful when we decide to bridle those creative efforts.
The bigger problem is that these investments are being sold by people who are paid to sell them, yet are not required to have the client’s best interests in mind when they do.
In my mind, the most crucial aspect of the Financial Services Bill currently in the Senate is the part that deals with a “Fiduciary Standard of Care.”
Some investment professionals are already under a fiduciary standard of care, but most are not.
A uniform fiduciary standard of care for all investment professionals who give advice to clients would mean that everyone giving advice would be required by law to do so with the clients “best interest” as their objective.
Failing to do so would put the adviser in jeopardy of prosecution.

Industry pushback
It seems simple enough and I have found it is what investors have expected from their advisers all along. However, there is a great amount of pushback from the industry.
Many firms in our business like the idea of selling product with a minimum risk to their firm if things go wrong. I can’t blame them for that, but that doesn’t make it right.
There is a difference between selling product and using product, and it is a difference that can have enormous consequences for the investor. It is not the creation of a product that causes problems for investors; it is the implementation of a product.
Holding investment advisers responsible for what they recommend is the fastest way to see real change in the industry and, in my mind, the best way to protect investors from the greed of Wall Street.
If this makes sense to you, let your congressman know that you are for a “Uniform Standard of Care for Investment Advisers.”
You might be surprised at how few products like the Goldman deal would be sold if the advisers who sold it had to act as fiduciaries under the law.

Scott Reed, CIMA, AIFA, is CEO of Hardy Reed Capital Advisors in Tupelo.