By Jason Zweig | Oct. 5, 2012 5:41 p.m. ET
Image Credit: Christophe Vorlet
The Financial Industry Regulatory Authority is examining how major investment banks and brokerage firms define and manage conflicts of interest between themselves and their clients. Will the first systematic look at conflicts on Wall Street in years make a difference for investors?
In the next few weeks, according to Susan Axelrod, an executive vice president at Finra, its regulators will start to examine 14 big firms, which she declined to name.
Finra—a self-regulatory organization funded by the securities industry—telegraphed its intentions in May, when its chief executive, Richard Ketchum, said in a speech that “we will look to have a focused conversation with you about the conflicts you have identified and the steps you have taken to eliminate, mitigate or disclose each of them.”
Mr. Ketchum added that he would like detailed reviews of conflicts of interest to “become a standard part of operating procedure” on Wall Street.
Finra’s call appears to be the first time in nearly a decade that regulators have explicitly targeted the question of how Wall Street handles conflicts of interest. In a speech in 2003, Stephen Cutler, then director of enforcement at the Securities and Exchange Commission (and now general counsel of J.P. Morgan Chase), urged every financial firm to run a “top-to-bottom review” that would seek to correct “conflicts of interest of every kind.” He added, “No one is in a better position than you to identify” such conflicts.
Mr. Cutler’s speech, say other regulators, led to an outpouring of submissions to the SEC in which firms laid out the conflicts they had identified and the safeguards they had put in place to control them.
Investors should bear two things in mind in light of Finra’s examinations.
First, conflicts of interest aren’t a part of how Wall Street does business; conflicts are its stock-in-trade. Even as they were professing their purity to the SEC in response to Mr. Cutler’s call, many firms turned out to be enticing ignorant borrowers into taking out mortgages they couldn’t afford, unloading portfolios of toxic debt on unsuspecting clients and manipulating one of the world’s most widely used interest rates for their own benefit.
“We understand that conflicts exist,” says Ms. Axelrod of Finra. “What defines firms and their culture is how they deal with those conflicts.”
Even so, it might be too much to expect Wall Streeters to identify their own conflicts.
In a recently published study, researchers led by behavioral economist George Loewenstein of Carnegie Mellon University asked hundreds of physicians and financial planners to evaluate conflict-of-interest policies. Half of each group read a set of proposed rules to minimize conflicts for doctors; the other half saw almost-identically worded rules to reduce conflicts for financial planners.
The doctors were outraged that financial advisers might accept pens, coffee mugs, free meals or educational junkets from investment companies. Yet the physicians rejected the idea that accepting pens, coffee mugs, free meals or educational junkets from drug companies could ever compromise the integrity of doctors.
The financial planners wanted doctors to be barred from accepting gifts from pharmaceutical companies, lest their objectivity be compromised—but thought the same restrictions in their own profession would be unnecessary and onerous.
In short, our eagle eye for spotting other people’s biases is blind as a bat’s to our own.
“Each of us tends to think that we are much more fair and more impartial than other people are,” says Prof. Loewenstein. “So we believe there’s no need for us to worry that we might be influenced by conflicts of interest, even as we think everyone else is.”
“There’s plenty of people who sell bad stuff knowingly,” says Robert Seawright, chief investment officer at Madison Avenue Securities, a financial-advisory firm in San Diego, “but I think the far bigger problem is inappropriate sales that are well-intended. I’ve seen people who sell bad stuff to their moms, because they thought it was the right thing.”
Remember now, as always, that the individual investor is at the bottom of Wall Street’s food chain—a speck of plankton adrift in a sea of predators.
The challenge is to defend yourself without being offensive. Never forget to ask your financial adviser: What benefit is there for you in selling this investment to me? And with a kind voice and a smile, ask for the answer in writing.
Source: The Wall Street Journal