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The Cost of Regulation

by on May 31, 2015 6:00 AM

At a conference in Las Vegas, Mark Cuban had disparaging remarks for the Securities and Exchange Commission (SEC), saying, "...burn it down and start again."

Certainly, there is a personal grudge in the entrepreneur's dislike of the SEC.

The commission went after the millionaire with an insider trading case for which Mark Cuban was found innocent in 2008.

In reality, not many Americans could fight to save their name as he did; Mark Cuban says he spent eight years and $20 million fighting because he believed he had done nothing wrong and, in the end, was proven innocent.

With regard to the case that proved baseless, Cuban stated, "It isn't just about the money or about the fight. What if I lose? What am I gonna tell my kids?"

Even Errors and Omissions (E & O) insurance is created with a caveat limiting any liability to the amount for which they could settle the case. So while insurance may save your finances to some degree, it won't necessarily protect your reputation.

I have been in the investment business all of my adult life and had my share of audits and regulation. As with any industry, you have good guys and bad guys. Of course, most of the news is about the bad guys and their misdeeds.

My concern with regulators is that the rules are being tailored for the lowest common denominator, with rules piled on top of existing rules. This mountain of regulation only works when properly enforced.

For instance, in the Bernie Madoff scheme, he and his associates created statements of trades that never happened and positions that did not exist. There were many regulatory exams of Madoff's operations and none took the time to verify the positions' existence or the trading activity with a third party – a specific action written in the regulators' rule book.

A "trust but verify" policy might have saved victims' money and heartache. Yet, the rules are being multiplied subsequently to try to prevent another similar Ponzi scheme but the reality is the rules were already there. In fact, in a subsequent investigation by the SEC Office of the Inspector General of the SEC's handling of Madoff, it was determined that despite three examinations and two investigations, a thorough and competent investigation or examination was never performed.

The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff's hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff's investment operations that appeared in reputable publications in 2001 and questioned Madoff's unusually consistent returns."

When I started in the business, clients would request a change of address with a simple phone call or note and we would update it for them. Being a local firm, we know most of our clients and their circumstances. In fact, we know their voices when they call. Now, we need signed forms to change addresses.

It seems an advisor in California was changing clients' addresses on their actual accounts, misappropriating their funds and then sending false statements to the clients' real address. It does provide protection for clients, which is very important, but I don't believe that someone willing to steal would let a false signature for an address change dissuade them. Yet, now this rule is in place and it adds to the cost and burden of paperwork for clients.

The real estate bubble and subsequent collapse in housing devastated retirement accounts and the banking industry. Many rules and guidelines are back in place to try to avoid similar catastrophes in the future. Covered under the new rules are financial institutions that are deemed 'systematically important.'

Those institutions are so large that their failure might trigger another financial crisis and thus are expected to have greater reserves and must go through stress tests to see if they would survive another debacle. Many banks that were given bailouts and asked to take over other failing institutions were subsequently fined for their part in the 2008 collapse.

The irony is that the very government that is decrying the stupidity and recklessness of these financial entities was goading them on to give the very loans that triggered the collapse.

A classic example is Barney Frank in June of 2005 saying "Homes that are occupied may see an ebb and flow in the price at a certain percentage level but you are not going to see the collapse that you see when people talk about a bubble...we will continue to push for home ownership." It's like someone encouraging you to lend money to a relative then admonishing you for your stupidity in doing so when they don't pay you back.

In the end, capitalism and free markets require regulation. More importantly, they require ethics and common sense.

In housing, it can be as simple as someone having 'skin in the game,' which means requiring a substantial down payment when buying home --say 20 percent of the market value. This shows a person was capable of creating the money to buy a home and that they are putting their assets at risk as well as the lending institutions.


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Judy Loy, ChFCâ, is a Registered Investment Advisor and CEO at Nestlerode & Loy Investment Advisors, State College, Pa. A graduate of Penn State University, Loy has been with the firm since 1992, assisting clients with retirement planning, brokerage services and investment advice. She can be reached at [email protected]
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