TAKING SIDES: Investor confidence makes the market

What should someone make of the public’s reaction when a 15-year-old who makes nearly $800,000 through stock fraud over the Internet is hailed as a hero instead of a cheat?

According to Securities and Exchange Commission Chairman Arthur Levitt, the public is merely reacting to a perception that he did nothing different from what industry professionals do every day.

That was one of the points Mr. Levitt made during his speech last week at the annual meeting of the Securities Industry Association in Florida. His remarks were largely upbeat and reflective, based on his years in the industry and as its chief regulator. But Mr. Levitt also made clear that even in these prosperous times, the market is “not immune to creeping cynicism.”

He was putting it mildly.

During his speech, Mr. Levitt demonstrated a clear understanding of the changing dynamics of the marketplace, unlike many in the industry who are still trying to do business the old-fashioned way. The fact is, the market is changing dramatically, driven by what Mr. Levitt calls “the rise of the individual investor.”

Indeed, the democratization of the stock market has changed and will continue to change the rules of investing unlike any other trend in recent memory. Individual investors are now the driving force, and how well the industry recognizes the trend and serves the new constituency will go a long way in determining the long-term health of the market.

Much of the SEC’s effort during Mr. Levitt’s tenure has been focused on that realization. As he told the gathering, “Nothing more than the power of a confident investor guarantees a steady flow of business.”

He emphasized “disclosure” and “duty” as the top priorities for maintaining investor confidence.

“Whenever practicable, costs should be transparent to both the market professional and to the investing public,” he said in his prepared remarks. By the same token, he noted, “market intermediaries are bound by fiduciary duties to act in the best interest of their customer.”

In other words, he explained, “those that spend other people’s money must exercise the same care as they would in spending their own.”

Those are lofty goals without a doubt, but as yet still unrealized.

Even as he spoke, he noted, the SEC’s division of investment management was nearing completion of a comprehensive study of mutual fund fees. The study is a prelude to a broad attack on what he calls the “tyranny of compounding high costs” of mutual funds. Among other things, the study will recommend standardized dollar disclosure fees.

Mr. Levitt raised concerns about brokerage commissions, their impact on fund expenses and the lack of more competition in full-service commission rates. “Why hasn’t the emergence of electronic markets – which offer execution five times cheaper – driven these commissions lower?” he questioned.

He also challenged the current practice of allocating IPOs, which are largely still determined by the “weight of the brokerage relationship” with clients. “Those clients that direct most brokerage business to investment banks are more likely to be rewarded when it comes time to divvy up an IPO,” he conceded.

The problems also extend to the costs imbedded in the markets. “More pointedly,” he said, “investors are being denied the benefit of narrower spreads – and the industry is keeping the difference.” Those costs are largely invisible to customers.

And finally, he called attention to abuses of an SEC rule that permits corporate officers and directors to adopt certain stock option plans without shareholder approval. In the coming weeks, he said, the agency intends to require full disclosure of options grants that dilute shareholders’ stock holdings.

All of this, he said, “brings us to a fundamental truth. Investors commit capital because they have confidence in the quality and the integrity of America’s markets. That faith does more than fuel markets – it makes them possible.”

We wholeheartedly agree.