Taking Sides: Levitt’s legacy: Aiding small retail investors

Last summer, Paul Roye, director of the Securities and Exchange Commission’s division of investment management, told the Investment Advisers Compliance Conference in New York that the federal agency would clear most of the investment-related measures from its agenda by the November elections.

Of course, no one could have foreseen that the election would drag on for most of the month through torturous rounds of court challenges and ballot counting. But for the most part, the SEC has been true to Mr. Roye’s prediction.

Some two years ago, SEC Chairman Arthur Levitt embarked on a crusade to address some long-standing industry problems that skewed markets and put individual investors at a disadvantage.

In many cases, those practices had been business as usual on Wall Street and helped to tilt the game in favor of industry insiders and favored clients.

To his credit, Mr. Levitt realized that the financial services industry was undergoing vast changes, inspired in part by government deregulation. Those changes paved the way for discount brokerages, online investing and a host of other innovations.

Perhaps most important, they opened up the market to a whole new class of retail investors. Today, after 10 years of prosperity, those investors are driving the growth of the market and the financial planning industry.

Many of the reforms that have been proposed on Mr. Levitt’s watch were designed to level the playing field for those investors, but financial advisers stand to gain as well. The new regulations should help them lower costs and improve the quality of their advice to clients.

As InvestmentNews reporter Sara Hansard notes in this week’s issue, the new SEC rule requiring a range of disclosures by stock market trading centers and broker-dealers promises to save investors millions of dollars.

Effective this April, trading centers and dealers must disclose the site where trades are executed, whether investors get the best price available and whether brokers receive payments to route their orders to particular traders, known as payment for order flow. It will also shed light on how firms “internalize” their trades.

The rule is designed to foster competition among brokerage firms, exchanges and electronic communications networks. For the first time, investors will get a glimpse into the process once trades are phoned in by brokers or advisers.

The new rule follows recent action by the SEC to approve Regulation FD, which dictates how corporations must handle sensitive information.

Now they can no longer selectively leak material information to insiders or selected analysts. Whenever they announce anything, it must be available to everyone.

That removes the suspicion – if not an outright practice – that firms tip off their most valuable customers so that they can move in advance of the market.

Finally, the SEC has also enacted new rules to clean up the potential for conflicts of interest in the accounting industry. The rule draws clearer lines between a firm’s role as an independent outside auditor and as a consultant supplying services to the firm.

None of the new rules, of course, is perfect. Each contains loopholes, born of compromise, that will subject them to manipulation. Regulation FD, for example, allows companies to divulge material information if an analyst swears to keep it confidential and not act on it until the information is released.

The auditor independence rule stops short of barring the Big Five accounting firms from providing consulting services for company computer systems, the most lucrative sideline for most of the firms.

And the new trading rule contains a provision that will help protect firms from investor lawsuits that might be filed if a firm disclosed that it failed to obtain the best execution.

Each of those loopholes is troubling in its own right, but on the whole the new rules are a step in the right direction. The SEC also should be applauded for pursuing an examination of the mutual fund industry, including an investigation into the practice of “portfolio pumping,” as reported in this week’s issue.

As more and more individuals enter the market, protecting investor confidence is critical. As his tenure winds to a likely close, Mr. Levitt should be commended for having the foresight to recognize that above all else.