What’s missing from Obama’s reforms: Investor protection

Even as President Barack Obama unveils his financial regulatory reform proposals, critics are hammering the weaknesses in his plan — everything from lack of consolidation of ineffective federal agencies to setting up a dubious council of regulators to the continuing too-big-to-fail bank problem. Still, there is some praise for one of Obama’s proposed reforms — the creation of [...]

Even as President Barack Obama unveils his financial regulatory reform proposals, critics are hammering the weaknesses in his plan — everything from lack of consolidation of ineffective federal agencies to setting up a dubious council of regulators to the continuing too-big-to-fail bank problem.

Still, there is some praise for one of Obama’s proposed reforms — the creation of a consumer financial product safety commission that would monitor the marketing of mortgages, credit cards and other loan products. The agency would take power away from bank regulators, who have proven to be more focused on keeping banks running than protecting consumers. The notion of a financial product safety commission was first proposed by Elizabeth Warren, a former Harvard law professor and now chair of the TARP Congressional Oversight Panel.

Sounds good. But there’s a crucial element missing: some form of protection for small investors, not just borrowers. After all, the victims of the financial meltdown included millions of middle-class Americans who were trying to save for retirement and the children’s college educations. Many were poorly informed about the risks in their investments by their brokers, insurance agents and fund companies.

As first conceived, the financial products safety commission would have played an investor protection role by regulating a wide range of financial products, including mutual funds and possibly annuities. Along the way, however, the idea of giving the new agency authority over investments was scrapped. Pressure from financial services lobbyists was clearly one reason. But mostly, the Obama administration is keeping its focus on the causes of the market meltdown, which include too much consumer borrowing. Says Mercer Bullard, law professor at the University of Mississippi and head of Fund Democracy, an investor advocacy group, “So far I’ve seen nothing to suggest that the Obama administration has any interest in investor protection.”

All of which means the job of looking out for small investors remains with existing agencies —  in particular, the Securities and Exchange Commission, which has famously been asleep at the switch for many years. Just ask anyone who invested with Bernie Madoff.

Since becoming SEC chair earlier this year, Mary Schapiro has promised that the agency will take a more active role. On Thursday June 18, for example, the SEC will hold joint hearings with the Labor Department on problems with target-date retirement funds, many of which shocked investors with their losses in the meltdown. In a recent speech before a House financial services subcommittee, Schapiro suggested that improved disclosure of the risks of these funds was one of her goals.

Still, other moves by Schapiro suggest that investor protection is not a priority. The SEC shelved reforms of mutual fund 12(b)-1 fees, which were designed to pay for marketing for small funds but have become de facto sales loads. And the agency is moving slowly, if at all, toward ensuring that all brokers and financial advisers follow similar high standards.

Currently financial advisers are regulated by the SEC, as well as as the states. And they must meet tough fiduciary standards, which require them to put the client’s interest first. Brokers are regulated by FINRA, a self-regulatory agency funded by brokerages, which only requires them to offer products that are “suitable” for the clients without mentioning conflicts of interest. Most investors don’t know the difference.

Bullard, along with Barbara Roper, a longtime investor advocate with the Consumer Federation of America, were recently named to an SEC investor advisory panel. And last week they sent a letter to the SEC listing long-overdue reforms. Among them: requiring that brokers provide a prospectus before selling a fund; disclosing fund fees in dollar terms on quarterly statements; and mandating a document for potential clients that would explain the differences between brokers and financial planners.

Will these efforts have any impact? Roper is skeptical. “I’ve been an investor advocate since 1986,” she says, “and it just keeps getting worse for investor protection.”

What do you think Obama should do to help protect investors?