Pennsylvania Investment Observer

Heightened Regulation, Unintended Consequences

by Daniel J. Nestlerode

For some time now, New York State's Attorney General Elliott Spitzer has been taking aim at Wall Street, the health care industry and the insurance industry. His high profile announcements have, to some extent, preempted the normal regulatory channels and perhaps embarrassed the Securities and Exchange Commission and the National Association of Securities Dealers - Regulation. All of this activity seems to have caused the regulators to increase their enforcement, auditing and overseeing of the securities industry to a point where the Law of Unintended Consequences is starting to bear fruit. Some of these consequences will have an impact on the retail investor

Heavier handed regulation, generally, is like heavier taxation. The more difficult or costly it becomes to operate in a particular business leads to less service and fewer participants in the industry. This is unintended, but it happens nevertheless. Secondly, as the cost of carrying regulation increases, the investment industry realizes that it can no longer service and sell to clients who do not have large portfolios. No one notices that the successful brokerage and investment advisory firms are concentrating their business on larger and more profitable accounts. Minimums are increased and small accounts no longer have a representative, but are directed into a call center or some other anonymous service bureau.

More specifically, financial institutions are beginning to change their policies so that clients get fewer breaks in charges and fees. The Franklin Templeton Group of mutual funds recently amended their prospectus to prohibit clients from accumulating accounts held at different brokerage firms in order to qualify for commission discounts. As a retail client, neither your broker nor your securities regulator is going to inform you of this change. Franklin Templeton informs its shareholders and potential shareholders through its prospectus, which few people read or understand. If you are like most retail brokerage clients, you probably have accounts with more than one brokerage firm. If you own Franklin Templeton mutual funds through your brokerage firm, however, to obtain the maximum sales charge discount, make sure that all your funds are with just one broker.

In the aftermath of September 11th, all the regulators have decided that each client will have to update all their agreements with their investment firm every three years. In the industry, we call this "repapering". So if you are tired of receiving, reading and discarding the privacy policies of all the financial firms with which you deal, be prepared for a lot more intrusive paperwork. Paperwork, of course, costs money. So if you have a small account, it is very likely that you will be dropped by your brokerage firm.

In stark contrast, the largest retailer in the world, Wal-Mart, has figured out how to effectively deal with clients both large and small, whether you are buying a pack of batteries or a home computer. The brokerage industry, by contrast, under the push of rising costs and deeper regulation, is moving upstream, discarding small clients in order to cut costs, and providing service only to their major accounts. I would seem that, for small investors, the do it yourself investment plan is the only one that will be available in the future.

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