Protect the Financial Industry by Protecting Investors

Friday marks the first anniversary of the Jumpstart Our Business Startups Act. As the industry awaits overdue Securities and Exchange Commission guidance on some of its provisions, consumer advocates rightly worry individual investors will get burned again.

You may know of someone – a relative, a neighbor, a colleague – who sold a house and now technically meets the "accredited investor" rule with a net worth exceeding $1 million.

But does that mean he or she is sophisticated – ready and able to make decisions about investing in private placements?

Inexperienced and even unaccredited investors, including many clients of the wealth management and financial advisory arms of commercial banks, are likely to find themselves evaluating such choices as a result of the JOBS Act. Among other things, it calls for the SEC to amend Regulation D to allow the alternative investment industry to market and communicate to the broader public about private placements and other products.

In today's world of low yields, the individual investor is hungry for alternatives. Rather than settle for 2 percent on a long-term CD – or nothing if they're among those still sitting on the sidelines of the stock market – he or she may jump at a new product, especially if it's marketed by someone calling himself a financial advisor.

There are some benefits for investors, such as access to information that sectors of our industry have been providing for decades to the privileged few. Those who might not have had access to better-performing products could more easily find them now – even if those investors are not a part of the old boys' network.

But investors could also be hurt. Private placements are complicated products, but unlike mutual funds they've been exempt from regulation under the Securities Act of 1933.

So private placements have often lured unwary investors whose portfolios suffered. In the past three years alone, a number of broker/dealers have folded as a result of ensuing litigation; some of those affected are well-known names.

Some names are well-known. In 2011 Ameriprise Financial sold its Securities America division over failures related to fraudulent private placements that its brokers marketed. Financial advisors like David Lerner have been sanctioned by the industry. In Lerner's case, FINRA last fall levied a $14 million fine and suspended Lerner for a year, accusing the firm of selling a complicated non-traded REIT to unsophisticated and elderly clients.

If we have bad actors selling products fraudulently or investor complaints about unsuitable recommendations that blew up their retirements, you can be sure it will lead regulators to eventually wield their hammers more heavily.

Dodd-Frank and other legislation have emerged from the wreckage of the 2008 crash. Often the outcome can be extreme – and it can make operating a financial business more challenging.

What can we do?

For one thing, target the right investor. This takes on a higher level of importance as unsophisticated investors consider products that might carry greater risks. Consumer advocates already are demanding more investor protections around the SEC's Reg D revisions, with some hinting at litigation against the SEC if they believe its guidance falls short. Defined wealth for accredited investors ought to be higher; one call for minimum income of $400,000 and net worth of $2.5 million is a good benchmark. Financial firms ought to embrace this definition unilaterally; if they don't act to ensure fair play, you can bet that regulatory-minded congressmen in Washington will move to do so.