Adopt Rules on Selling Government Securities
Government securities are generally considered the safest form of investment, but the absence of rules on sales practices can make these securities even more risky than junk bonds.
Just how risky has been shown by the S&L crisis in which many banking institutions -- the principal purchasers of government- and mortgage-backed securities -- lost millions purchasing securities that dealers presented as having predictable rates of return and safety.
Failure to Reveal Risks
Dealers in government securities have been able to repackage and mark up the sales of less-than-sound securities without giving full disclosure. In many cases, dealers have failed to indicate the risks involved in purchasing derivative instruments.
New regulations are required to prevent these unsound sales tactics from creating further financial chaos. One of the most constructive proposals before Congress is a bill that would authorize rules requiring full disclosure by those who sell government securities.
Rules on sales practices for common stock have been extremely effective in stabilizing transactions and in preventing fraud -- and would have the same effect on the selling and trading of government securities.
The Securities Act of 1986, passed after the failures of several major dealers in government securities, requires only that dealers register with the government and keep their clients' securities safely.
Since no sales practice rules were included in this law, many government securities dealers continued to charge excessive fees and sell unsuitably risky securities to banks and thrifts.
Even though lawsuits have been filed against a number of these dealers, the cases are difficult to win because actual fraud must be proven in the absence of sales practice rules.
Rep. Edward J. Markey, D-Mass., a member of the House subcommittee on telecommunications and finance, has proposed a set of sales practice rules. Dealers in government-and mortgage-backed securities would be required to sell government securities with full disclosure and without excessive markups.
These sales guidelines have applied to common stocks for decades and to municipal bonds for years and have proven to be remarkably effective in preventing abusive practices. Furthermore, the regulations cost the government virtually nothing to implement.
Some have contended that these regulations would interfere with the government's ability to sell its debt. However, rules on sales practices have never interfered with the efficiency of the markets in stocks and municipal bonds.
Guidelines are a critical and inexpensive way to reduce the growing financial institution crisis and to better protect banks and individual investors from further losses. They should be enacted.