| 04 March 2010

"Conflicted" is a mild way of putting it. When we read news today that FINRA's Education Foundation has approved $1.5 million in grants to support local community education efforts, we are happy for those underserved communities, and we are happy for United Way and their new funding partner. Good for them.

We are disheartened, to say the least, that the FINRA foundation abandoned its mission to educate investors. While their parent organization takes on serious heat (yesteday a government oversight group called the organization "incestuous") it seems to us that the Foundation exists simply to smooth the waters with feel-good stories focused on grass-roots community education initiatives.

And what's so wrong with grass-roots community education initiatives? Nothing, if that's your charter. But FINRA's Education Foundation was created to help "the investing public that could benefit from additional resources." Instead, with this latest grant, they've chosen to focus on helping low-income households develop a budget. We are certain these households and communities need help. But we are also certain that there are plenty of higher-income investors who are unprotected, uneducated and at great risk of losing all that they have worked hard to achieve thanks to lax oversight and a dearth of available quality education.

The Foundation's stated goals sound great to us: "Our grants allow researchers to explore investor behavior and develop practical ways to avoid costly mistakes and prepare for the future," they say in their mission. "Grant funding also helps nonprofit organizations ensure that reliable financial and investor education is available to all who need it, when they need it—at the workplace, online 24/7, or wherever it’s most effective." Here, here!

"By sharing research and tools broadly, the FINRA Foundation adds to the collective wisdom about how best to help investors." [Emphasis added.] 

To be fair, the FINRA Foundation has funded a few interesting initiatives, such as a study at the Florida State University to understand "superior personal investing performance." But most of their initiatives, strangely, are not aimed at the prime investor demographic. Instead, they focus on low-income, teens, and broken households. We even wrote with dismay about their effort to fund law clinics for people who shouldn't need law clinics.

With all this in mind, we decided to come up with our own list of 10 initiatives the Foundation should fund, based on their own stated goals, but that they probably won't:

1. A study comparing the recommendations made by financial advisers and brokers. The idea here is to see which group performs better over the long term and which group acts in the best interests of their clients. The results should shape legislation. Financial advisers have a fiduciary responsibility to act in the best interest of their clients. Brokers, however, are only held to a "suitability" standard and often push certain products in order to receive a higher commission. The New York Times gave us a great explanation about this today.
   
   
2. A study analyzing the turnover at brokerage firms. Turnover is a reflection of a firms ability to retain clients and by-and-large clients who make money and feel good about their performance don't switch firms. If, however, a firm encourages inappropriate activity (such as frequent, unprofitable trading) the firm profits in the short-term but turns over many more clients long-term. Their profitability allows them to harvest new clients and continue the loop. This is a particularly dire problem among foreign currency dealers.
   
   
3. An effort to develop educational materials and disclosure guidelines for investors so that they can better understand fees. This is a two-parter. Investors often don't understand the fees they are charged by their advisers or how those fees are levied. Even companies like Schwab are guilty of receiving kick-backs for pushing certain funds which appear to be "free" to the individual. (It is not illegal, by the way.) Then there are the fees charged in the products themselves. Mutual funds are particularly nasty in this regard. Most investors don't know anything about this.
   
   
4. A study analyzing how much a 401(k) and/or IRA investor pays in fees as a percentage of total gains or losses. We include a second suggesting to analyze fees since there's a whole group of investors mucking around in 401(k)s that never leave the confines of their corporation's "platform." So their fee dilemma is unique. There are some great studies available and cases pending, but they are outdated and we are looking for more consistency. We also suggest that we develop a simple tool comapring the costs associated with marketing a fund to its subsequent performance.
   
   
5. Creation of a group responsible for ranking the efforts of "educational" companies and publishers on their ability to actually improve the investing returns of their clients. Financial education firms and publishers work behind what is known as the "publishers's exclusion" and are therefore exempt from SEC or FINRA oversight. The FTC gets persnickety if they don't tell the truth. But rarely are their claims of returns verified. Instead of working to regulate their efforts, we suggest FINRA fund a program to just go out and track and verify their performance. Mark Hulbert did this for years with his Hulbert Financial Digest, but we humbly suggest the industry has changed and evolved beyond his oversight capabilities. How did Money Magazine's "10 Best Funds to Own Now" perform last year anyway?
   
   
6. An agency to review the marketing materials of education providers and publishers. Yes, this is slightly different than #5 above. And we admit that #5 may be too difficult to create, so we add this one as a back-stop. If FINRA can review every little bit of marketing created by every registered broker and adviser for accuracy and truthfulness, why not create a similar standard for investing education providers and publishers. Before you can claim returns of 4,801%, they have to be verified and they have to be achievable to the average investor today.
   
   
7. An annual award fund for the best new initiative by a broker or adviser to protect the interests of his or her clients. Hey, what works for the Nobel Committee works for us. If you encourage and reward positive behavior we are given a chance to focus on what could be right in the investing space, rather than all that is wrong with it. You want positive PR, FINRA? Go out and prove that not all brokers act in their own best interests.
   
   
8. A program to help compulsive day-traders. We have similar programs for compulsive gamblers and alcoholics. It's time to recognize compulsive day-trading as a problem.
   
   
9. Study the impact of survivorship bias on a fund company's track record. Survivorship bias is the ugly truth that fund companies are able to tout impressive track records because they sweep their losers under the rug. How good are they if you include the disasters? While a few studies of survivorship bias exist, we suggest the creation of standards here.
   
   
10. An effort to improve the readability of statments and prospectuses. This is one of the most important sentences in a PowerShares prospectus for the PowerShares DTO product: "The Crude Oil Double Short ETNs offer investors two times leveraged exposure to the inverse monthly performance of the DB Benchmark Crude Oil Index, plus the monthly TBill index return, subject to the investor fee." We understood it. Did you? 

The irony is not lost on us that many online brokers go to great lengths to educate their clients, without any such requirements from FINRA. Firms like optionsXpress (OXPS), for example, have hired internal VPs of Education. Scottrade recently launched a comprehensive Knowledge Center. E*TRADE Financial (ETFC) works closely with groups like The Market Guys to produce a slew of live and recorded educational events for their clients. TD Ameritrade (AMTD) bought investing education provider Investools (aka thinkorswim) last year for a hefty $600 million. They added accounts, but also a full array of educational products and initiatives.  

We suggest that instead of paying their executives huge bonuses for not doing their jobs, FINRA insead funnels that money into their Education Foundation to fund real initiatives, with real money, that really help investors. They need it.

We had plenty more ideas that didn't quite make the list, but are nontheless interesting! We thought, for example, it would be interesting to document how frequently industry professionals move from FINRA to the SEC and then to the NY State Securities Agency and then back again. But we figured that one wouldn't make any list.

What about you? Any grant ideas you want to share?