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Sense on Cents Financial Reform

Posted by Larry Doyle on May 21, 2010 9:05 AM |

In the midst of all the legislative wrangling in Washington and the financial gyrations on Wall Street, what does it all mean for everyday American investors? I am not so sure it means all that much. How much are everyday Americans impacted by proprietary trading, derivatives, merged regulators? Very little actually. I am not writing this to discount the proposed financial regulatory reform coming out of Washington, but I remain underwhelmed that it will truly protect everyday investors from the ways of Wall Street.

To this end, I am happy to propose my own Sense on Cents Financial Reforms which I believe regulators should impose on financial intermediaries (brokers, bankers, money managers, et al). I am not only proposing these reforms here, but I am sharing them today with Washington based financial regulators. In deference to my readers, you’re getting the first look. Feel free to share your thoughts on my proposed reforms, and add others which you believe should be implemented.

The goals of my proposed reforms will be to create greater transparency in products offered by financial intermediaries  with an eye to achieving greater understanding of the real risks involved. To that end, I would ask those reading this commentary how often and how extensively you read and review the prospectus for a securities offering? Probably not all that often or all that extensively. Even if you do read the prospectus, do you fully understand all the risks? I am guessing not. How do we rectify this critically important shortcoming in the investment process?

Sense on Cents proposes that financial intermediaries must be required to develop and disseminate a simplified form hereby defined as Risk Parameters for each and every security offered to the public. I believe Risk Parameters should not only cover and highlight the implicit and explicit risks of each and every security offered to the public, but also assign a relative grade of 1-5 for each measure of risk. I would fully expect Wall Street to wail long and loud about providing these Risk Parameters. If regulators do not mandate them to do just that, investors can still request this info from their brokers. If you do not receive this info, then I recommend you find another broker.

What should the Risk Parameters document encompass and detail? The following:

1. Market Risks: How might this security perform in up or down markets? What market benchmark should investors utilize to measure the relative performance of this security?

2. Interest Rate Risks: How will movements in interest rates impact the value of this security?

3. Liquidity Risks: How liquid is this security? What type of secondary market should be expected in this security?

4. Volatility Risks: Will an increase in volatility positively or negatively impact the value of this security? Is there an embedded option in the security which will change in value given a change in volatility?

5. Credit Risks: What type of credit risks are involved in this security? Corporate credit risks? Individual credit risks? Sovereign credit risks? Who is evaluating and assigning these credit risks? What is the outlook for the credit risks involved in the security?

6. Currency Risks: Is there a currency risk in the security? How so? Is the currency risk hedged or not?

7. Structure Risk: Is the security part of an overall structured transaction? Where does this security fall in terms of overall subordination?

8. Counterparty Risk: Even if the security itself performs, are you put at risk if the counterparty with whom you are dealing fails to perform? (Do you think the thousands of investors with exposure to Lehman Brothers wished they had effectively considered this risk?)

9. Extension Risk: Can the return of your principal and interest take on a longer time horizon than initially thought or perceived, thus creating extension risk? How? Why? Think investors in auction-rate securities wish that they were apprised of this risk?

10. Transparency Risk: How actively traded is the security? Is the trading of the security reported on TRACE? If not, how will you be able to know what sort of typical bid-ask spread is involved in the security?

11. Competency Risk: How well versed is the broker in understanding the risks involved in the security? This is a HUGE risk and must be assessed.

Wall Street would fight this Risk Parameters document, but if they were smart they would embrace it. While this document may initially eat into revenues, I strongly believe it will lead to greater investor confidence and ultimately greater volumes.

Are you sitting there thinking that you can’t ask these questions of your brokers, or you don’t feel comfortable asking them? Oh, yes you can. In fact, you must!! Remember, the real lesson of this economic and market crisis is Caveat Emptor. Don’t wait for regulators to mandate that Wall Street implement these Risk Parameters.

If your brokers, financial planners, banks, and money mangers are neither willing nor able to provide you a significant degree of comfort on all of the above risks, why would you do business with them?

I hope you will share this Sense on Cents Financial Reform with your friends and colleagues.


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  • sweet ebony diamond

    Hello Larry,

    The lesson of this crisis is not Caveat Emptor.

    The lesson of this crisis is Conflict of Interest.


    • LD

      Sweet Ebony Diamond,

      Good point. There are obviously many lessons. These are only two of them BUT they are two of the bigger lessons.

  • phil trupp

    Brilliant. Truly brilliant and wise. Risk parameter will give all investors–not just retail trade–an opportunity to make reasoned and pragmatic decisions. Unfortunately, as you’ve noted, Wall Street will fight the concept to the death.

    • LD


      The regulators should not allow the industry to dictate terms. Bring the Risk Parameters to the Hill, get them to pass it, and say “here you go, boys and girls.” This delivery should become industry norm not only for all new issues going forward but also for all outstanding securities as well.

  • EsJee


    What we need is –

    a. Ban on naked short selling

    If the affected security is not delivered within 3 days,
    then the gain will be 100% taxed.

    b. Ban on naked credit default swaps

    Only if you are owning the bonds then you would be
    allowed to buy protection which would be only for 100%
    of the bond value.

    If you happen to sell the bonds, then you are to clear
    the CDS position within 48 hours.

    c. Seperation of trading and banking

    This is putting glass segal act back in force.

    d. Types of accounts for FDIC insurance –

    a. Stock Trading (no margin) Cash upto 100k
    b. Stock Trading on margin Cash 50% no exceeding 50k

    c. Demand checking account All Cash insured.
    Will carry zero or negative interest

    d. Interest (Savings) account

    No cash insured. If investors want to get interest
    then they take risk.

    e. US Bonds account 100 % insured.

    e. Sharing of orderbook with 3rd parties as illegal.

    f. Minimum time an order has to stay in market. It should
    not be possible to just flash show an order without
    intent of actually buying or selling the security.

    g. Limits on leverage at brokerage houses.

    h. Stop losses fraud – providing improved stop loss orders
    to investors where the stock has to actually trade at
    the price or below the price for specific number of mins
    and or specific number of shares.

    i. No management fees without gains on the customer

    This should include all mutual funds as well.

    j. Mortgage backed securities –

    This area – the bank has to have its own money on the
    line. Without this, the system invites fraud.

    k. Rating agencies –

    I am yet to hear any proposal on how to build a system
    of accountability in the rating agencies.

    l. Capital tax reforms

    Some proposals here are –

    a. No capital gains tax and no income tax

    The govt should increase the money supply every year
    by 5 % of GDP and use that as tax collection money.
    The local govt should only use tax as they can not
    print money. The GDP calculation should be done in
    a transperant way.

    b. flat tax

    m. Health insurance and drugs

    Govt should provide all citizens, health insurance at
    a fixed cost. This should compete with private

    The govt should also take over the pension libiality of
    companies and city govts. Here there would be drastic
    cuts and a one size fits all minimum pension to be
    provided by govt. The company should be free to provide
    additional pension but the management of pension funds
    need to be outside of the company and not by the company.

    n. Audit the judiciary (not only fed)

    There is no system in United States where the supreme
    court can rewrite the constitution at their will and
    there is no review. This must be stopped.

    o. Term limits on senators and congressmens on 1 term only.

    I hope we get to these first before anyone else so that
    capital formation can occur in our country once again and
    we are on the growth path.



    • Martin

      About short selling,

      If there are repeat offences, then the party will be blocked from trading the security for 30 days. If this
      happens again for the same security by same party then
      there needs to be heavy penaulty.

      Rest is fine.

  • LD


    You provide a wealth of concepts and topics for discussion. I agree with a number of them, but disagree with a few, specifically management fees (if we go into a protracted bear market, who is going to want to be in the money management biz?).

    As I read and review your financial reform ideas, I am impressed with the extent of your thoughtful opinions and your willingness to share them here at Sense on Cents.

  • disenchanted

    Larry-I agree with most of what you say. One big issue. What investor actually understands a prospedtus? I thought that they were supposed to be written in plain English and not lealeze. If that has changed, they are still difficult to read. A prospectus should be clean, clear and to the point. Then an investor will attempt to read it and maybe be able to understand it. Also, I agree with your point on Management fees. No one has a crystal ball.

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