Commentary: Teaching The Rules Of A Stacked Game
Critics have long complained that "investor education" is, all too often, little more than thinly disguised self-promotion by securities firms and Wall Street trade groups. So when a $52.5 million "investor education entity" became part of the $1.4 billion global research settlement between the Securities & Exchange Commission and the 10 largest investment banks, cynics predicted that it would do little more than teach people how to buy stocks -- rather than warn investors against industry abuses. Their views hardened when Charles D. Ellis, an old colleague of SEC Chairman William H. Donaldson, was picked as chairman.
At first blush, Ellis seems a far from propitious choice. His selection was criticized as "very troubling" by Charles W. Austin Jr., president of the Public Investors Arbitration Bar Assn., an organization of investors' lawyers. Austin noted that Ellis is a "lifetime member of the financial services industry" and likened his appointment to the fox not just guarding the henhouse, but building it. Ellis responds that he "honestly doesn't see how [his appointment] can be troubling, and if so, I'd like to know what it is."
Well, the answer to that is simple: The 66-year-old Ellis is a Wall Street insider in a position that seems to cry out for an outsider. His résumé says it all: former vice-president of Donaldson, Lufkin & Jenrette Inc. (CSR ), founder of a prominent pension fund consulting firm, and author of numerous books that usually carry glowing blurbs from Street luminaries. It hasn't helped that Ellis has said he may appoint brokerage execs to the group's advisory boards -- a questionable idea, since the fund was set up to correct monumental abuses by Wall Street analysts.
But let's not be too hasty to hold Ellis' curriculum vitae against him as he organizes the "entity" in the coming months. Ellis may prove to be an inspired choice if -- and this is a huge if -- he puts into practice the kind of things he has been saying in his books, particularly his best-selling Winning the Loser's Game: Timeless Strategies for Successful Investing. A perusal of his writings discloses that Ellis has had insightful things to say about the brokerage industry. If Ellis abandons his ill-advised notion of taking advice from the industry and hews to the sentiments he has expressed in the past, he'd be off to a fast start:
DON'T TRUST YOUR BROKER. Any investor education program worth its salt needs to teach investors about the basic rules of the game -- including how brokers make money at the expense of investors. Ellis made the point eloquently in Loser's Game: "Don't be confused about stockbrokers. They are usually very nice people, but their job is not to make money for you. Their job is to make money from you." Ellis noted that the typical stockbroker talks to 200 customers a year with invested assets of $5 million. To earn $100,000, brokers must generate $300,000 in commissions, 6% of those assets. So "the broker cannot afford the time to learn what is 'right.' He has to keep the money moving -- and it will be your money."
AVOID "HOT" INVESTMENT PRODUCTS. Investors also need to be taught about the pitfalls of real estate partnerships, hedge funds, and other investment products that tend to be far more lucrative for promoters and brokers than for investors. Ellis has certainly cautioned against such things in the past. "Don't invest in new or 'interesting' investments," he has written.
FORGET PORK BELLIES. Commodities futures contracts are another sucker bet, in which the risks are horrendous for most small investors. Ellis has strongly advised against commodities in his writings, saying bluntly in Loser's Game: "Never do commodities."
AS A MATTER OF FACT, FORGET ABOUT STOCKS ALTOGETHER. Over the years, Ellis has extolled the virtues of index funds, which he has encouraged investors to buy instead of individual stocks. Indeed, he sits on the board of Vanguard Group Inc., the fund group that sponsors numerous index funds. Such funds are like giant vacuum cleaners that suck commissions from the wallets of brokers, and as such they are despised by the Street.
Ellis cautions against drawing any conclusions from his past investment writings. "I have some opinions and I think they're pretty good opinions, but I'm not going to impose them on investor education," says Ellis.
Well, that's too bad. They are indeed good opinions, and they must be promulgated by the education group if it is to have any credibility. Ellis needs to ensure that investors are told the truth about the realities of the securities industry, no matter how much that may dismay his old pals on Wall Street.
By Gary Weiss