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Demographic Shifts Create Slippery Slope: NASD: Industry Faces Equal Measures of Opportunity, Risk


As the nation's largest demographic enters retirement in the coming years, the financial services industry will likely be presented with incredible opportunities to meet their investing needs.

But according to Mary L. Schapiro, vice chairman of the NASD and president of its Regulatory Policy and Oversight unit, equally incredible will be meeting the compliance risks associated with America's aging population.

The first risk, Schapiro said in an address to the recent NASD Spring Securities Conference in Chicago, is to assume that the nation's 75 million Baby Boomers command a degree of financial expertise that eliminates the need for intermediaries to conduct proper suitability analysis.

"True, as a group, this generation is better educated than those that preceded it," explained Schapiro, a longtime regulator whose office oversees the rulemaking and governance of nearly every aspect of the securities business. "This is the first generation that became broadly comfortable with mutual funds, with stock and bond investing, even with hedge funds and non-conventional products. But suitability is not a group analysis."

To the contrary, Schapiro offered, suitability depends upon an investor's individual circumstance. Unfortunately, many Baby Boomers are just now racing to catch up with their retirement savings.

In fact, as Schapiro noted, personal savings as a percentage of disposable income in the U.S. is 0.6%, which is the lowest since the Great Depression and far behind the 11% of Germany and 5% of Japan.

Equally disconcerting is that over half of all U.S. workers do not participate in any kind of employer pension or retirement plan, and the average balance an individual has in their 401(k) plan is just $69,000. Among employer-sponsored plan participants, one in five workers does not contribute enough to qualify for the full employer matching contribution.

"We must help them understand that chasing high returns through risky investment strategies is not the path to a secure retirement," Schapiro said.

While Baby Boomers might share some of the same suitability concerns as their parents, like illiquidity and market volatility, they'll be living much longer than their predecessors. That means, Schapiro said, Baby Boomers will need to maintain retirement income for a longer period and may also require continued accumulation of wealth during retirement.

Suitability Challenges'

"We cannot allow the greater wealth and financial sophistication of the aging population to lull us into a sense of complacency. Suitability challenges must be addressed one customer at a time," she remarked.

Another risk, the former SEC commissioner submitted, lies in the very product innovation that has served the financial services industry and its customers so well over the years - but not all innovative products are suitable for all investors. When a firm offers product for the first time, said Schapiro, whose group scrutinizes the marketing and advertising efforts of the industry, the firm might be tempted to market certain features without presenting a full and balanced description of the product. And brokers, she added, may not be entirely familiar with the product.

"The firm must ensure adequate training and guide the brokers' disclosure and suitability analysis," Schapiro said, noting that the NASD just recently issued a "Notice to Members" alert that suggests a number of compliance issues surrounding the sale of new products.

A third risk the NASD anticipates is a failure to recognize the status of new products under the federal securities laws. Perhaps a broker was to sell a product that combined investment with an insurance component. Would that be considered a security, or something else, Schapiro asked.

She cited equity-indexed annuities as financial products that guarantee a stated interest rate, protect against loss of principal and can earn additional interest based partly upon the performance of an index. Thus, equity-indexed annuities could be a useful tool for protecting and accumulating a Baby Boomer's wealth. But some equity-indexed annuities aren't registered as securities, and some firms allow their representatives to sell them as if they were traditional insurance products.

The legal distinction between a security and an insurance product, however, isn't always clear, and firms that keep selling them as a security could be running the risk of a "selling away" problem that has not been adequately policed.

"Moreover," Schapiro added, "equity-indexed annuities are very complicated products that do not provide the liquidity that some older investors may need. Consequently, they present disclosure and suitability issues that the firm has failed to address."

Baby Boomers aren't the only demographic phenomenon that's creating challenges for the industry. Echo Boomers, or those people born between 1974 and 1994, number 72 million and started entering the workforce about five years ago.

These Echo Boomers are beginning to collect wealth, and, as Schapiro pointed out, they might be even more confident investors than their parents, especially since their advanced Internet skills are perfectly suited to researching stocks, bonds and mutual funds.