Out With the Old, in With the Fintech: How Millennials are Changing the Investment Landscape

By Giancarlo Cueto

They’re risk-averse. They distrust institutions. They want transparency. These are a few of the traits attributed to millennials in a recent Fidelity study. As millennials, or those born between 1980 and 1997, approach their peak earning years, who will manage their hard-earned cash? If history is any indication, traditional portfolio managers, advisors, and brokers would be salivating over the opportunity, given that millennials are now the most populous generation in the U.S. However, the Great Recession dissipated millennials loyalty to history and tradition, opening the doors to the new wave of asset management—Fintech.

Financial technology, or Fintech, is used to describe technology that facilitates and modernizes the delivery and use of financial services. Originally, Fintech referred to technology implemented at financial institutions to manage their operations and processes. But this definition has taken on a new consumer-oriented focus with the rise of the smartphone generation. According to EY’s 2017 Fintech Adoption Index, “one-third of consumers utilize at least two or more Fintech services.” Notably, the explosive growth of Fintech has left some of the antiquated finance giants to play catch up as they lose clients to flexible start-ups aimed at simplifying investing and expanding financial inclusion. Among the key selling points for Fintech start-ups like FutureAdvisor, Betterment, and Wealthfront, are low fees, little to no account minimums, snapshots of your portfolio on your smartphone, and very limited human interaction.

Stefanie O’Connell, the 29-year-old author of The Broke and Beautiful Life, offers some insight to recent trends. “When millennials see baby boomers doing their finances, they worry . . . in their eyes, boomers are the ones who created the problems to begin with.” Some of the industries heavy hitters seem to agree. Back in 2015, BlackRock—the world’s largest asset manager—acquired FutureAdvisor, a robo-advisor start-up based out of San Francisco. “We didn’t think we had enough retail and millennial DNA, [but] if we could find the right firm to bring into BlackRock, we could accelerate our plans,” says Robert Fairbairn, senior managing director at BlackRock. In the end, the fight to manage millennials money will bring either competition or partnerships from the incumbents themselves. In 2015, Charles Shwab launched their Schwab Intelligent Portfolios, a robo-advisor that builds and manages your account. More recently, Goldman Sachs announced a partnership with Betterment, the largest robo-advisor with $10 billion in assets under management, founded by millennial entrepreneur Eli Broverman.

But why the change now? In a survey by LinkedIn and Ipsos, nearly 70% of millennials said they were open to trying financial products and services from nonfinancial brands while only 47% of Gen Xers said the same. This should come as no surprise considering that millennials grew up during peak technological disruption thanks to the likes of Steve Jobs at Apple, and Larry Page and Sergei Brin at Google. Whether this sentiment is a result of more user friendly products or simply trustworthiness compared to big-banks is still up for debate, but millennials certainly seem to lack trust in the financial infrastructure of old.

Concerned About a Possible Recession? Here’s How You Can Protect Your Investments

By Julia Osmolia

The U.S. Treasury Bond Market issued a warning three months ago about a possible recession. A recession is defined as “a period of significant economic downturn that lasts longer than two consecutive quarters.” During a recession everyone is subject to risk, but the level of risk varies depending on how much a person has invested and the strategies used for those investments.

On August 14, 2019, the U.S. Treasury Bond market experienced an inverted yield curve where the 2-year short-term bonds paid more interest than the 10-year long-term bonds. The last inversion occurred in December 2005, two years before the Great Recession in 2007 and three years before the financial crisis in 2008. Since 1985, there have been three inversions, each preceding a recession by 13 to 17 months. As a result, the inverted yield curve is widely regarded as a warning sign that a recession is looming.

An inverted yield curve, however, is just that—a warning sign. It does not mean a recession will happen or indicate how long a recession will last. When an inversion occurs, investors should not panic and make rash decisions about their investments. Instead, investors should evaluate their portfolios to assess any possible damage if a recession occurs.

Below are some ways investors can protect themselves against a possible recession:

  • Evaluate Investment Strategies & Define Achievable Goals – Investors should evaluate and discuss with their financial advisors their investment goals, asset allocation, risk tolerance, and time horizon. Someone close to retirement may want more conservative investments in the wake of a recession, whereas younger investors may have different goals and higher risk tolerances because they likely have more time to recover from losses suffered from an economic downturn.
  • Understand Potential Risks – Investors should know or ask their financial advisor what their portfolio looks like amid an economic downturn to understand the risk they are taking on.
  • Diversify Your Portfolio – Investors can mitigate damages suffered from a recession by diversifying their portfolios. Diversification reduces the volatility of the portfolio because different assets react differently during a recession.
  • Calculate Personal Cash Flow – Calculating personal cash flows helps investors determine how much cash they should have during a recession. This decreases the chances of investors having to sell their investments at the worst possible time to scrape up some extra cash.
  • Confirm Your Broker or Financial Advisor Made Any Necessary Changes to Your Accounts – Investors should contact their financial advisors to ensure the necessary changes have been made to their accounts and that these changes are documented. If a financial advisor completed documents, read through and confirm that the information on the forms is correct before signing any documents.

There is no telling when a recession will happen or how long it will last when it does. Therefore, if you’re concerned about a possible recession, the best safeguard is to ensure you have an investment plan that is tailored to your specific needs to decrease potential losses.

On Track to Modernize SEC Disclosures

By Arda Barlas

Recent Development

On August 8, 2019, the Securities and Exchange Commission (“SEC”) announced a proposal for amendments to update Regulation S-K. The new set of rules is intended to simplify compliance efforts of registrants and improve disclosures for investors. The rationale behind these new rules is the dramatic change in the world economy and markets over the past 30 years when public companies’ business disclosure rules were adopted.

The SEC plans to achieve this rationale by modernizing the description of business, legal proceedings, and risk factor disclosures under Regulation S-K.

According to the proposal, the SEC considered input from comment letters received in response to these disclosure modernization efforts, the staff’s experience, and changes in the regulatory and business landscape since the adoption of Regulation S-K.

What Does the Proposal Say?

Mainly, the proposal foresees amendments for the following items:

General development of the business (101(a))

The proposed revision for Item 101(a) requires the disclosure of a topic to the extent such information is material to an understanding of the general development of a registrant’s business. In such cases, the information will be deemed material if there is a substantial likelihood that a reasonable investor would consider the information important in deciding how to vote or make an investment decision.  Moreover, providing a prescribed time frame for this disclosure is intentionally avoided. Also, the proposed revision for Item 101(a) provides a non-exclusive list of the types of information that a registrant may need to disclose.

Another important update is that the proposed revision for Item 101(a) allows a registrant, in filings made after a registrant’s initial filing, to provide only an update of the general development of the business that focuses on material developments in the reporting period. However, such update should be accompanied with an active hyperlink to the registrant’s most recent filing and along with the update, the full discussion of the general development of the registrant’s business must be present.

Description of the business (101(c))

The proposed revision for Item 101(c) includes human capital resources as a disclosure topic. This topic includes any human capital measures or objectives that management focuses on in managing the business. Again, the extent of such disclosures are limited to materiality. Moreover, the regulatory compliance requirement was extended, as against being limited to environmental provisions, by including new material government regulations.

Legal proceedings (103)

The revision proposed for Item 103, which deals with legal proceedings is designed to encourage registrants to avoid duplicative disclosure. The required information about material legal proceedings may be provided by including hyperlinks or cross-references to legal proceedings disclosures located elsewhere in the document. This will provide more reader-friendly legal proceedings sections and reduce the complexity or confusion significantly.

Moreover, the $100,000 threshold for disclosure of environmental proceedings to which the government is a party to is proposed to be raised to $300,000. The rationale behind this threshold raise is to adjust for inflation.

Risk factor (105)

The proposal requires a new structure for risk factors to be organized under relevant headings, along with any risk factors that may generally apply to an investment in securities disclosed at the end of the risk factor section under a separate caption. Also, the disclosure standard is proposed to be changed from the “most significant” factors to the “material” factors. Also, if the risk factor section is longer than 15 pages, the summary risk factor disclosure will be required to be disclosed.

 

Heightened Duty of Care Under Regulation Best Interest

By Katie Black

Investors often face overwhelming decisions in deciding if and how to enter the market. In addition to the types of investments in which they might be interested, retail investors must also determine who they trust to help them invest their money. By adopting changes to its program of Regulation Best Interest, announced as of June 2019, the United States Securities and Exchange Commission (“SEC”) is working to implement industry-wide protocols that give investors more security in and knowledge of the firms with which they might choose to invest. Set to go into effect on September 10, 2019, the new Regulation Best Interest rule bolsters the standard of conduct broker-dealers owe their retail investor customers through a two-pronged “general obligation” of requiring heightened protection of their customers’ best interests, while also mandating thorough disclosure policies regarding broker-dealer conflicts of interest.

Though the Regulation Best Interest rule acknowledges the fundamental conflict of interest that occurs given the commissions received as compensation in the relationship between a broker-dealer and their investor customers, the rule endeavors to mitigate conflicts of interest that arise when broker-dealers recommend specific investment-related actions for their clients. More specifically, the SEC breaks the Regulation Best Interest rule down into four “component obligations”: disclosure, care, conflict of interest, and compliance.

The disclosure component requires broker-dealers to be up-front with their customers about any investment recommendations, as well as the relationship that broker-dealer has with the customer they are advising. Relative to this process, broker-dealers must disclose costs, services, and limitations regarding their position as investment brokers. Further, the disclosure obligation facilitates enforcement of the conflict of interest and compliance obligations, which call for the creation of and strict adherence to protocols and procedures to disclose and mitigate any conflicts of interest that exist regarding broker-dealers and the investment recommendations they may make.

In addition to the disclosure-related obligations is the new care obligation, which creates a heightened standard of “diligence, care, and skill” in broker-dealer engagements with their investor clients. Moreover, under Regulation Best Interest, broker-dealers are charged with a renewed duty to consider their clients’ exposure to risk, balance that against the potential for reward, and factor in the potential costs that may come of any investment recommendation.

Ultimately, the Regulation Best Interest rule serves to better inform investors, as well as ensure broker-dealer compliance with higher standards of care relative to their clients. Broker-dealers must comply with this Regulation Best Interest mandate by June 30, 2020 at the latest, which gives broker-dealers just over a year from the rule’s announcement to bring their practices into compliance with the new standards.

Shorting Glaciers: Why You Should Know Your Asset Manager’s View on Climate Change

By David Hoy

This year is on track to be the hottest on record due almost exclusively to climate change. With a warming planet comes rising sea levels, severe storms, and drought. While governments are taking steps to prevent, or at least mitigate climate change, asset managers are looking for new investment opportunities. Fund managers now join politicians and business leaders at international climate summits and invest in technology that tracks and predicts significant climate events.

Climate events significantly impact national and local economies. In 2018, more than 1.8 million acres of California land was affected by wildfires which resulted in $24 billion in damages. The damages stemming from the floods in the midwestern United States earlier this year are still unknown, but some estimates put the total losses at least $12 billion. The total long term effects of unencumbered climate change cannot be quantified. Potential profits for those who can model climate trends and invest accordingly, however, can and are being monitored carefully.

Investor response to climate change has come in three forms. There are those who invest in mitigation technology like electric cars and solar panels, those who invest in disaster prevention (think sea walls and disaster kits) and those who place bets on how climate events will impact industries and economies. To a certain extent, the last category encompasses the first two.

In the short term, climate change will hurt some communities and benefit others. Some asset managers have capitalized on this trend by investing in real estate away from the coast because they anticipate that local governments will struggle to provide the infrastructure needed to mitigate the reported one- to four-foot increase in sea level within the next century.

Other professional investors are skeptical that there is enough time to reverse the effects of climate change, but still believe that sound investing can help mitigate its most severe consequences. These firms seek to align their capital with companies that try to reduce the amount of carbon dioxide in the atmosphere and prevent deforestation.

It is essential for clients of large mutual funds and private wealth management firms to be aware of the policies those firms have toward climate change and to understand where their money is going. Some may even opt for climate-sensitive mutual funds that primarily invest in energy efficiency and battery storage. Investors should discount any potential effects that their positions have on the planet from profits made by climate-agnostic firms. Everyday investors should seek to align themselves with asset managers that are climate hopefuls. If they are unsure of how to do so, they should, at the very least, express their concerns to their brokers.

The Dangers of Margin Trading

By Brandon Mantilla

Margin trading, although common practice in the investing community, can make or break your investment portfolio. Many investors, however, do not understand how margin loans work or why they can be so dangerous when not properly utilized or understood. Margin can vastly increase the profit in an account if the leveraged securities increase in value. On the other hand, investors can also lose more money than they put in if the securities perform poorly.

A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. There are several inherent risks investors should be aware of before agreeing to trade on margin. Pursuant to margin agreements, it is usual that firms can force the sale of securities in your accounts to meet a margin call. This means that a brokerage firm does not need permission to sell off securities when it determines an account-holder’s equity in the account is too low. Often firms are also not required to contact the investor when securities are being sold, although they often do. Another surprising aspect of margin calls, as these sell-offs are called in the industry, may be that investors do not have a right to choose which securities or assets are sold in the event of a margin call or to receive an extension of time. Lastly, firms reserve the right to change their margin requirements, or minimum amount of equity as a percentage of current market value, on any security, position, or account at any time without advance notice to account holders.

Despite the heavy risk involved in using margin, you can protect yourself from some of these risks by fully understanding the situation you are getting into when you open a margin account. Firstly, you should always make sure you fully understand how margin accounts work by reading about them in materials from reliable sources such as FINRA or the SEC before opening a margin account. Reading the margin rules, FINRA Rule 4210 and Regulation T, as well as your firm’s margin agreement and policies can also go a long way toward preventing any catastrophic consequences that commonly result from a poor understanding of margin trading.

In the event that you do choose to open a margin account, it is critical to actively manage your margin account by regularly reading account statements to understand exactly what is happening in the account. Finally, as any wise advisor might say, you should not put all of your eggs in one basket. In other words, do not put all of your available money in a margin account. Although a financial professional may want to maximize your margin use to raise funds for the firm on interest, keeping safety net funds outside of the account is integral to maintaining your financial well-being.

SEC Adopts Rule Intended to Protect Retail Investors

By Shawn Wilborne

On June 5 2019, the U.S. Securities and Exchange Commission (SEC) adopted a package of rules and interpretations relating to its Regulation Best Interest, including the Form CRS Relationship Summary (Form CRS). Form CRS is designed to increase transparency and decrease confusion surrounding investment relationships. Form CRS requires broker-dealers and registered investment advisors to provide retail investors with clarity and understanding. For example, firms are required to provide the nature and scope of services offered, the type of fees the investor will incur, any conflicts of interest, and the firm’s disciplinary history.

In the interest of simplicity, the Form CRS has a two-page limit. Dual registrants — firms operating as both a broker-dealer and an investment adviser — are permitted to combine the forms, but it must not exceed four pages. The format of the form is question-and-answer to promote standardization and to allow the SEC to easily compare filings. Initially, the Form CRS filings will be under close review by SEC staff “to help ensure that the relationship summary fulfills its intended purpose.”

Indeed, clarity and transparency are key elements that the SEC wants to preserve for retail investors. The SEC defined retail investor as any “natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.” This definition includes potential and existing customers. In addition, the retail investor definition applies to natural persons regardless of assets or net worth. In pertinent part, the SEC found that “all individual investors would benefit from clear and succinct disclosures regarding key aspects of available brokerage and advisory relationships.”

Individuals participating in 401(k) and other employment retirement plans are also included in the Form CRS requirements. However, the SEC noted that participants making ordinary plan elections and not selecting a firm or brokerage or advisory service, fall outside the definition of retail investor and the Form CRS delivery obligations.

Moreover, brokerage firms and registered investment advisors must include on their websites an introductory paragraph with a link to the SEC’s investor education website. The SEC and its staff will also develop additional education content to increase the information available to investors.

The deadline for firms to file initial Form CRS’s is June 30, 2020.

Financial Exploitation of Seniors

By Mariano Scialpi

Senior citizens have found themselves in the cross-hairs of scammers and fraudsters throughout the United States. Financial exploitation occurs when a person misuses or takes the assets of a vulnerable adult for his/her personal benefit. This exploitation frequently occurs without the explicit knowledge or consent of a senior or disabled adult, depriving him/her of vital financial resources for his/her personal needs. New data has shown that senior citizens become increasingly vulnerable to all forms of frauds as they age. This data is concerning for a class of people that hold “83% of the wealth in America.”

The numbers are even more alarming in the securities industry where the AARP recently reported “victims lose $3 billion annually or more than $120,000 per household.” The losses reported by the AARP symbolize the life savings of a generation who can longer work to maintain a household. The Investor Rights Clinic has represented many seniors who have lost their life savings due to financial exploitation. Although the work the Clinic performs provides essential relief to victims of exploitation, changes in policy are necessary to protect a vulnerable class of citizens.

Before 2018, the numbers from the AARP report were aggravated by the lack of statutory language protecting whistleblowers in the industry. Luckily, in May, senior citizens could applaud the first anniversary of the Senior Safe Act (SSA). SSA, a federal program modeled on a program by the same name in Maine, has attempted to empower financial service providers to “identify warning signs of common scams and help prevent senior citizens from becoming victims.” More specifically, the act “addresses barriers financial professionals face in reporting suspected senior financial exploitation or abuse to authorities.” The act addresses these barriers by allowing broker-dealers the opportunity to train their employees on how to detect and report “senior financial exploitation.” Broker-dealers who train their employees are provided immunity provisions from liability in any civil or administrative proceeding, particularly regarding violations of privacy requirements.

Although the SSA represents an important step towards protecting elderly citizens, a lot more can be done in terms of policy. One financial advisor advocates for quizzing clients over 60 on their decision-making abilities. Basic tests might be a simple way to ensure that senior citizens are fully aware of the decision they are making regarding their finances. One thing is sure, financial exploitation of the elderly is a problem that will not go away in the future, and only Congress has the power to protect its constituents from further abuse.

Hidden Impacts of the US-Mexico Trade War

By Mathew Slootsky

On May 30, 2019, the President issued a threat to apply tariffs of up to twenty-five percent on goods imported from Mexico. Although the President later canceled the planned tariffs, he may decide to impose tariffs at a later date. The first thing that comes to mind when reading this for most consumers is, “How will this affect me?”

The popular fast-food restaurant Chipotle experienced a 7% dip in their stock price as a result of the news of the threatened tariffs. Chipotle uses avocados grown in Mexico and sells Corona and Modelo, two Mexican beers. A typical investor would reasonably believe Chipotle to be a reliable stock. Their restaurants are typically busy and there has been impressive expansion throughout much of the United States. But those investors lost a significant amount of value based upon the rumored tariffs. If rumors of the tariff are causing a ripple-down effect, imagine what could happen if these tariffs came into effect? Under this scenario, it is likely that consumers will see additional losses.

Not only is the food and beverage industry at risk for consumers holding securities because of lurking tariffs, there are other industries that are also affected. For example, Samsung Electronics Co. produces many of their televisions in Mexico. The Samsung televisions that are sold to the United States from Mexico could potentially see a price increase. As a result of this possibility, Samsung’s stock also fell on the threatened tariffs news. Additionally, the auto industry is affected by this threatened tariff. Many vehicles are manufactured in Mexico, including Audi, Volkswagen, and others. This rumored tariff will cause an increase in price for these vehicles as well, which will likely cause the stock price to decrease in value.

Many investors believe that a trade war against Mexico may become the catalyst that starts the next recession in the American economy. In fact, a recent study from Duke University showed that the two-thirds of chief financial officers believe that the economy will fall into a recession by the third quarter of next year, as a result of this plausible trade war.

As securities prices fall due to the trade war with Mexico, many investments will likely lose money. Consumers will be hesitant to spend extra money for a Samsung television made in Mexico when they can purchase a Sony television manufactured in a country that is not paying a 25% tariff. Mexican and American trade is heavily intertwined, and a trade war affects nearly every citizen. Automobiles, electronics, and food are only some of the most popular securities that will be directly affected by these tariffs. Many of these securities were previously considered relatively conservative, as the past trade relationship between the United States and Mexico was not only predictable, but very stable. Now, the relationship between these two countries is not as stable as it once was.

Consumers will need to be cognizant about where products are manufactured, and where companies import their goods from. If these tariffs against Mexico are enacted, then consumers may want to avoid investing their hard-earned monies in companies that are doing business in Mexico.

Using RegTech to Spur Proactive Regulation

By David McDonald

The 2008 crisis exposed critical regulatory and supervisory failures in the current financial system. This is not news, and, in fact, some would argue that oversights and loopholes are part and parcel to the system. After all, there is always a potential for mismanagement where regulation must be reactive to new disruptors in markets. However, developments since the ’08 crash have emerged that might have the power to encourage a new proactive stance. Enter the rise of “RegTech” or regulatory technology. As a subsector of financial technologies (“FinTech”), RegTech was initially created as a way for financial companies to reduce compliance costs by automating information gathering and reporting. Since then, however, the niche has exploded at an alarming rate. Technologies include everything from machine learning to cut down on time filling out forms to real-time authentication for digital transactions. Considering the World Bank estimates that eight percent of gross national product (GNP) is spent on regulatory compliance, any technologies that can streamline processes and reduce costs are certainly welcome.

However, this is where our issue arises. As more entrepreneurial companies enter the RegTech sector, financial institutions are receiving multitudes of disjointed possible answers rather than one uniform solution. To use a simplified example, consider software such as TurboTax. It’s an efficient way for households to fill out multitudes of tax forms in one convenient system. However, when the “household” is an international financial institution with countless regulatory agencies across the globe to report to, the household is going to need some crazy computing power to make sense of everything. RegTech is an opportunity to use technology in order to streamline the filling out of these regulatory forms and reduce the amount of manpower needed simply to disclose that information. But, the system only works if there is one comprehensive solution. To return to the TurboTax example, there needs to be one TurboTax rather than fifty different firms all trying to sell their niche version of the software.

There are two likely ways to achieve this goal: a RegTech innovator will come up with a solution that dominates the market and becomes the main supplier of regulatory technology or, ironically enough, through continued restrictive regulations. To expand on the second option, if regulators can detail exactly what standards a RegTech firm should be catering to, then the regulators have an opportunity to save these financial institutions billions in manpower that could be dedicated elsewhere. It would require a proactive approach by regulating this new sector in a way that ultimately benefits the financial institutions, rather than waiting for some failure in the market (a data breach caused by a cyber-attack, for example) to spur lawmakers into action. Taking such steps can be extremely beneficial as it sets a list of regulations for a still fledgling market that can then grow into what regulators want it to be, rather than letting the sector run rampant until regulators are forced to react to a catastrophe that they could have prevented.