Newly appointed SEC Chair Mary Jo White has been busy. During recent House Financial Services Committee oversight hearings she was grilled over high frequency trading (also known as“HFT”, or “flash trading”), a controversial practice that has dominated the financial news. On another front the Commission has been tasked under the Dodd-Frank Act with “harmonizing” the separate standards for investment advice that apply to Registered Investment Advisors (RIAs) and Brokers-Dealers.

The good news is that the first issue generally poses little threat to investors who follow our approach while the second matter may be a positive development for investors who work with investment professionals.

HFT has grabbed headlines on the heels of a new book, “Flash Boys”, by Michael Lewis. HFT is practiced by traders who employ highspeed computer technology to anticipate order flow from other market participants. This information is gathered mere fractions of a second ahead of others. But it allows traders to perceive trends before others in the market and to reap big rewards, albeit on miniscule margins, by placing trades on the direction of those very short-term trends.

Lewis and others condemn HFT because it reduces transparency and may constitute insider trading. Others see no harm; they characterize the practice as smart trading, and one that provides market liquidity. We do not know whether regulators will attempt to rein in the practice, or what impact such measures might have. Regardless, Investment Guide subscribers can take comfort: there is little risk that index fund owners who trade infrequently will fall victim to HFT traders. We do share the concerns of those who point to the systemic risk posed — the vast arbitrage system is complex and there is no guarantee that the “flash crash” of 2010 will not be repeated, perhaps with more severe consequences. But ultimately this is simply a new, high-tech source of capital market risk. The emergence of HFT should not dissuade equity investors who seek positive real returns.

Chairman White is pushing for a decision to clarify the roles and duties of RIAs and broker-dealers. Broker-dealers have long been regulated as salespeople under the Securities Exchange Act of 1934, while RIAs have been regulated as providers of advice under the Investment Advisors Act of 1940. As we explain in a following article, RIAs have been held to a higher (fiduciary) standard than brokers, yet brokers have increasingly been assuming an advisory role. This has created confusion among consumers as these services have converged. We hope this will soon be remedied with a positive outcome for individual investors.

Also in This Issue:

Quarterly Review of Capital Markets
Financial Service Providers: Part 1
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles