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Before We Reinvent Social Security

By Arthur Levitt
Monday, November 16, 1998; Page A25

Earlier this year, the president called for a national discussion of Social Security. Most experts agree that Social Security reform is necessary and that it is better to act sooner rather than later. But benefit cuts and revenue increases are difficult, so reform plans often rely on an ostensibly more attractive route: raising the expected rate of return on contributions. These plans would invest in the stock market, either directly through the Social Security Trust Fund or by creating a system of individual accounts.

Proposals to invest Social Security in the stock market raise several issues of fundamental importance to the Securities and Exchange Commission: SEC's mission is to protect investors. And investing Social Security in equities -- through any conduit -- raises issues that go to the heart of such protection. A system of self-directed individual accounts would require an unprecedented level of broad-scale policing of the equity markets. Otherwise, fraud and sales practice abuses could be perpetrated against society's most vulnerable investors.

One need only look at England's experience with Social Security reform. In what has become known as the "mis-selling" controversy, high-pressure sales tactics were used to persuade people to switch out of the public pension system and into unsuitable private accounts. These sales practices, coupled with inadequate regulation, led to billions of dollars in losses for investors.

Investing Social Security in the stock market would require additional investor education. Increased risk, through greater choice, holds the potential for greater returns. But uninformed investors often won't be in a position to capture that potential. They risk making poor decisions, perhaps through ignorance or because they fall prey to fraudulent advice or misleading sales practices.

Today, more and more people are taking responsibility for their retirement needs. By leaving the secure world of banks and entering the less certain world of our capital markets, more than 50 million American investors have assumed higher risk in the hope of higher reward.

But the gap between financial knowledge and financial responsibilities is unacceptably wide. For example, more than half of all Americans do not know the difference between a stock and a bond; only 12 percent know the difference between a load and no-load mutual fund; only 16 percent say they have a clear understanding of what an Individual Retirement Account is; and only 8 percent say they completely understand the expenses that their mutual funds charge.

While some progress has been made, closing this "knowledge gap" is among the most important challenges we face today. It becomes even more of an imperative with individual accounts, under which more than 140 million American workers would be investing their retirement funds in securities.

Simply put, America's investors need to understand two words: risk and cost. Too many investors fail to recognize the relationship between risk and return, and the benefits of a diversified portfolio. This understanding is critical to making suitable and sound investments.

People also need to realize that investing in our markets costs money. Executing transactions, sending account statements, even switching investment managers entail expenses that are paid by the investor. And fees can reduce -- sometimes dramatically -- an investor's bottom line. Indeed, in Chile, which has privatized its public pension system, one study found that fees reduced annual returns by almost one-third during the first 10 years of the system.

Finally, those who oppose self-directed individual accounts often favor a more direct form of government investment in the securities markets. Such investments also would have serious implications. For example, those who support trust fund investments in the stock market argue that it would enable market risk to be spread across society and across generations and that economies of scale would help reduce costs.

But opponents question whether the government would have a strong incentive to control market fluctuations, if not the market itself. And trust fund investments could lead to political interference in deciding which companies to invest in and how those companies were run. Could the government invest in a tobacco company? What about a company that was a toxic polluter a decade ago? America's markets have earned their status as the world's premier securities markets. Maintaining that integrity is of utmost importance to the SEC.

Today, our nation confronts a historic choice: should we meld the protection of Social Security with the vibrancy of our markets? While the SEC does not support or oppose any particular plan to reform Social Security, we will remain strongly committed to protecting the interests of America's investors as the discussion moves forward.

The writer is chairman of the Securities and Exchange Commission.

© Copyright 1998 The Washington Post Company

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