Are you Ready?

Although the healthcare debate has effectively swamped much else that’s going on in Washington, there is another and very important-to-the-Obama-Administration set of legislative reforms that is the subject of intense debate, lobbying and scrutiny in the capitol: financial services reform. The Capital is abuzz with discussions regarding re-regulation of financial services, something that the Administration wants to see passed by year-end.

One of the proposed reforms that should matter to wealth managers and their clients is the call to: “Establish a fiduciary duty for broker-dealers offering investment advice and harmonize the regulation of investment advisers and broker-dealers,” according to page 71 of the Obama Administration’s June 17 white paper. We have said many times that the devil is in the details, but if there was ever a time when this could be accomplished, it would seem to be now.

Clients of RIA firms have, of course been fortunate–mostly–in this regard, since investment advisors have had a fiduciary duty to clients all along. But as advice-giver became the function of many broker/dealer registered representatives as well, and as titles of reps. and investment advisors overlapped, many clients have had the false sense that their registered rep. advice giver was–like a doctor or CPA, or lawyer–bound to put client’s interests first–a fiduciary relationship, when in fact, the relationship ahs been governed by a starkly different suitability standard, with much less protection for the client–or customer–as they are typically referred to by B/Ds. Regulation needs to catch up with the real perception of individual investors that their advice giver of whatever stripe is bound to put the client’s interests first and makes full disclosures.

Securities and Exchange Commission Chairman Mary L. Schapiro has been vocal about this issue in speeches and interviews for a long time, even before she was SEC Chairman. She met with The Committee for the Fiduciary Standard September 11, at the SEC’s Washington, DC, headquarters. The Committee has called on Congress and regulators to uphold the authentic fiduciary standard, which is based on centuries of established law, in any reforms and legislation. The topic: The Committee’s five core principles of the authentic fiduciary standard. This editor is a member of the Committee.

The Committee’s five core principles of the fiduciary standard are:

• Put the client’s best interests first;
• Act with prudence; that is, with the skill, care, diligence and good judgment of a professional;
• Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts;
• Avoid conflicts of interest; and
• Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

While, of course, what Chairman Schapiro said in the meeting with the Committee is off the record, she has publicly been an advocate of stronger investor protection, one of the SEC’s main responsibilities. In an exclusive interview with Wealth Manager in March, Chairman Schapiro told me that, “I’ve said for a long time that it’s really a flaw in our system that investors get different standards of care and different standards of regulatory protection depending on whether they’re going to an investment advisor, a registered rep., an insurance agent, an unregulated advisor of some sort–and it’s not fair for us to leave to investors to figure out what protections they’re entitled to depending on which regulatory regime just happens to capture the person they’re dealing with.”

In a speech at the New York Financial Writers Dinner on June 18, Chairman Schapiro said in even stronger terms: “When investors receive similar services from similar financial service providers, they should be subject to the same standard of conduct — regardless of the label applied to that financial service provider. I therefore believe that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients.

The fiduciary duty means that the financial service provider must at all times act in the best interest of customers or clients. In addition, a fiduciary must avoid conflicts of interest that impair its capacity to act for the benefit of its customers or clients. And if such conflicts cannot be avoided, a fiduciary must provide full and fair disclosure of the conflicts and obtain informed consent to the conflict.

A fiduciary owes its customers and clients more than mere honesty and good faith alone. A fiduciary must put its clients’ and customers’ interests before its own, absent disclosure of, and consent to, conflicts of interest.”

For groups that are working on behalf of investors, it seems that this is positive news. But there is much work to be done. House Financial Services Committee Chairman Barney Frank (D-Mass.), Chair of the Financial Services Committee, has posted September and October hearings on many parts of the financial reforms that are called for in the Obama white paper.

Open questions remain, including: if there is one regulator overseeing all advice givers, which one should that be? If it’s SEC, they’re going to need more funding. According to SEC Commissioner Luis Aguilar, the SEC currently gets an annual appropriation from Congress that’s a fraction of what SEC earns in fees on transactions. For the past four years, SEC’s received about $900 million of the $1.2 to $1.4 billion they take in (this doesn’t include fines). The rest goes to Treasury. For 2010 year, SEC will get something like $1.2 billion of the $1.7 billion that it’s projected that SEC will take in; that missing half-a-billion dollars could go a long way toward ferreting out fraud and regulating advice givers.

The funding issue is a big deal because what the SEC must regulate is enormous: with 3,600 staffers (including 400 examiners) SEC oversees 12,000 public companies, 11,300 investment advisors, 5,500 broker/dealers, 600 transfer agents, 5,000 mutual funds with roughly $9 trillion dollars invested in them, 10 self-regulatory organizations, the stock exchanges, the Municipal Securities Rulemaking Board (MSRB) and Public Company Accounting Oversight Board (PCAOB).

In contrast, the FDIC has 5,000 in staff to regulate 5,100 FDIC banks, and a budget that is self-funded that went from $1.2 billion to $2.2 billion during the credit crisis.