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Industry Spotlight > Broker Dealers

The View From Outside The Industry

By Warren S. Hersch

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In the wake of the House Financial Services Committee’s October 6 hearing on the proposed Investor Protection Act of 2009, industry stakeholders outside of the insurance business remain at odds as to what the draft legislation should stipulate in final form. But on one point there is consensus: broker-dealers who provide investment advice for a fee should be held to a uniform standard.

“As a matter of public policy, individual investors should be assured that, regardless of which advisor they see, they’ll receive the same protection,” says John Taft, head of U.S. Wealth Management at RBC Wealth Management, Minneapolis, Minn., and chairman of the Private Client Group Steering Committee of the Securities Industry and Financial Markets Association. “That’s the idea: to harmonize and bring consistency to the standards and regulatory structure surrounding individual investment advice.”

In addition to SIFMA, whose members include international securities firms, U.S.-registered broker-dealers and asset managers, National Underwriter spoke to representatives of the Investment Adviser Association and the Financial Planning Association to ascertain the impact of the proposed IPA on investment advisors, including life insurance professionals whose advisory services would fall under the legislation. Washington, D.C.-based IAI offers advocacy, compliance and educational services for IAA member firms. The FPA, Denver, Colo., is an advocacy and educational arm for the financial planning community, including CFPs, broker-dealers and life insurance agents.

For broker-dealers who continue to receive only a commission on the sale of a product, observers say, the proposed IPA would likely have no effect. They would still fall under a “broker-dealer” exclusion of the Investment Advisers Act of 1940 and continue to be regulated by anti-fraud provisions of Securities Act of 1934. And in respect to the sale of, say, variable annuities, they would continue to be bound by product suitability requirements established under state law.

But if the broker receives “special compensation (e.g., asset-based fees) when providing investment advice to retail clients, then, as now envisioned under the IPA, an amended Advisers Act would come into play. What additional responsibility might the act’s fiduciary standard impose that state suitability laws don’t already require?

“Under the suitability standard, if you recommend buying a particular security, then as long as the product is suitable, you pass the test,” says Dan Barry, a staff liaison and director of government relations at the Financial Planning Association, Washington. “Under the fiduciary standard, if a conflict of interest arises in recommending a suitable product because the advisor stands to gain personally from the sale, then he or she has to disclose this information.”

Suitability aside, industry representatives remain divided as to what a “harmonized” standard should specify. David Tittsworth, an executive director and executive vice president of the Investment Adviser Association, Washington, D.C., argues the IPA should maintain the rigorous duty of care now required under the 1940 act.

The association worries that the draft legislation, released by the Treasury Department on July 10, would “water down” or “eliminate” the fiduciary obligations owed to institutional clients by covering only “retail clients” or individuals. To close this gap, says Tittsworth, the IPA (specifically Section 913) should simply amend the Advisors Act to extend the current fiduciary obligation to broker-dealers.

SIFMA agrees that the providing of personalized investment advice about securities should trigger the fiduciary standard. The association asserts, however, that certain broker-dealer activities, such as a “non-discretionary” stock trades, should be exempted from the standard because they do not constitute investment advice. These activities, says Taft, should be addressed by a new “fiduciary light” standard.

“Activities subject to the Investment Advisers Act that [brokers-dealers] perform are only a small part of what we do for our clients,” says Taft. “If the existing act were the standard for broker-dealers, we would have to shut down many of these activities, including the purchase and sale of individual stocks and bonds.”

“Episodic recommendations about particular securities should be subject to a different standard of care than, say, the continuous, discretionary management of a client’s retirement portfolio,” he adds. “This is the ‘tailoring concept.’ There should thus be a continuum of duties, ranging from full fiduciary duty to fiduciary light.”

Tittsworth disagrees, noting that he is “unaware of any meaningful investor choices” that are prevented or impeded under the existing fiduciary standard. Nor does he see how establishing a new federal standard would improve upon the Adviser Act’s fiduciary duty, as SIFMA claims.

Whatever the standard of care imposed on advisors, says Taft, it should be made explicit in a revised Investment Advisers Act. One problem with the fiduciary concept, he argues, is that its application is subject to interpretation because it has been shaped by state and common law. SIFMA thus seeks a revised federal standard that would supplant a body of court rulings and states statutes.

Tittsworth opposes this approach. Since the U.S. Supreme Court ruled in 1963 that a fiduciary duty exists under the Investment Advisers Act, all courts have looked to this standard in deciding cases, he says.

“Some of our friends in the brokerage industry do not like the fact that a fiduciary duty is not something that you just write down,” says Tittsworth. “It is a principles-based common law concept. And it is applied based on specific facts and circumstances.

“If you try to write down every possible variation of the fiduciary duty, all you’re doing is creating a road map for wrong-doers because they’ll just figure out a way to circumvent the standard,” he adds. “It is no more appropriate to try to define fiduciary duty than it is to try to define what fraud is.”

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