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Industry Spotlight > Broker Dealers

Mr. Dodd's Message from Washington

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Now that we have heard from both the House and Senate committees on finance and banking about the importance of protecting investors from practices on Wall Street which often confuse or could even be misleading investors about the nature of the relationship that they have with their broker or advisor, let’s not misinterpret what they are saying.

For most investors, the nature of their relationship with their investment advisor is pretty clear: the advisor is bound by a duty of fiduciary loyalty and required by law to put the clients’ interests first. Period.

What’s also clear is the metamorphosis of the sales relationship between brokers and customers to one of a trusted advisor-client relationship, without the important framework of fiduciary principles and regulatory and legal structures to back that up. That hampers efforts by B/Ds and their registered representatives who wish to build long-term, trusted relationships with their clients, and one way or another it looks like this may be about to change. These relationships are important and there is room for a broker-sales relationships with customers as well as (separately) fiduciary-advisory relationship with clients.

The nature of the relationship needs to be clear from the start, and that includes appropriate titles, consistency of the relationship–no changing back and forth–robust and understandable disclosure of conflicts, and a real understanding on both sides. In a fiduciary relationship, there’s the additional duty to put investor’s interests first at all times, to act with prudence, to avoid conflicts and if they are unavoidable to manage conflicts in favor of the investor, and to disclose all material facts.

It is interesting to note the differences in the House and Senate’s proposals for the Investor Protection Act (IPA) regarding fiduciary duty for those who provide advice to individual investors. The House Financial Services Committee, chaired by Rep. Barney Frank, (D-Massachusetts) voted for a version of the IPA that says: “a broker or dealer that is providing investment advice to a retail customer (and such other customers as the Commission may by rule provide), the standard of conduct for such broker or dealer with respect to such customer shall be the same as the standard of conduct applicable to an investment adviser under the Investment Advisers Act of 1940. The receipt of compensation based on commission shall not, in and of itself, be considered a violation of such standard applied to a broker or dealer.”

Senate Committee on Banking, Housing, and Urban Affairs, chaired by Sen. Christopher Dodd (D-Connecticut) introduced its discussion draft of the IPA on Nov. 10 (Highlights, full draft). The Senate version takes a different tack, adding a requirement that broker/dealer representatives who provide advice to individuals must be registered investment advisors. The approach is different but the upshot to the individual investor is a higher standard of care from either version of the IPA, with a framework of law in place to help ensure that the fiduciary standard of loyalty applies.

Questions remain:

  • Which of the two proposals is better for investors?
  • Does fiduciary duty preclude smaller investors from getting advice? Why?
  • Who should regulate investment advisors and broker/dealer representatives who provide advice? SEC as is currently the case for RIAs? FINRA as a new RIA SRO? Another player to-be-named-later?
  • Can the SEC get the necessary funding it needs to oversee all providers of advice to investors? (There are provisions in both Senate and House IPA drafts for vastly improved funding. Is it enough?)
  • Do broker/dealers end up separating an advice-giving or RIA arm from a capital raising, trading, and market-making arm?

Just to be clear, I am not questioning the important broker/dealer functions of raising capital, distribution of IPOs, of self-directed brokerage in the original model–where no advice is given–of market making, product origination, innovation or any other important functions of brokers or dealers that are not listed here.

At issue is how to best serve the investing public and help them achieve their goals–especially for retirement–for, as we see from many studies, the bulk of Americans who are in their pre-retirement years are woefully financially unprepared to actually retire. This is a much larger issue than mere retirement. If Americans can’t afford to retire, they must continue to work, if they are well enough to do that. This need to earn, in turn, keeps older Americans in the work force longer. While there’s nothing wrong with that at first blush, it’s not how many Americans had anticipated spending their golden years, and makes it harder for younger people to enter the work force, setting off myriad problems, including a boost in un- or under-employment. And what of the older Americans who are not well enough to continue to work into their 70s or 80s? Do we really want to be known as a society that ignored this issue because it was too vast and politically unpopular to resolve? Does the future cost of dealing with a population that cannot retire because of the flaws in the advice model of the past make the TARP, TARF, car company and other bailouts of the past two years look like chickenfeed?

Comments? Please send them to [email protected]. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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