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Dodd Bill Likely To Propose Study Of Fiduciary Standard

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A provision to study whether a fiduciary standard should be required in the sale of investment products, and another provision subjecting large insurers to federal systemic risk overseers will likely be included in Senate financial services reform legislation that could be unveiled as early as this week.

The bipartisan legislation being drafted by a group led by Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee, and Sen. Bob Corker, R-Tenn., has been the subject of much redrafting.

As to the fiduciary standard, it appears likely that the insurance industry has won a key victory by persuading the bill’s drafters to include in the bill a provision calling for a study of the fiduciary vs. suitability issue.

Consumer and trade groups representing financial planners and investment advisors have mounted a strong public campaign to persuade the committee to include in the bill language contained in legislation proposed by Dodd in January.

Sec. 913 of his bill would have imposed a single harmonious standard in the sale of investment products. It would have done so by deleting an exemption under the Investment Advisors Act of 1940 for any broker or dealer whose investment advice was “solely incidental to his business as a broker or dealer and who receives no special compensation therefore.”

Under that exemption, insurance agents and brokers can sell products under the lesser suitability standard.

But, a letter sent to Dodd by Sens. Tim Johnson, D-S.D., and Mike Crapo, R-Id., was apparently decisive in persuading Dodd to substitute their amendment calling for a study of the issue.

The issue is critical because inclusion of the original language would have required the industry to make members of the committee take public votes in favor of insurers and agents as opposed to consumer groups, investment advisors and financial planners.

The two senators argued in the letter that a case has not been made as yet for a total fiduciary standard in sale of investment products.

Their amendment would require the Securities and Exchange Commission to “conduct rulemaking” designed to address regulatory gaps or overlap in regulation related to the standard to be used in the sale of investment products.

The proposed amendment calls for studying the issue, and then proposing a rule that would address the “findings and conclusions of a comprehensive study of the effectiveness of existing standards of care for protecting retail customers.”

The letter said the study would also be designed to identify regulatory gaps or overlap in regulation that should be addressed by rule or statute.

Further, the amendment would also require a report to Congress of the SEC’s findings and recommendations.

In seeking to replace the Sec. 913 language, Johnson and Crapo argued that a single standard “would have required thousands of brokers, dealers and their associated persons, who already were subject to registration, oversight and regulation under the Securities Exchange Act of 1934 to also register as investment advisors under the Investment Advisors Act, and to comply with rules under that act as well.”

Since this far-reaching change had not been the subject of committee hearings, “we had no ability to evaluate whether investors would be better protected under this additional regulatory scheme, or the proposal’s cost or impact,” their letter said.

Moreover, this “approach did not appear to account for the differing relationships retail customers have with different financial service providers–some of whom provide comprehensive financial planning or have discretion over customer accounts; others to whom customers look primarily for securities and financial product sales,” the letter said.

“Section 913 did not appear to account for customer choice of financial service providers and, more important, did not address access and affordability issues,” the letter said.

Insurance agents said Dodd is making the right decision by calling for a study of the issue.

Tom Currey, president of the National Association of Insurance and Financial Advisors, said the “other side is overstating the case.”

These are merely “two different ways of doing business. I don’t believe one system is superior to the other, and I do believe they can co-exist, as they have so far.”

Currey said the industry position is that “if we’re selling a product, any kind of product, we all have a contractual relationship with the company that manufactures that product.”

For example, he said, “suppose I am under contract with an insurance company and I sell a variable annuity. I have a contract that specifies the things that I can do, and things that I can’t do.

“The rules of engagement and behavior are very structured; I can’t do anything that would put a company at risk just to get a product on the books,” he said.

Furthermore, he said, “all of us who operate in the product sale arena are subject to certain rules imposed by the company whose products we sell.

“But, that is not to say that we are not acting in the best interest of our customer,” Currey said. “Our contractual obligations don’t impede on our responsibility to act in the best interest of the customer.”

He explained, “What we’re talking about is the legal relationship. When you see the word fiduciary you think ‘lawsuit.’ It is an undefined term, a subjective term and anything that is subjective can subject you to potential liability.”

The difference, he explained, “is that fiduciary is subjective, while suitability is objective. A suitability standard provides for rules, what you need to do to comply with the rules to ensure that the customer is protected, and allow these folks to represent a company and represent the products of that company.”

The concern the industry has with a fiduciary standard is “that over the next 20 years, our careers will be determined one lawsuit at a time.”

“The fiduciary standard raises the specter that five years after the product is sold, the customer will say that you should have done this instead of that,” he said.

As to the other critical issue, signs are emerging that negotiators crafting the bill have agreed to raise $50 billion in fees on the largest U.S. financial companies to cover the cost of paying for the collapse of financial firms.

The money would be used to fund a resolution authority supervised by the Federal Deposit Insurance Fund.

However, the issue has generated strong concerns from various insurance interests, especially on the issue of whether the large institutions should be forced to pre-fund the resolution authority.

A study commissioned by the American Council of Life Insurers and released last week contends that prefunding “may encourage the same irresponsible behavior that gave rise to the economic crisis.”

At the same time, guaranty fund trade groups and the National Conference of Insurance Legislators are arguing that the insurance industry has a viable resolution system and should be excluded from the federal system that would be created under the emerging Senate bill, and already included in legislation that passed the House last December.

A letter to Corker and Dodd sent by officials of the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA) and the National Conference of Insurance Guaranty Funds argues that insurance companies are fundamentally different than banks.

It explains that the existing guaranty fund system is designed to protect consumers above commercial interests in any liquidation; and creating a new system would undermine the existing guaranty system used to resolve troubled insurers.

“A proposal to resolve insurer failures directly, in a new resolution regime that would not protect or effectively replicate the priority status of policyholders (and of the ‘safety net’ protecting policyholders), perversely could leave policyholders at greater risk of incurring financial harm in connection with insurance company receiverships than they are today,” the letter said.

And a resolution adopted by NCOIL at its recent spring meeting asks the committee to exclude the insurance industry from systemic risk regulation, federal resolution authority, and assessments to fund the resolution of systemically risky financial firms.

The resolution argues that insurance activities generally do not create systemic risk and that existing state guaranty fund systems are the appropriate venues to unwind failing insurance companies.

It also states that insurers should not be forced to pay for the resolution of failing systemically risky non-insurers.


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