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Industry Spotlight > Broker Dealers

Investors Will See the Light

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Once investors understand those differences, where do you think they will go? It may well be that a “study” of whether brokers should put their clients’ interests first–as called for in the Senate’s new version of financial reforms–will call even more attention to the differences between those who put client’s interests first and those who don’t have to.

Both the House version of financial reforms, passed last December, and the Senate’s draft of November 10, look more robust in some ways than the Senate’s current proposal of financial reforms, the Restoring American Financial Stability Act. The House bill followed more closely the guidance from the Obama Administration, Treasury and SEC in the June blueprint for financial reform.

The new version of the Senate’s proposed Bill, proposed by Senate banking committee Chairman Christopher Dodd, (D-Connecticut), was voted out of committee on March 22. The Senate bill contains provisions on “Consumer Protections,”–although this version houses the group within the Federal Reserve rather than as a standalone agency. It also, according to the summary, “Ends Too Big to Fail,” creates an “Early Warning System,” designed to “to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy;” and provides “Transparency & Accountability for Exotic Instruments,” including, Dodd said in the March 15 announcement, “hedge funds and derivatives” as well as, “mortgage brokers and payday lenders.”

Of note for investors and wealth managers, the new Senate bill significantly weakens Investor Protections from what was mandated in its November draft–and from what is in the bill the House passed. In particular, the new bill deletes the call by the Obama Administration, SEC, and many regulatory and industry leaders, to extend the fiduciary standard to all who provide advice to investors. The Senate’s November version called for:

Uniform Standards for Advisors: Mandates uniform standards for anyone providing customers investment advice, eliminating different standards for broker-dealers and investment advisers. Small investors should have uniform protections regardless of the title of the financial professional serving them has.”

The November Senate version had also required advice to be given in the Best Interest of the Client: Brokers who give investment advice will be held to the same fiduciary standard as investment advisers – they will be required to act in their clients’ best interest.”

So it’s disappointing that the March 15 Senate version strips out the language above, substituting this: Investment Advice: Requires a study on whether brokers who give investment advice should be held to the same fiduciary standard as investment advisers – should be required to act in their clients’ best interest.”

Should brokers who give investment advice “be required to act in their clients’ best interests?” That is the question! (My apologies, Will Shakespeare)

What happened between November and March? For one thing, the insurance industry has said publicly that they will be not able to sell annuities if they have to put clients’ interests first. Perhaps there should be a study on why that’s the case.

There is overwhelming consensus that the fiduciary standard should be extended to all who give investment advice. President Obama, the U.S. Treasury, House of Representatives, SEC Chairman Mary L. Schapiro, FINRA CEO Rick Ketchum, Goldman Sachs Chairman and CEO Lloyd Blankfein and Commodities Futures Trading Commission Chairman (and former Goldman Sachs executive) Gary Gensler all support such a provision.

In addition, Nobel Laureates, economists and industry leaders have called for extension of the fiduciary standard–see “Nobel Laureates Call for Fiduciary Standard.” This editor is a member of The Committee for the Fiduciary Standard.

The background

The original Senate version of November 10 included the requirement that brokers who provide advice to retail investors must register as investment advisors, thereby extending the fiduciary duty that investment advisors have had since the enactment of the Investment Advisers Act of 1940, to brokers. The November 10 Senate version also took away the broker/dealer exemption that allows brokers to give advice without holding them to the fiduciary standard, allowing them to give advice that was “suitable” but not necessarily in the client’s best interest.

The new Senate version substitutes a study of whether the gaps in regulation of broker/dealers and investment advisors are bad for investors, and if brokers need to put clients’ interests before their own. Seriously. See related article about payments to the Senate banking committee’s members from the financial services lobby, “Will Dodd’s Legacy be Anti-Investor, Pro Broker and Insurer?” in which a report notes that Senate Banking committee members have received $41.9 million in campaign contributions from financial services PACs and individuals since 2005.

The report says that in the first nine months of 2009 alone, 2567 lobbyists for the Financial Sector spent $ 336,005,436. to lobby Congress. It adds that from 2005 to 2009, Dodd himself received, “$9 million from the financial sector, 51% of his fundraising over the five-year period. Ranking member Richard Shelby (R-Alabama) raised $2.5 million, 28% of his total money raised, from the financial sector.”

As different as night and day

Brokers, of course, are self regulated through FINRA, and subject to a commercial standard of care or “suitability,” under which the product that generates the higher fee or commission can be sold to a customer as long is the security itself is deemed suitable for that investor–even if advice is given in the process of that sale. Investment advisors, regulated by the SEC under the Investment Advisers Act of 1940, are required to be fiduciaries, and as such, act in a prudent manner; disclose conflicts and all important facts; avoid or manage in the investor’s interest all material conflicts; disclose fees and control expenses; follow and document a due diligence process in making decisions; and diversify investments. Brokers are not required to do this.

In fact, the two regulatory regimes are so opposite that if an investor accuses a broker of wrongdoing, the burden of proof is on the investor to prove that wrongdoing. If an investment advisor’s client accuses the advisor of wrongdoing, the advisor must prove that they acted in the client’s best interest. How much more opposite could brokers and investment advisors be? At issue is the fact that investors perceive that the advice they get from their advisor–whether broker, insurer or investment advisor–is in their interest, when in fact that’s required only of the investment advisor.

The House version of financial reform passed in December mandates that the fiduciary standard be extended to those providing advice to investors. This is part of what would be taken up in conference, to reconcile the Senate and House versions of financial reforms if the Senate’s version of the financial reforms bill passes.

Why do we need a study of whether brokers should put their clients’ interests first?

The Committee for the Fiduciary Standard, a group of industry experts, including investment advisors–many of whom were formerly brokers–has nurtured the discussion of the need to extend fiduciary duty to all who provide advice to investors.

At the request of the office of Sen. Tim Johnson, (D-South Dakota), who first proposed replacing the fiduciary standard requirement with a study, the Committee has analyzed the proposal and believes that the study is not necessary and that most of the answers are already well known. Here is the Committee’s analysis of the study proposal.

Dodd full draft from November 10: Restoring American Financial Stability Act of 2009.

Summary of November 10: Restoring American Financial Stability Act of 2009.

Dodd March 15 reworded Restoring American Financial Stability Act.

Summary of March 15: Restoring American Financial Stability Act.

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.

Read more Wealth Manager: Viewpoint blog posts: Six Choice Pieces of Fiduciary Misinformation March 18, 2010 There is a great deal of chatter surrounding the fiduciary movement that is just plain incorrect–as in, not fact–whether from ignorance or deliberate obfuscation. Why Shouldn’t Investors’ Best Interests Come First? February 25, 2010 Are Senators strong enough–and do they have enough integrity–to stand up on behalf of retail investors and insist on extending the fiduciary standard to cover those who provide advice to retail investors?… Greater Good: The Unintended Consequences of Repaying TARP January 29, 2010 Did the requirement to repay TARP funds in order to pay bonuses for 2009 prompt some banks to repay the bailout funds too early? … Smart Money January 19, 2010 Goldman Sachs Chairman and CEO Lloyd C. Blankfein testified that at Goldman Sachs, “…we do support the extension of a fiduciary standard to broker/dealer registered representatives who provide advice to retail investors.” … Ever Hopeful December 29, 2009 As we emerge from a challenging economic crisis, there is reason to hope that changes and opportunities we will see in this new year–some as a direct result of the economic crisis–will be positive…. Schapiro’s Call for Fiduciary Standard Reflects SEC’s Original Mandate December 07, 2009 “I believe that all securities professionals should be subject to the same fiduciary duty,” says SEC Chair Mary L. Schapiro…. Mr. Dodd’s Message from Washington November 16, 2009 Now that we have heard from both the House and Senate committees on finance and banking about investor protection, let’s not misinterpret what they are saying. Can the DJIA at 10,000 Inspire “Animal Spirits?” October 16, 2009 The Dow Jones Industrial Average hit a year-to-date high and jumped above 10,000 on Oct. 14, and the next day hit another high of 10,062.94. Unless you are short, this is good news for you and for your clients.


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