Elizabeth’s note: Sara Hansard, a 13-year-veteran of Investment News and a business reporter for 30 years, has agreed to be a contributor to RIABiz. With her deep knowledge of regulatory issues facing advisors, she can tell RIAs what they need to know about Washington, D.C. We’re glad to have her bringing her insights to RIABiz readers.
Advisor groups say that a proposed amendment to the Dodd financial services reform plan could lay the groundwork for shifting regulation of investment advisors from the SEC to FINRA.
The amendment, put forward by Sen. Tim Johnson, D-S.D., charges the SEC with conducting a study of the regulations governing brokers and advisers within 18 months. The agency would have to issue new regulations within two years. Download the amendment here:
Slim chance at bipartisan reform
Advisor groups are paying close attention to machinations on the Hill because it now seems there’s a chance — albeit a slim one – of a bipartisan financial reform bill seeing the light of day in the Senate Banking Committee. After bipartisan negotiations broke down with Sen. Richard Shelby, R-Ala., Sen. Christopher Dodd, D-Conn., has begun talking to Sen. Bob Corker, R-Tenn.
David Tittsworth, executive director of the Investment Adviser Association, says he believes there’s a chance of a bipartisan proposal being released as early as next week.
What’s spurring so much interest, now, in a proposed amendment to a still-unseen new draft of a reform bill? The issues raised in the bill are the same ones used by FINRA when it makes the case that it ought to be the regulator of RIAs.
“The insurance lobbies and some of the broker-dealers are making some headway by getting through to Johnson,” Tittsworth postulated. “Those lobbies are very effective.”
The amendment points out that the SEC does not have enough resources to adequately inspect advisers, only 9% of which are expected to be inspected in fiscal 2011 despite a 12% increase requested in the SEC’s budget by the Obama administration. In contrast, the Financial Industry Regulatory Authority inspects 55% of broker-dealers annually.
By raising the question of resources, “it clearly opens the door to FINRA regulation of investment advisors,” says Tittsworth.
Duplicates the RAND study?
The amendment would also cut the Dodd proposal’s plan to eliminate the broker-dealer exemption to the Investment Advisers Act of 1940. If the exemption were eliminated, brokers who give advice would have to register as investment advisers and come under the traditional fiduciary standards by which advisers have to abide.
“FINRA continues to talk to policymakers about the importance of regulatory reform for investors,” said a FINRA spokesman. “While it would be premature to comment on legislative proposals still in the drafting stage, FINRA Chairman and CEO Richard Ketchum has spoken publicly and testified about the need to harmonize oversight of brokers and investment advisers.”
Advisor and consumer groups argue that the study is unnecessary given that the study conducted by the RAND Corp. for the SEC in 2008 already established that there is consumer confusion about the differences in regulations governing brokers and advisers.
Johnson spokesman Jeff Gohringer has said that the RAND study only found that consumers are confused about broker-advisor regulations, but it did not make recommendations on how to resolve the issue.
'Particularly cynical’
“Clearly the intent is to ensure that if there’s any increase in the standard for brokers, it will be implemented by FINRA. That’s why they raised the resources issue,” said Barbara Roper, director of investor protection for the Consumer Federation of America. The amendment “tries to use the fact that Congress has under-funded SEC investment adviser oversight for decades as an excuse not to hold brokers to a fiduciary duty when they give investment advice. That’s particularly cynical in my view.”
CFA and the Americans for Financial Reform, a coalition of labor and consumer groups, sent a letter Feb. 16 to Dodd and Banking Committee ranking member Richard Shelby, R-Ala., urging them to reject the study proposal.
In addition to urging Congress to provide more resources to the SEC to oversee advisers, the letter went on to say, “The only investor 'concerns’ to be addressed by the proposed study are taken directly from misleading industry talking points, which self-servingly suggest that raising the standard for brokers would result in increased costs or reduced investor choice,” the letter said. “But we have several decades of experience from the financial planning industry to tell us that combining a fiduciary duty for advice with product sales to implement recommendations has no such ill effects. On the contrary, investors stand to see costs reduced dramatically if brokers are required, as they would be under a fiduciary duty, to take costs into account when making recommendations. The only products that investors would lose access to under this approach are those that cannot be sold under a 'best interests of the client’ standard.”
The study proposal also would not give the SEC any new authority needed to address regulatory gaps, the letter said. If SEC authority was inadequate, it would still be up to Congress to act, which might not happen, the two groups argued. Read the whole letter here
Systemic risk
Of course, to most, or maybe all, of the Senators on the Banking committee, the issues pertaining to the fiduciary standard and regulation of advisors and broker-dealers are mere footnotes. Among the larger issues addressed by the Dodd proposal, and the legislation passed by the House, are systemic risk; the question of when an institution is too big to fail; and how to regulate the derivatives market.
One perennial problem advisors face is that they do not have the deep pockets to finance major campaigns to, say, explain the fiduciary standard to Americans, and make it a major issue in the U.S. Congress.
Consumer groups, including the AARP, are loosely allied with advisors on the issues of transparency for consumers and how to align investors’ interests with those of their advisors. Some custodians speak for advisors on the issues, but they walk a difficult line if their parent companies include discount brokerages, because some legislation that would apply the fiduciary standard broadly might sweep in discount brokerage services.
Though advisor groups have embraced the language of the original Dodd proposal that would have removed the broker-dealer exemption, TD Ameritrade thought it might be “too broad,” said Brian Stimpfl, managing director of advisor advocacy and industry affairs. In his view, the Johnson amendment “could be a prudent approach.”
Stephen Winks added: (Thursday 2.18.10 8:22a.m. PST)
THE SELF INTERESTS OF THE INDUSTRY AGAIN TAKE PRECEDENCE OVER THE BEST INTERESTS OF THE CONSUMER
Senator Johnson could not possibly understand what it literally means to act in the consumer’s best interests and advance such a proposal. It is not in the best interest of the investing public and therefore not appropiate public policy. The self interests of the industry again takes precedence over that of the consumer. This is the reform in the best interests of the consumer that regulators, legslators and consumers all agree must occur if the trust and confidence of the investing public is to be restored. Senator Johnson ignores the fiduciary duties specifically required under ERISA and UPIA and denigrates the entire concept of fiduciary standing which were hundreds of years in the making. The voting public in South Dakota might be interested in understanding why Senator Johnson places the self interest of the brokerage industry before that of the consumer, the investing public.
SCW
Ron A. Rhoades added: (Friday 2.19.10 5:47a.m. PST)
As this article alludes to, the substantial economic interests of large broker-dealer firms, including Wall Street’s investment banks, plus insurance companies, oppose any extension of the fiduciary duty. Moreover, they even seek, in the name of “regulatory reform,” to lessen the existing bona fide fiduciary standard for RIAs.
The major culprit in FINRA. It advocates not on behalf of the consumer, as a regulator should, but on behalf of its member firms. Rather than consistently seek to raise the standards of the securities profession as envisioned by the author of the Maloney Act (which led to the creation of NASD, now FINRA), it has consistently opposed any raising of standards of conduct, clinging to a “suitability” standard which relates nearly completely as to only investment risks, with little or no regard given to the fees, costs, tax impact, etc. of investment products and strategies on the consumer.
Moreover, I am fearful that the language contained in paragraph “(f)” of the Amendment would be construed by the SEC, which has long been subjected to regulatory capture by the very BDs it regulates, as a grant of authority to “harmonize” BD and RIA regulation – and lead to a lowering of standards of conduct for RIAs in the process. So many SEC rules of late have refused to apply the Advisors Act broadly, as Congress intended. For example, the fee-based accounts rule (overturned in recognition that fee-based accounts constitute “special compensation” and render the BD exclusion inapplicable). On the same rationale, the 1% annual 12b-1 fee also constitutes “special compensation” and is but an investment advisory fee in drag – but the SEC has given no indication that it will even consider this issue. Additionally, the “two hats” proposed rule of Sept. 2007, and the SEC’s tortured interpretation of “solely incidental” in the associated release, truly challenges the truth that “words should be given their meaning.”
The SEC’s refusal to apply the Advisors Act to the investment advisory activities of registered representatives and BDs is bad enough, and constitutes a graver error of inaction on the SEC’s part. As to a grave error of affirmateive and incorrect action, FINRA is doing everything possible to weaken RIA regulation. This is an economic issue, pure and simple. FINRA and its BD firms desire to preserve an archaic business model that consumers in today’s complicated financial world don’t want. (Ask any consumer, “Do you want to work with someone who sells products, or someone who does not … 90% or more of the time the consumer wants the trusted advisor, not the product salesperson.) Forward-thinking RIAs and RRs recognize this, and will provide consumers with what they desire. And they will feel better each day, as they work in an environment with greater investment choices, fewer conflicts of interst, and in a client-centric enviroment.
Kudos to the Consumer Federation of America and Americans for Financial Reform for their timely, and well-written, letter. And shame on FINRA for again advocating lower standards for RIAs, and reduced protections for investors. FINRA is a failed regulator, and consideration should be given to dismantling it and giving its authority to someone who will look out for individual investors, first and foremost.
A professional regulatory organization, whose members are individual investment advisers and financial planners, would be a far better structure, to preserve the fiduciary standard of conduct and to promote the highest standard of conduct under the law. History has shown that professionals – knowing the importance of the fiduciary standard to preserving client trust – will maintain it. History has also shown that corporate interests, such as FINRA, will do everything possible to avoid application of fiduciary standards.
FINRA’s numerous failures as a regulator over the past decade are just too great, in both quantity and severity. In my personal view, FINRA should be disbanded, and a better regulator created for the benefit of professionals and consumers.
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