Old foes in the fiduciary debate join new battle to sway SEC's six-month study

Advocates were working down to the wire to submit comments by the end of yesterday

Monday 8.30.10 by Elizabeth MacBride
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The bright lines of the debate over fiduciary regulations are emerging as the SEC begins its six month-study of how to create a regulatory regime that applies to brokers-dealers and advisors.

Advocates were working down to the wire to submit comments by the end of yesterday on the study. The Dodd-Frank financial reform bill mandated the SEC to do a six-month study on harmonizing regulations for broker-dealers and advisors. The Commission opened a comment window for 30 days.

“That’s not a lot of time when you have a day job,” said David Bellaire of the Financial Services Institute, which represents independent broker-dealers and their affiliated advisors. He said the FSI’s submission was likely to top 50 pages.

Among the organizations submitting comment letters yesterday were the FSI, the Investment Adviser Association, the Securities Industry and Financial Markets Association, the American Council of Life Insurers and the Financial Planning Coalition, which includes the Financial Planning Association, the National Association of Personal Financial Planners and the CFP Board of Standards. FSI and the ACLI did not send their comment letters to RIABiz by press time yesterday.

The SEC’s free hand

Just about everyone in the financial services business has a stake in the outcome of the study and the rulemaking that most people think is likely to follow it. The SEC has almost a free hand to design a regulatory regime to apply to advisors and to broker-dealers and insurance agents that offer advice to retail clients.

One potential outcome is that broker-dealers and insurance agents will be forced to abide by a standard that requires them to put their clients’ best interests first – the established fiduciary standard.

But another possibility is that the SEC reforms the regulations to bring advisors closer to the world of broker-dealers, possibly subjecting advisors to a host of detailed rules.

All sides in the debate are arguing the high ground of what’s best for consumers. On one side of the debate are the IAA and the FPC, which argue that consumers will benefit if advisors and broker-dealers are both bound to the principles-based fiduciary duty to put clients interest first.

SIFMA and FSI argue that forcing broker-dealers and insurance agents to comply to a principles-based fiduciary standard will mean that broker dealers and insurers will eliminate some investment choices that are questionable – and that, in turn, consumers will be hurt because they will have fewer choices.

The Financial Planning Coalition implicitly recognizes that broker-dealers are facing a risk to their business model if the SEC adopts the fiduciary standard.

“The Commission should not mold the fiduciary standard to accommodate business models with substantial embedded conflicts of interest. Rather, it should impose a strong and uniform fiduciary standard of care, and then allow clients and the market to determine which business models will succeed under that standard,” the Coalition’s letter reads.

Here are some of the issues to watch for in the debate:

• Whether the regulations extend the existing fiduciary standard found in the Investment Advisers Act of 1940 to broker dealers, or whether the regulation establishes a new, somewhat different standard based on rules, rather than principles.

This is likely to be the single most contentious question, because it is the broadest.

The Investment Adviser Association and the Financial Planning Coalition are advocating for what’s known in Washington as the 40-Act standard, saying that it’s the highest standard. It’s the one that RIAs operate under.

“The breadth and flexibility of the fiduciary duty have allowed the regulation of investment advisers to remain dynamic and relevant in changing business and market conditions,” writes the Investment Adviser Association in its letter.

SIFMA is arguing for a rules-based “uniform standard of care,” specifically not the one found in the Advisers Act. SIFMA says the Advisers Act was never designed to regulate the complicated world of broker-dealers.

The principles-based Advisers Act standard, it says, might bring into question, rightly or wrongly, whether commission-based services such as “initial and follow-on public offerings and other underwritten offerings, structured and affiliated products, and securities sold from a broker-dealer’s inventory such as municipal bonds and proprietary mutual funds” are actually in the best interests of clients. “If a uniform standard of care cannot be applied and supervised in a practical manner, broker-dealers will likely significantly curtail offering certain commission-based services and securities,” SIFMA writes.

A rules-based standard, on the other hand, could result in SEC rules that offer clarity to a broker-dealer offering those services, SIFMA says.

• Disclosure is emerging as a secondary battleground. Potentially, if the SEC opts to create a new standard, it might still impose very high disclosure requirements. SIFMA advocates high levels of disclosure. But insurance agents may seek a regulatory regime with less emphasis on disclosure — that’s because they likely stand to lose the most if they had to disclose the complicated compensation arrangements that come along with some insurance products.

• Underlying the entire debate is the question of what kinds of enforcement mechanisms to find and punish rule-breakers the SEC might put in place. Asking how well enforcement works raises questions of whether advisors ought to be regulated by FINRA, which examines firms more often than the SEC does.

More excerpts from the letters:

From the Financial Planning Coalition:

“There are real, practical effects of (the) difference in standards of care between broker-dealers and investment advisers. A broker-dealer client does not receive a document like the Form ADV which provides a comprehensive disclosure of the firm’s business practices and potential conflicts of interest, and a description of the background and the qualifications of the firm’s principals. An investment adviser may not engage in trading practices that would be permitted for a broker-dealer. An investment adviser may not enter into certain types of fee arrangements or assign its advisory contracts to others without the client’s affirmative consent. For all of these reasons, there are significant gaps between the current standards of care that apply to broker-dealers and investment advisers, and in each case the gap operates to the disadvantage of the retail customers of broker-dealers.”

SIFMA’s letter:

“Retail clients need a choice of investment models, products and services. While the investment adviser model is appropriate for many retail customers, for some it may not provide access to the range of investment opportunities that the retail customer seeks or it may require a higher fee in exchange for a level of service that many retail customers may not desire. For a retail customer who determines that an advisory model is not the right fit, a broker-dealer model provides access to a wider range of products and the retail customer is able to pay the broker-dealer for transactions and incidental advice on a commission basis. This model may be particularly cost effective for retail customers who infrequently trade securities.”

The IAA’s letter:

“The fiduciary duty under the Advisers Act generally does not prohibit a particular type of activity or compensation arrangement but requires disclosure and/or mitigation of potential conflicts of interest that a particular arrangement or transaction may pose. If the SEC imposes a fiduciary duty on broker-dealers for the provision of personalized investment advice to retail clients, the most significant changes to the broker-dealers’ obligations and to the broker- dealers’ business models generally would be the requirement on broker-dealers to manage potential conflicts of interest and to make appropriate upfront disclosures to clients regarding potential conflicts of interest, compensation, and other material facts. Most important, the extension of the fiduciary duty to broker-dealers who provide investment advice would require these broker-dealers to develop a fiduciary culture among those who provide personalized investment advice to retail clients to act in the best interests of their clients and to place the interests of the clients above their own. Imposing the fiduciary duty on broker- dealers in this fashion would be unequivocally beneficial to retail investors.”

*FSI’s letter:”

“Unfortunately, a small number of Financial Advisors take advantage of their clients’ trust by directing clients to high-priced options intended to generate more compensation for the Financial Advisor or, worse still, simply converting client funds to their own use. When one unscrupulous Financial Advisor abuses an investor’s confidence in this fashion, the reputation of all Financial Advisors is sullied. When one investor is harmed, the trust and confidence in our markets and Financial Advisors is shaken in all investors. Thus, recent market events, including the emergence of several high profile Ponzi schemes, indicate that a careful reexamination of our current financial services regulatory framework is needed.
IBD firms and independent financial advisors recognize these facts, but still have significant concerns about the potential unintended consequences of sweeping reforms enacted without careful consideration of their impact on:

• Investor access to advice and service;
• Investor choice between available providers of advice and service;and
• Effective investor protection efforts.”

David Bellaire

SEC | FPA | NAPFA | FINRA | SIFMA | Investment Adviser Association | CFP Board | Financial Planning Coalition | Financial Services Institute