Fiduciary standard an issue in unifying advisory regulations

However, the fear by some is that fiduciary standards would be weakened if the Financial Industry Regulatory Authority Inc. of Washington and New York were in that position.

The concerns are in reaction to a statement made last month at a Senate Banking Committee hearing by Richard Ketchum, chairman and chief executive of Finra, that the regulator is in a good position to oversee all advisers (InvestmentNews, March 30).

"Clearly, [SEC Chairman Mary] Schapiro and Ketchum think that bargaining away the fiduciary issue may result in Finra becoming the adviser [self-regulatory organization]," said Mercer Bullard, president and founder of Fund Democracy Inc., a non-profit mutual fund shareholder advocacy organization based in Oxford, Miss. That would result in lowering fiduciary standards, he said. "I do not believe [that Finra] really support[s] a fiduciary standard," he said.

"These are the same people who have fought tooth and nail against a fiduciary standard for years," Mr. Bullard said, referring to Finra as well as Ms. Schapiro, who was chief executive of Finra until she became chairman of the SEC this year. "It's hard to believe that their idea of a fiduciary standard would be adequate," he said.

A key issue that would have to be dealt with is whether brokers acting as fiduciaries could continue to make principal transactions — selling their companies' proprietary products. Current regulations governing investment advisers, who are held to be fiduciaries, make it difficult to conduct such transactions. They must receive written consent from clients for each principal transaction.

If the Securities and Exchange Commission and Finra continue to move toward consistent regulations for broker-dealers and investment advisers, there could be a compromise requiring all advisers to be fiduciaries, while changing the rules regarding principal transactions, said Barry Barbash, a partner in the Washington office of New York law firm Willkie Farr & Gallagher LLP. He was also director of the SEC's Division of Investment Management from 1993 to 1998.

"If the SEC were to adopt a rule that would make it operationally easier to engage in principal transactions that are consistent with the clients' interests, that would cause those broker-dealers to be more likely to be willing to register as investment advisers" and come under fiduciary standards, Mr. Barbash said.

He pointed out the problem that clients must give written consent for each principal transaction, which is time-consuming.

"It takes too long. A transaction can't be undertaken on the most beneficial terms for the client," Mr. Barbash said.

A solution would be to allow broker advisers to obtain one-time "blanket" consent from clients with proper disclosures, he said.

"One of our biggest fears is that if Finra ends up being the regulator [of all investment advisers], the fiduciary standard is going to end up somehow being watered down," said Susan MacMichael John, president of Financial Focus Inc., a Wolfeboro, N.H., firm that manages $125 million. She is chairman of the Industry Affairs Committee for the National Association of Personal Financial Advisors in Arlington Heights, Ill.

Adopting the fiduciary standard "is well worth exploring," SEC commissioner Elisse Walter said.

But the SEC would need to deal with the issue of principal trades, she said. "There is obviously a need for brokers to trade as principal," she said, adding that any regulations governing such transactions "would have to be a workable standard."

A temporary rule that is set to expire at the end of this year which allows dually registered firms to make principal trades with fewer restrictions may be a model that the SEC scrutinizes.

"If a fiduciary standard were adopted across the board, we would have to look at all solutions to the principal-trading problem," Ms. Walters said when asked if the temporary rule could be a way to resolve the issue.

"One of the reasons why the wirehouses have not adopted a fiduciary standard for their investment advisers previously is because they could not get relief from the prohibited-transaction rules," which govern principal transactions, said Don Trone, chief executive and founder of Fiduciary Ethos, an organization based in Mystic, Conn., that develops training for investment advisers. He is also president of the Foundation for Fiduciary Studies in Mystic, which developed fiduciary standards of practice.

"Now that you've got Schapiro at the SEC, you have somebody who has the capacity to write or promulgate that exemption," Mr. Trone said.

Brokerage firms engage in many types of transactions that could cause broker advisers to run afoul of prohibited-transaction rules, he said. That could include initial public offerings or underwriting other types of investments, Mr. Trone said.

"The issue for the wirehouses is, they can't monitor that," he said.

A model that could be used for fiduciaries engaged in principal transactions could be the investment advice provision of the Pension Protection Act of 2006, Mr. Trone suggested. "If the broker investment adviser demonstrates that they have followed the fiduciary practices, then they [would] be insulated" from running afoul of prohibitions against principal transactions, he said.

Other industry officials think that requiring broker advisers to act as fiduciaries without a compromise of the standard would lead to major changes in the way brokers operated.

"It would be the final nail in the coffin to commissions," said Joseph Birkofer, a co-principal of Legacy Asset Management Inc., a Houston investment advisory firm that manages about $200 million. He is also co-principal of brokerage firm Legacy Asset Securities Inc.

"If everyone had to become fiduciaries, it would force a compensation change structure," Mr. Birkofer said. "It would force level compensation across products."

According to the latest figures available, 36% of the brokerage industry's revenue came from commissions during the first three quarters of 2008, said Scott Smith, a senior analyst for intermediary distribution with Cerulli Associates Inc. of Boston.

E-mail Sara Hansard at shansard@investmentnews.com.