What the financial-reform bill means for financial advisers

Jun 25, 2010 @ 8:13 am

By InvestmentNews staff

For the past two weeks, 43 members of a House-Senate conference committee labored to meld each chamber's version of a sweeping financial-reform measure into a final bill that totaled nearly 2,000 pages.

The final legislation, which was passed in the early morning hours of Friday, still needs to be approved by the full House and Senate -- an outcome now seen as fairly likely. Congressional leaders aim to hold those votes next week and present it for President Barack Obama's signature by July 4.

What follows is a breakdown of some of the major provisions of the bill, along with the expected impact on the financial advice business.


The Skinny: Fiduciary duty advocates knew that the landmark financial- reform bill offered their best chance to get congressional approval for a universal standard of care for retail investors. After a pitched battle with the broker dealer and insurance lobbies, fiduciary proponents carried the day. [To see the updated section governing standards of care, Click here ]

The final bill gives the SEC authority to impose on broker dealers the same fiduciary standard that applies to investment advisers after it conducts a six-month study analyzing the differences in the enforcement of fiduciary duty and the suitability standard.

But the financial-reform bill hardly lays this issue to rest. The SEC will first have to conduct its review. The adviser and broker dealer communities likely will push hard to influence the outcome of the study through the public comment that the SEC will seek. (Read: What else needs to be done on the fiduciary front.)

Shaping the study is an important step in persuading the SEC to proceed to rulemaking, which is not mandated by the reform bill. The SEC has the option to write a regulation. But if it does move forward, it could potentially change the nature of dispensing financial advice. Everyone who provides guidance to consumers will have to act in their client's best interest and disclose conflicts of interest, leveling the playing field between advisers and broker dealers.

Who wins: Financial planners, investors. Certified financial planners, who adhere to the fiduciary standard, have long complained that some brokers offer clients planning advice and yet are subject to the less-stringent suitability standard. Moreover, investors who rely on advisers seem to be utterly confused by the whole issue of standards of care. Indeed, a recent survey released by Envestnet found that 36% of surveyed investors believe that all financial advisers act under the same standard of care. Another third said they weren't sure.

Certainly, the prospect of a single fiduciary standard thrills consumer groups. "Chairman Frank and House conferees really came through for investors," said Barbara Roper, director of investor protection for the Consumer Federation of America. The final language "allows the SEC to adopt rules that impose the full Advisers Act fiduciary duty on brokers, and it doesn't put any unreasonable barriers in the way of the SEC to prevent it from doing so."

Impact on advisers: Significant. A recent study showed that a higher standard of care could reduce brokers' income anywhere from 4% to 10%. Insurers won't be happy, either: they've lobbied hard against a single standard of care, claiming a fiduciary duty would eat into profits and limit the products brokers would be willing to sell to clients.


The Skinny: Under the financial-reform bill, oversight of smaller investment advisers will be transferred from the Securities and Exchange Commission to states.

The measure raises the threshold for state oversight from $25 million assets under management to $100 million. The only way for an adviser to remain under SEC jurisdiction if it manages less than $100 million in assets is to be registered in 15 states.

Who wins: State regulators, small investors. Celebrities and the wealthy aren't the only ones who get singed by invesment scams. Smaller investors have been burned in the past few years by private placements and other questionable investments. Greater regulation of these offerings probably can't hurt.

In truth, state securities regulators have been pushing hard to gain greater oversight of smaller securities firms. They say they are ready and willing to pick up the slack left by the SEC. “The SEC cannot or will not do this work,” said Denise Voigt Crawford, Texas Securities Commissioner and president of the North American Securities Administrators Association. “We can do it more efficiently.”

Impact on advisors: Medium. Advisers who have never been visited by the SEC will now have to prepare for the possibility of an audit. In fiscal year 2009, the SEC examined only 10% of investment advisers. The agency lacks the resources to provide timely reviews of the 4,000 advisers in the $25 million to $100 million range.


The Skinny: Under SEC rules, an accredited investor is defined as a natural person with an individual net worth, or joint net worth with a spouse, of $1 million or an individual income of $200,000 or a joint income of $300,000.

The bill gives the SEC the authority to review the standard and update it to reflect inflation and the characteristics of the modern economy. The bill also excludes the investor's primary residence from the $1 million net worth standard.

Who wins: Investors

Impact on advisers: Minor. The SEC review may raise the threshold for defining a customer as an accredited investor, forcing companies that sell securities to them to register the products with the SEC. Translation? Added costs.


The Skinny: An amendment to the financial-reform bill would maintain state regulation of equity indexed annuities. Debate over the instruments, which guarantee an income linked to a stock index, centers on whether they are an insurance product or a securities product.

The provision that was approved by the House-Senate conference settles the matter, barring the SEC from oversight. The products have generated startling stories of sales abuse over the years. Proponents say that the regulation has been vastly improved through a suitability model developed by the National Association of Insurance Commissioners.

Who wins: Insurers, broker-dealers. Registered equity-indexed annuities are not exactly popular products with broker-dealers, which is why insurers lobbied to get the amendment passed. And financial companies will now have more certainty about the regulatory regime they must follow when developing these complex products.


The Skinny: The bill creates a new Federal Insurance Office within the Treasury to monitor insurers, and requires a study that will recommend ways to further overhaul regulation of the industry.

The measures were prompted by the near-collapse of New York-based AIG in 2008. Insurers, which are mainly regulated by states, will now have to deal with a national watchdog. But the new office would have less extensive powers to pre-empt state insurance regulators in certain international insurance matters than would have been granted a proposed National Office of Insurance under the Senate's version of financial services regulatory reform. Under the compromise, the office would be required to notify certain House and Senate committees of its intention to pre-empt state law.

Who wins: Hard to say. The insurance industry has been split about the scope of the proposed office.

Impact on advisers: Minimal. Insurance industry groups say a new layer of oversight may complicate compliance and increase costs. That, in turn, may make insurance products slightly more expensive. Expect such costs to be passed on to consumers, though.


The Skinny: The overhaul legislation requires the SEC to conduct a two- year study on whether to create a board to decide who rates asset-backed securities. That curbed a Senate proposal to establish the board with SEC oversight. After the study, the board would be established only if regulators can't come up with a better alternative. In addition, legislators derailed an effort to make it easier for investors to sue ratings companies.

Who wins: Credit-rating companies. Given their performance in the subprime meltdown, ratings companies like Moody's, Standard & Poor's, and Fitch got off light. For starters, they may avoid a plan to have regulators help pick which firms grade asset-backed securities. Moreover, Congress softened the proposed liability provision, making it harder for investors to sue credit-raters. Under the final bill, litigation may only proceed if investors demonstrate a company “knowingly or recklessly” failed to conduct a “reasonable” investigation before issuing a rating. That's a higher bar than the 'grossly negligent' standard envisioned in the House bill

Impact on advisers: Minimal. In the long run, more accurate credit ratings help everyone. It remains to be seen, however, if the final proposal actually leads to more accurate ratings -- or reduces the conflicts of interest in the credit-rating business.


The Skinny: The bill gives the FDIC, which already has authority to liquidate failed commercial banks, power to unwind large failing financial firms whose collapse would roil the economy.

Regulators will have clout they lacked during the financial crisis when, instead of seizing flailing companies such as American International Group Inc., the government kept them afloat with a $700 billion taxpayer-funded bailout. Had such authority existed in September 2008, it might have been applied to Lehman Brothers Holdings Inc.

The House approved a version of the bill in December that proposed a $150 billion fund, to be paid for by the financial industry, to cover the government's cost of unwinding failing firms. Dodd proposed a similar fund of $50 billion in a Senate version of the bill, which was assailed by Republicans as a perpetual bailout of Wall Street firms. The protests stalled consideration of the legislation on the Senate floor.

Who wins: Taxpayers. In theory, they're no longer on the hook for bailing out collapsed financial firms.

Impact on advisers: Medium. Under the revised measure, the costs of unwinding failing firms will be borne by the financial industry through fees imposed after a firm collapses. Increased fees to unwind one firm could lead to higer costs for all other financial services firms, particularly wirehouses.

[Bloomberg contributed reporting to this story]


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