Fiduciary Corner

For fiduciary backers, fight not over

It remains to be seen whether the SEC will bring broker-dealers under adviser standard

Jul 11, 2010 @ 12:01 am

By Blaine F. Aikin

An important milestone has been reached on the path to the professionalization of financial advice with the inclusion of language in the financial-reform bill which would authorize the SEC to issue rules to extend the fiduciary standard to broker-dealers providing advice to retail clients.

But fiduciary advocates must not be too quick to proclaim victory.

First, Congress did not decisively declare that investors' best interests must be served by all those who provide advice. The bill would direct the Securities and Exchange Commission to conduct a six-month study and give it the authority — but not the clear-cut obligation — to establish a fiduciary duty for broker-dealers. Granted, Congress seems to be in favor of the fiduciary standard, and the majority of the members of the SEC have expressed strong support for extension of it to advice providers. Moreover, it is beyond comprehension that a legitimate study would conclude that investors would be better off getting advice under the lower standard of suitability, which allows less-than-thorough disclosure of conflicts of interest. But Congress had the opportunity to stop the buck through direct legislative action, and it chose to pass it to the SEC instead.

Second, in a tip of the hat to financial-product providers and the established sales culture of Wall Street, Congress included language which suggests that business model issues be considered in the rulemaking process. In particular, the legislation includes language stating that the receipt of commission compensation would not “in and of itself” constitute a breach of fiduciary responsibility — nor would the fact that a broker-dealer had only proprietary products or a limited range of products to offer. A broker-dealer also would not have a continuing duty of loyalty to the customer after providing individualized advice. These practices all involve inherent conflicts of interest that, if managed carefully, can conform to the fiduciary standard. The fact that Congress found it worthwhile to highlight those issues in the legislation provides fertile ground for those who want to dilute the fiduciary standard during the rulemaking process of the SEC.

Third, and most significantly, in a much less well-publicized move, conference committee negotiators removed a Senate provision that would have granted the SEC self-funding. In recent years, the SEC has been, and continues to be, chronically underfunded. In the period leading up to the financial crisis, funding shortfalls caused the total number of SEC enforcement and examination staff to decrease and impeded information technology initiatives.

During that same period, the number of registered investment advisers and the assets managed by those advisers grew by more than 50%.

The financial-reform bill alone would require the SEC's involvement in numerous new studies and would call upon the agency to engage in substantial new rulemaking that would go far beyond extension of the fiduciary standard. Thus, the SEC's resources likely would be stretched even more.

The SEC asked for self-funding. Six former chairmen of the commission recommended self-funding, consumer advocates and professional securities lawyers called for it, and House conferees agreed with the original language in the Senate's bill that would have allowed it.

So why did conference committee negotiators deprive the SEC of funding its own operations? The answer is money.

Former SEC Chairman Arthur Levitt, according to a recent press report, explained that “every major issue” that the SEC addresses affects market participants who are major contributors to political campaigns.

“The various oversight and appropriating committees simply don't want to say goodbye to this honey pot,” he reportedly said.

In fact, according to a Jan. 21 Consumer Watchdog report, “The financial sector is the largest source of campaign contributions to federal candidates and parties.” According to the report, Senate Banking Committee members alone received more than $189 million in financial-sector contributions between 2005 and 2009. Moreover, “the financial sector hired 2,567 lobbyists in 2009 and, in the first three quarters of the year, spent more than $336 million lobbying Congress.”

With the fiduciary standard authorized but not mandated, legislative language that specifically acknowledges inherently conflicted practices, and the purse strings of regulators firmly in the grasp of legislators that are beholden to the financial services sector, fiduciary advocates must not let their guard down despite the glimmer of hope provided by the reform legislation.

Blaine F. Aikin is chief executive of Fiduciary360 LLC.

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