‘Dramatic’ financial reforms now imminent for Wall Street

The financial regulatory reform legislation sought by the Obama administration, mired just weeks ago in a partisan congressional logjam, is likely to be passed by early summer, with major implications for the securities industry, a leading industry lobbyist said last week.

The financial regulatory reform legislation sought by the Obama administration, mired just weeks ago in a partisan congressional logjam, is likely to be passed by early summer, with major implications for the securities industry, a leading industry lobbyist said last week.

The Securities and Exchange Commission’s April 16 announcement of a civil fraud suit against Goldman Sachs & Co. and one of its vice presidents has reignited a populist backlash that will likely lead the Senate to pass a financial-reform bill in the next two weeks, Kenneth Bentsen, executive vice president for public policy and advocacy at the Securities Industry and Financial Markets Association, said last week.

A final law reconciling the Senate’s bill with the one passed by the House in December should be in place by July 4, he said.

“We are looking at a dramatic legislative and regulatory response, starting with what I believe the Congress will pass next month or the following month,” Mr. Bentsen said at SIFMA’s private-client conference in New York.

Much of the proposed legislation focuses on systemic and institutional issues that would likely give the government more power to break up large, troubled banks, curb some capital markets activities of investment banks in derivatives and proprietary trading, and create a consumer protection division within the Federal Reserve focusing on consumer banking.

Firms in the private-client and wealth management arena also are likely to face significant changes in their operational and revenue models, Mr. Bentsen and other conference speakers said.

The legislation could well impose on retail brokers who give advice a fiduciary standard that mirrors the “clients come first” standard applied to registered investment advisers — an issue that the Senate Banking Committee bill said should be addressed by the SEC after a one-year study. The securities industry is lobbying hard to keep its ability to conduct principal trades.

“It’s something that we have to be concerned about,” said Mr. Bentsen, a former Democratic congressman from Texas. “As you start to have the cycle turn against you … it has a tremendous influence on the legislative outcome.”

Indeed, proponents of a fiduciary standard in the independent advisory community who are eager for a level playing field said that they have stepped up their lobbying in the wake of the SEC’s charges against Goldman (See Page 4).

Although few securities industry attorneys and consultants give strong odds for a highly restrictive fiduciary standard to emerge in the legislation, they warned large and small retail brokerage firms to prepare for major operational changes emanating from the financial crisis that will directly affect their bottom line.

Vivek Agrawal, a principal at McKinsey & Co., said that new regulations promulgated in part by legislation would likely cost a “typical wirehouse” $20,000 to $40,000 per adviser, which he characterized as a “material” reduction of the $80,000 profit margin that wirehouses generally derive from each adviser.

Among the issues on Mr. Bentsen’s watch list for retail firms:

Mandatory arbitration changes. The House bill mandates that the SEC restrict contracts that require retail securities disputes be submitted to arbitration panels run by the Financial Industry Regulatory Authority Inc. and other industry self-regulatory organizations rather than courts. The Senate bill authorizes the SEC to either restrict or reaffirm the dispute forums. “This is a tough one,” Mr. Bentsen said.

New custody rules. The SEC has promulgated a rule requiring firms acting as trustees and holding clients’ asset in custody. Small firms, in particular, are worried that they will be subject to audits from which they are now exempt.

State jurisdiction over larger firms. Shifting investment advisers who oversee up to $100 million of client assets to state regulators from the SEC. Currently, states regulate only those advisers with $25 million or less. Many small and independent securities firms worry about their ability to supervise brokers under various state regimes. SIFMA is trying to maintain the status quo, but as a fallback could urge lawmakers simply to “grandfather” firms under their existing regulators.

12(b)-1 fees. The SEC is considering requiring such fees to be listed as “asset-based sales charges” on trade confirmations, something that would entail huge changes for firms using “archaic” systems, said Steven Stone, a lawyer at Morgan Lewis & Bockius LLP. The issue is a “top priority for us,” Mr. Bentsen said. SIFMA also is watching “very closely” regulatory efforts regarding point-of-sale disclosure on money market funds and possible discounting of mutual fund fees.

Although the Goldman charges and the broader mortgage securities losses that pummeled big firms in 2008 were not triggered by retail brokerage practices, they are bound to have a spillover effect on all parts of the securities industry, several private-client executives said. The public doesn’t distinguish, some said, between a trader of collateralized debt obligations and their local broker.

“The one thing that makes me sick about this financial debacle is the portrayal of the financial adviser by the press and ads from firms that want people to go direct, showing advisers in limousines or helicopters,” said Bill Dwyer, president of national sales and marketing at LPL Financial.

Another major issue affecting brokerage firms and independent advisers are impending tax changes. The capital gains rate that was cut to 15% from 20% under the Bush administration expires at the end of the year, as does the treatment of dividends as low-taxed ordinary income.

Although Congress could extend the tax cuts for another year, federal budget problems make that unlikely, several officials said. Given the recently imposed 3.8% Medicare tax on high-income people, the reversion next year in estate taxes to pre-2001 levels and discussions of a possible 15 basis-point securities transaction tax, SIFMA is “very concerned” about taxes this year, Mr. Bentsen said.

E-mail Jed Horowitz at [email protected].