Even if the Securities and Exchange Commission writes a regulation to impose a universal standard of care for retail investors, the end result will not make investment advisers and broker-dealers play by the same rules, according to a law professor who's also a former SEC staff member.
The primary impediment is a law on the books, known as the broker-dealer exclusion, that segregates broker-dealers from the advice requirements that advisers must meet.
“The SEC does not have the authority under Dodd-Frank to treat broker dealers exactly like investment advisers in all aspects,” said Arthur Laby, an associate professor of law at Rutgers University, who worked in a number of different positions over 10 years at the agency. “No matter what the SEC does under current law, the exclusion is still in place.”
In a presentation at the Fiduciary Forum 2010 in Washington on Friday, Laby called on the SEC to recommend to Congress that it change the law that codifies the difference between advisers and broker dealers.
The SEC is conducting a six-month study of financial advice regulation under sweeping financial-regulatory-reform law, named Dodd-Frank after its primary authors. The measure authorizes the SEC to proceed to rulemaking after it delivers its report to Congress in January.
When providing financial guidance, advisers must adhere to a fiduciary duty, which requires that they act in the best interests of their clients and disclose all material conflicts of interest. Brokers must meet a less onerous suitability standard, recommending only investments that meet a client's needs, timelines and risk appetite.
Advocates contend that the fiduciary standard better protects investors from adviser malfeasance. Opponents insist that broker-dealer regulation by the
Financial Industry Regulatory Authority Inc. is robust and consistent.
Starting in the 1940s, shortly after legislation was enacted that governed the advice industry, and accelerating in the 1990s, broker dealers increasingly have portrayed themselves as financial advisers, according to Mr. Laby. The distinction between an investment adviser, whose work is based on fees, and a broker dealer, who is essentially a salesperson, is often lost on investors.
“The broker-dealer exclusion is no longer tenable,” Mr. Laby said. “It's got to go.”
Excising the exclusion, however, would subsume retail brokerages within the advisory sector, undermining the business model, according to skeptics.
“We don't suggest that method of moving toward a universal standard of care,” said David Bellaire, general counsel and director of government affairs at the Financial Services Institute. “It makes broker dealers largely irrelevant.”
In addition, it could eliminate Finra's role in maintaining standards, leaving regulation solely to the underfunded SEC and states, Mr. Bellaire said.
“Where we really see the enforcement gap is on the adviser side,” said Mr. Bellaire, who attended the fiduciary conference.
As a practical political matter, the broker-dealer exclusion is likely to stay in place, according to Barbara Roper, director of investor protection at the Consumer Federation of America. She noted that an early draft of what became the Dodd-Frank bill included language removing the exception.
But that provision was dropped at the urging of Sen. Tim Johnson, D-S.D. Mr. Johnson likely will be chairman of the Senate Banking Committee in 2011.
“If we try to eliminate the broker-dealer exclusion, we have to go to legislation, and we will not win,” Ms. Roper said at the fiduciary conference.
Although the Financial Services Institute is not on the same side of the fiduciary divide as other sponsors of Friday's meeting — including the Committee for the Fiduciary Standard, the Certified Financial Planner Board of Standards Inc., the Financial Planning Association and the National Association of Personal Financial Advisors — the group believes that the divide can be bridged.
Mr. Bellaire said that FSI supports a universal standard of care based on fiduciary principles, effective disclosure, and strengthened examination and enforcement.
“It's how solutions in each of these areas are implemented where our groups have disagreements,” Mr. Bellaire said. “We're interested in maintaining an ongoing dialogue with all the parties in the debate.”
