The securities industry is worried that if the SEC imposes a fiduciary standard on retail brokers, they may lose their ability to sell initial public offerings to individual investors.
A strict fiduciary standard mirroring the one governing financial advisers would effectively ban brokers from recommending new securities, limited-partnership units, closed-end funds and other popular retail products because the securities are owned by the broker-dealers that underwrite the offerings and would therefore be prohibited “principal” transactions.
“Imposition of a fiduciary duty for dealings with retail customers may complicate an underwriter's ability to strike a fair balance between the issuer and the purchasers, perhaps leading to the exclusion of retail customers from participating in IPOs,” lawyers at Morrison & Foerster wrote in a recent report to clients on the impact of the new Dodd-Frank regulatory reform law.
Even if
IPO sales are permitted through such methods as blanket consent agreements from clients, retail investors may gag on conflict-of-interest disclosures that a fiduciary standard would require when brokers give advice, some lawyers and brokerage officials said.
For example, firms may have to disclose in account statements the fees they capture from underwriting assignments and the prejudicial effect that may have on pricing deals, which may favor issuers over investors. Those disclosures are now often buried in thick offering documents.
The law doesn't require the Securities and Exchange Commission to write a fiduciary standard for brokers, but gives it discretion to do so after completing a study due early next year that contrasts brokers' product-suitability standard with the fiduciary standard that requires advisers to make customers' interests paramount. SEC Chairman Mary Schapiro has embraced the chance to write a harmonized fiduciary standard that would be “no less stringent” than the one now governing advisers.
But she also urged brokers, advisers and members of the public to help the SEC shape the fiduciary study by commenting on ways to “craft rules that increase investor confidence while preserving brokers' ability to offer a full spectrum of services.”
The comment period ends Aug. 29.
“The SEC could say, "We're going to take the existing standard and apply it to everything,' but it's not likely,” said John Taft, chief executive of Royal Bank of Canada's RBC U.S. Wealth Management division and incoming chairman of the Securities Industry and Financial Markets Association. “If they did, retail investor access to IPOs would be a problem.”
It would be premature for independent advisers who have no access to IPOs or other proprietary products to celebrate a playing field so level that brokerage clients will be similarly deprived. Section 913 of the Dodd-Frank law, for example, says that the offering of proprietary products and the charging of commissions are not prima-facie evidence of violating a fiduciary standard.
DISCRETIONARY ADVICE
“Investment advisers have a one-size-fits-all product offering — discretionary investment management — and the fiduciary standard that exists today grew up around that,” Mr. Taft said.
“But you can write the rule the right way, and it will preserve client access to products and services and extend the standard of protection the law calls for,” he said. “Investment advisers don't want us to distribute IPOs, make markets in fixed-income securities, offer insurance or offer lending services, to name just a few of the many products and services that full-service wealth management firms offer because our clients want them.”
But it is Ms. Schapiro's call for a balance between investor protection and preservation of brokers' offerings that has securities firms and lawyers straining to guide the rulemaking process and scratching their heads as to how they will put a fiduciary standard into practice.
Even if the SEC merely calls for enhanced suitability standards and disclosures, retail distribution of IPOs could be profoundly affected, said Charles Gittleman, a securities lawyer at Shearman & Sterling LLP.
Rather than let each broker make a judgment as to what is best for his or her client when it comes to a new issue, brokerage executives are likely to establish an investor profile for many issues that will allow sales only to high-net-worth and experienced investors, he said.
“I can't believe they'll totally exclude the retail investor, but I expect that whole swaths of people that you might ordinarily try to allow into an offering could be cut out,” Mr. Gittleman said.
“A reflexive decision will likely be made toward a more solvent client base.”
WEAK MARKET
Investors these days, of course, are hardly clamoring to invest in new issues. IPOs have been scant for two years and many of those that have hit the market — including seven of the eight deals priced in the first two weeks this month — traded flat or down on their first day in the market.
Issuers aren't as eager as in pre-dot-com days to place their shares with small investors, who are no longer perceived as long-term holders less likely to flip shares than sophisticated institutional investors.
“Only about 15% of the actual distribution of high-quality IPOs goes to retail, unless it's a retail product like a closed-end fund or master limited partnership,” said James Freeman, a former
Credit Suisse First Boston executive whose Freeman & Co. LLC unit offers merger and management consulting services to financial services firms.
Full-service investment banks such as
Bank of America Merrill Lynch and Morgan Stanley Smith Barney LLC, however, still flaunt their retail brokerage networks as selling points to potential issuers. Last week's filing of plans for a $100 million IPO by Skype SA, meanwhile, is creating a buzz that technology venture capitalists, bankers and investors haven't seen since Google Inc. went public six years ago.
“The relative importance of institutional versus retail varies from time to time in different market cycles, but IPOs are still a very important part of the investment strategy of many individual investors,” Mr. Taft said.
“Any investment banking firm will tell you,” he said, “that if you prevented individual investors from buying newly issued stocks or bonds, you would hurt capital formation in America.”
And that may explain why Charles Johnston, president of Morgan Stanley Smith Barney, the world's biggest retail broker, is co-chairman of the working group that is writing SIFMA's comment letter on the fiduciary standard.
E-mail Jed Horowitz at [email protected].
