Financial Services Reform: Who Are They Kidding?

Includes: KBE, KRE, RKH, XLF
by: Clemens Kownatzki

In light of renewed discussions about a Consumer Protection Agency and the ongoing disputes between US House Financial Services Committee Chairman Barney Frank and members of the senate, let us revisit an earlier article by the New York Times (Struggling Over a Rule for Brokers):

While most of the debate about financial overhaul legislation has focused on the impact on how big banks do business, one piece that would affect consumers directly has received little public notice: a requirement that stock and insurance brokers act in their customers’ best interest. And that provision may not make it into the final overhaul plan.

Investment advisers are held to the standard of fiduciary duty in that they must always act in the best interest of clients. In practice that would mean recommending an investment that may not be lucrative for the adviser (he may not make any or much less commissions) but would clearly be most beneficial to the client.

Stock and insurance brokers are held to a (lesser) standard known as suitability, which requires them only to direct their clients to investments which are considered “suitable.”

The difference of these two standards is not just one of semantics but a conceptual distinction so fundamental that it hits at the very existence of the financial services industry. As long as brokerage and insurance firms’ core revenues are coming from the sale of financial products and as long as the brokers have to primarily rely on commission income for their livelihood, this apparent conflict of interest will not go away.

Chances are therefore that we might see a rather watered down financial services reform. We can expect massive lobbying efforts and stiff resistance from the major players in the brokerage and insurance industries.

Disclosure: No positions

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