We’ve all seen the headlines. The financial reform bill is intended to do many things: regulate banks, protect consumers, and prevent another crisis. What is unfortunate is that in all the chaos surrounding financial reform, one very important and very fundamental, idea has been overshadowed: the fiduciary provision.
As of Friday, Congress was at an impasse on that provision. At present, the 1,974 page financial reform bill base text contains the language of the Senate provision. And last Wednesday, Representative Barney Frank proposed replacing the Senate language with that of the House. The Senate needs “a few more days, maybe less” to respond, according to Senator Christopher Dodd.
The House bill would basically impose a universal standard of care, meaning that brokers/agents would have to act in their clients’ best interest, as registered investment advisors do now. How? The House version would allow the Securities and Exchange Commission to write rules requiring broker dealers (and insurance agents) to act in a fiduciary capacity, rather than under the suitability standard. The suitability standard, by the way, requires brokers to provide investments that are “suitable” to clients…not necessarily in their best interests. That’s a BIG difference to the consumer!
The Senate bill, on the other hand, would simply have the SEC conduct a one-year study of the matter. After that, the SEC could write rules…but only within its current authority. And its current authority doesn’t allow the commission to enforce the fiduciary standard across the board. In other words, the Senate bill would forestall any meaningful change.
Opponents of the House bill would say that imposing a fiduciary standard on brokers (who “sell” investments) is not practical because the standard is too ambiguous. After all…how do you define what is “best” for a client?
Well, if the fiduciary standard is too vague, then the suitability standard is totally obscure. A “suitable” investment product could very well be one that underperforms its peers and is loaded with excessive fees. And what’s more, the House bill would still allow brokers to sell proprietary products. And it would allow brokers to receive a commission…they would just have to disclose that to their clients. But, as evidenced by the opposition to the bill, most brokers don’t want to tell people how (and how much) they are paid.
But what really bothers broker dealers about the House version of the bill is what they stand to lose. According to Ticonderoga Securities LLC, some firms stand to lose as much as 4 to 10% in profitability per broker if they are subject to the fiduciary standard. This is because brokers are inclined to sell the products that carry the highest commission. And if they are legally bound to consider their clients best interests, those hefty commissions will be lost.
The bottom line: the status quo is not working. But don’t count on the government to effect serious change. I will not be surprised if the final reform bill does not contain language that equals a material improvement in investor protection. And if the fiduciary provision doesn’t make it into the final bill, the real irony will be this: the government can impose universal healthcare, but not a universal standard of care for investment advice to protect you from a So-Called Financial Advisor.