A long-odds fight by advocates and a well-timed Goldman Sachs stumble and -- voilà -- brokers may have to begin putting customers' interests first

June 28, 2010 — 7:29 AM UTC by Elizabeth MacBride

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Brooke’s Note: There’s still a too-good-to-be-true feeling about the victory of fiduciary advocates over their better-funded Wall Street and insurance-giant foes. See: Improbable win for fiduciary standard: Congress set to hand SEC power to impose fiduciary duty on broker-dealers But this narrative from Elizabeth shows that the right combination of work and luck make this amendment very real indeed.

Last summer, the Obama Administration’s Treasury Department released a white paper that laid out a blueprint for reforming the financial system in the wake of the worst crisis in living memory. The white paper included the idea that the fiduciary standard should be extended to broker-dealers.

“It was like, “We’ve been invited to the party,” recalls Kristina Fausti, then the newly hired director of legal and regulatory affairs for fi360, a Pittsburgh, Pa.-based company that provides fiduciary education and services.

An invitation it might have been – but it sure looked liked fiduciary advocates were likely to be seated at the last table by the door.

Congress was already debating larger issues more directly related to the crisis, including systemic risk, too-big-to-fail and how to regulate the derivatives market. Moreover, the question of whether the fiduciary standard ought to be extended to broker-dealers had been raised many times before. Anyone who chose to take on the battle in the past had gone down in flames, caught up in the complexities of the issue and the steadfast opposition of Wall Street and the insurance industry.

This time around, the story had a different ending. Last Thursday, the conference committee working on financial services reform agreed on a compromise that empowers the SEC to extend the fiduciary duty to broker-dealers after a six-month study. The amendment has been almost universally hailed as an advancement for investor protection.

Not a perfect ending

“The story doesn’t have a perfect ending,” says Diahann Lassus, president of Lassus Wherley & Associates, based in New Jersey and Florida. “But it certainly has a lot better ending that we thought it might.”

So what happened to change the tale this time around? Certainly, the historic nature of the crisis opened the door – and minds on Capitol Hill — to extending the fiduciary standard. But the change also came about because of an intense lobbying effort by the hodge-podge of scantily funded organizations that represent advisors and their interests. Lassus, the former chair of the National Association of Personal Financial Planners, a group of fee-only advisors, was member of the group of advocates that banded together last summer.

Over a year of ups and downs, they made new political allies and enemies. The SEC delivered them one lucky break on a Goldman Sachs platter. From February and July, it looked as if they had been defeated.

In the end, in a stunning political turnaround, Barney Frank, chairman of the House Financial Services Committee, delivered the victory at the end of a grueling week of conference committee negotiations.

“Chairman Frank said at the beginning of the (conference commitee) process that this issue was a priority for him,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “He and the House really came through for investors.”

The cast of characters

Historically, the groups serving financial advisors have been somewhat divided based on their memberships and their purposes. The Financial Planning Association allows both fee and commission-based advisors to join. NAPFA’s members are fee-only. The CFP Board of Standards offers certification and education.

In the summer of 2009, brought together by the financial crisis and the chance to influence sweeping financial reform, the trio banded together as the Financial Planning Coalition.

The fiduciary standard was one of the planks in their lobbying platform; as were the regulation of financial planners and the establishment of a professional organization that would serve as the regulator for the industry.

Meanwhile, the Committee for the Fiduciary Standard was formed around that same time, by individuals in the private sector. The group currently counts more than 700 members.

The Investment Adviser Association, which represents advisors serving individual and institutional clients and is generally regarded as the best-organized advocacy group for advisors, joined forces with the Financial Planning Coalition at key points in the year, as did the National Association of State Securities Administrators, which in addition to the fiduciary standard had its own axe to grind. It wanted regulatory oversight of the advisors with less than $100 million in AUM, rather than $25 million, shifted to the states – an outcome that now looks likely pending passage of the legislation.

As the year wore on, the advisors’ groups also formed alliances with some consumer groups interested in protecting investors, including the Consumer Federation and the AARP.

A watershed, and a sign of battles to come

The first watershed came on Oct. 7. In testimony before the House Financial Services Committee, witnesses representing the Securities Industry and Financial Markets Association and the American Council of Life Insurers agreed that the fiduciary standard was a higher standard than the suitability standard that SEC and FINRA had used to regulate broker-dealers for years.

The stark acknowledgement was a reflection of how much the conversation had changed over the previous months as the financial crisis had unfolded. SEC Chairwoman Mary Schapiro, who had been a defender of the suitability standard when she was head of FINRA, was on record endorsing the fiduciary standard, as were at least two other commissioners. Now SIFMA was seeming to change its tone, too.

Knut Rostad, chairman of the Committee for the Fiduciary Standard, noted that even nine months before, the sight of SIFMA testifying on behalf of a fiduciary standard for broker-dealers would have been unthinkable.

However, the representatives from SIFMA and the insurers delivered nuanced comments – sketching out battle lines for the coming months and years.

Vigorous opposition from insurers

Bruce W. Maisel, managing counsel for Thrivent Financial for Lutherans, testifying on behalf of the American Council of Life Insurers, acknowledged the fiduciary standard as a higher standard than suitability. But the insurance business stands to take a big hit on sales of variable annuities, with their high up-front commissions, high surrender fees and other fees, if they are subject to disclosure under the fiduciary standard (as now looks possible). Over the course of winter and spring, as the reform debate continued, the insurance industry turned out to be the most vigorous opponent of the fiduciary standard legislation.

SIFMA’s representative took a more nuanced stand. He agreed with the concept of a fiduciary standard, but indicated that the Wall Street advocacy group would attempt to reshape the standard and/or the rules flowing from it.

“SIFMA’s vision of a harmonized fiduciary standard is even stronger, and more pro-investor, than any other alternative we have heard advanced,” said John Taft, head of wealth management, RBC Wealth Management.

The low point

The House of Representatives passed financial services reform legislation in November. Advocates declared a victory – sort of. With the help of Barney Frank, who was becoming fiduciary advocates’ key ally, a last-minute effort to put dually registered advisors under FINRA regulation was excised from the bill.

The legislation called for extending a fiduciary duty to broker dealers, but it left a lot of power in the hands of the SEC. Nothing in the legislation suggested that the Investment Advisers Act of 1940 needed to be the basis of the rules that the SEC would write. In the view of fiduciary advocates, that was critical: the Investment Advisors Act wording was based on a common law standard of fiduciary provided well-established consumer protections.

As the new year began, Sen. Christopher Dodd, D-Conn., released his draft of a financial services reform proposal, which would have used the Investment Adviser Act as the basis for extending a fiduciary standard to brokers when they were offering financial advice.

The fiduciary advocates were celebrating, but it wasn’t to last.

In February, Sen. Tim Johnson, D-South Dakota, proposed an amendment calling for an 18-month study of the fiduciary issue and the regulation of broker-dealers and advisors. A Johnson spokesman said at the time that the study would deliver proposals on the complicated question of unifying the regulations.

The amendment also pointed out that the SEC does not have enough resources to adequately inspect advisors, only 9% of which are expected to be inspected in fiscal 2011 despite a 12% increase requested in the SEC’s budget by the Obama administration. In contrast, the Financial Industry Regulatory Authority inspects 55% of broker-dealers annually. By raising the question of resources, the amendment “it clearly opened the door to FINRA regulation of investment advisors,” said Tittsworth at the time. See Why advisors see FINRA as the devil.

The length of time that was devoted to the study would have meant the idea of extending the fiduciary standard would die on the vine, advocates believed.

“The low point was when Sen. Johnson came out with that study,” said Robert Glovsky, chair of the CFP Board of Standards. “It was clear it enabled those who wanted to kill the fiduciary standard to do so.”

The Goldman effect

The low point became a trough in the early spring, as it became clear that Sen. Johnson’s amendment was likely to be part of the final bill passed by the Senate.

Then came a lucky strike. In April, the SEC filed a securities fraud case against Goldman Sachs, alleging that the firm allowed hedge fund Paulson & Co., which was making short sales against the mortgage market, to influence the mortgage securities included in securities Goldman sold to investors.

Senators were asking Goldman executives what kinds of ethical standards they were operating under – and the answer wasn’t “the fiduciary standard.” It was something much hazier and much less defensible.

Suddenly, the fiduciary standard, long a backwater topic on Capitol Hill, became the subject of new amendments and hearings. Jumping on the bandwagon, Sen. Arlen Specter of Pennsylvania suggested that people who violate the fiduciary standard should do jail time. Fiduciary advocates found two new allies in Sens. Daniel Akaka, D-Hawaii, and Robert Menendez, D-N.J., who prepared an amendment to replace the Johnson amendment (though the Akaka-Menendez amendment never came up for a vote).

The furor seemed to die away as financial reform passed the Senate. Quietly, on one front, the Financial Planning Coalition had seen a victory separate from the fiduciary standard fight: both the House and Senate versions called for a GAO study of the regulation of financial planners.

End game

But as the conference committee began negotiations, it was using the Senate bill as its baseline legislation. That meant that the version containing the Johnson amendment was likely to trump even the imperfect House bill version.

Then, early last week, the situation looked even worse. The House conferees offered their version of the fiduciary reform up to the Senate conferees for their consideration, and the Senate returned with a version that specifically directed the SEC to devise a new fiduciary standard for broker-dealers that was not based on the Investment Adviser Act.

Fiduciary advocates hovered over C-SPAN all week, tuning in between meetings and their regular business, hoping to hear the House’s response. It was delayed again and again – until Thursday, when, in a brief moment in the conference room, Frank offered an amendment that, though imperfect, was better than had seemed possible only the week before.

There would be a six-month study; and the SEC was empowered to issue rules based on the Investment Adviser Act.

Some attention is already turning to the next questions, such as whether the SEC will be too busy to act, and how much influence the broker community will have, versus the advisor community, in new rules’ development. But for a few days, anyway, the fiduciary advocates are enjoying a sense of accomplishment.

“It was a very long and time-intensive effort, and it was very much worth it,” said Glovsky.

Mentioned in this article:

Financial Planning Association
Association
Top Executive: Lauren S. Schadle, CAE, Executive Director and CEO

National Association of Personal Finance Advisors
Association
Top Executive: Ellen Turf

Certified Financial Planner Board of Standards
Association
Top Executive: Kevin Keller

FI360
Financial Planning Software
Top Executive: Blaine Aikin



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Skip Schweiss said:

June 28, 2010 — 2:14 PM UTC

Great summary! This has been quite interesting to watch, and it’s not over. It’s all about what’s in the best interest of the customer.


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