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One-Man Think Tank: When Wall Street has investors' 'best interests' at heart, watch out

As Senate is poised to take up reform, Ron Rhoades contends the movement to create a "new" fiduciary standard is a campaign of disinformation

Tuesday, April 27, 2010 – 6:19 AM by Ron Rhoades, Columnist
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Ron Rhoades: When will Congress stand up to Wall Street?

I am often struck by the disinformation campaign waged by large financial services firms, and their lobbyists, when they speak of putting the “client’s best interests” ahead of their own. The past two weeks have seen more gross misrepresentations, as many large Wall Street seek to have Congress weaken the protections existing under current law for so many individual and institutional investors.

SIFMA’s misinformation campaign: The New Federal Fiduciary Standard

At a recent annual conference of the American Council on Consumer Interests (ACCI) on April 15th in Atlanta, Georgia, Ira D. Hammerman – a representative of the Securities Industry and Financial Markets Association (SIFMA, the brokerage firms’ lobbying organization) – acknowledged that “the brokerage industry is after providing the same service as the investment advisor.” He stated that SIFMA proposed a “new pro-investor federal fiduciary standard that is uniformly applied to broker-dealers and investment advisors” and denied that SIFMA is attempting to “water down” the best interests fiduciary standard found in the Investment Advisers Act of 1940.

While Mr. Hammerman touted SIFMA’s proposed standard as “new and improved,” Professor Mercer Bullard, also speaking at the ACCI conference, noted: “There is no doubt in my mind that SIFMA wants to water down the fiduciary standard.” Professor Bullard is the founder and CEO of Fund Democracy, LLC (www.funddemocracy.com), which advocates on behalf of mutual fund shareholders and their advisors. He also currently serves as chairman of the Investor as Purchaser Subcommittee of the SEC Investor Advisory Committee. Professor Bullard noted that SIFMA’s effort, if it succeeds, would indeed lower the best interests fiduciary standard of conduct currently applicable to investment advisers, despite SIFMA’s claims of an “improved” standard.

This only begs the question – an improved standard for whom – consumers or Wall Street’s profit-making machine? And what reasons does SIFMA provide in support of the need for a “new federal fiduciary standard?”

1. SIFMA states that the state common law of fiduciary duty is uneven. Yet, if that is the case, why not apply the current Advisers Act’s fiduciary standard and preempt state law – why is it necessary to create a new one? Moreover, in this author’s extensive research into state common law, I have observed differences in when fiduciary standards are applied; yet – when the best interests fiduciary standard is applied to financial advisers, brokers, and investment advisers – I have noted no disparity in the best interests standard itself – i.e., the fiduciary duties to act toward each client with due care, loyalty, and utmost good faith. As Professor Mercer Bullard noted at the ACCI conference, what SIFMA really desires is an abandonment of “hundreds of years of precedent” defining the best interests standard of conduct under fiduciary law, in an effort to escape the oversight of state securities regulators – whose role in combating securities fraud is “deeply imbedded” in our federalist system.

2. SIFMA also argued that the Advisers Act is not designed to regulate brokerage activities. This fact is granted, but it has no relation to the issue at hand. The business oftransactions in securities is regulated by the Securities Exchange Act of 1934. But the business of investment advice is regulated by the Advisers Act. The proponents of the fiduciary standard merely seek to apply the Advisers Act to the functional activities the Advisers Act was designed to regulate. As stated by Harold Evensky, the president of Evensky & Katz Wealth Management and past chair of the CFP® Board of Governors, who also spoke at the ACCI Conference, it has not been suggested that the fiduciary standard should apply to all brokerage activities – only that it should apply when investment advice is provided.

3. SIFMA says the Exchange Act already regulates broker-dealers. Yet nothing in the Exchange Act imposes the fiduciary standard upon the investment activities of broker-dealers. Instead, the far lower suitability standard is applied, behind which so many broker-dealer firms hide when accused of misconduct. One could also argue the point that the Exchange Act “WELL” regulates broker-dealers, when all the evidence points to a long history of abusive practices by Wall Street firms at the expense of individual Americans.

4. Lastly, SIFMA argues that broker-dealers would migrate en masse to a fee-based model, and as a result investors would suffer by losing choice and paying higher fees. Mr. Hammerman argued that the fees and costs paid by investors under the RIA model were much higher than those paid under the broker-dealer model. Yet, it has been the experience of this author that new clients migrating from broker-dealer firms to our firm, typically save 30% to 70% in total fees and costs. How is this possible, when our firm charges an average assets-under-advisement fee of 1%? It’s because brokers act as representatives of product manufacturers, and they often receive compensation for selling higher-priced products. For example, one must ask if variable annuities would be sold in such high volume if the same break-points existed as existed in sales of Class A mutual fund shares. By contrast, investment advisers act solely as representatives of the purchaser, and possess every incentive to seek out lower-cost products for their clients. The result? The individual investors receives better-quality advice (investment advisers are bound to undertake due diligence, and possess the requisite knowledge to provide investment advice) for lower total fees and costs.

None of the reasons for a “new” standard survive even modest intellectual scrutiny.

Morgan Stanley’s annual report touts a fiduciary standard, yet its CEO argues against one

Accompanying Morgan Stanley’s recently issued Annual Report was its April 7, 2010 letter to shareholders, in which CEO James P. Gorman writes: “Above all else, the people of Morgan Stanley always have looked to do what is best for our clients … we insist that our people conduct business with the highest standards of professionalism and respect.” Yet, Morgan Stanley President Charles Johnson stated at a recent SIFMA conference on April 22, 2010, as reported by Reuters, that he is worried that new rules which would seek to impose a fiduciary duty upon brokers could do unintended harm to investors and urged “regulatory restraint.” (Joseph Giannone and Joe Rach, “Morgan Stanley warns regulatory reform might do harm,” Reuters, April 23, 2010.)

Goldman Sachs’ e-mails reveal bets against clients

The high-flying and highly profitable firm of Goldman Sachs, in its 2010 communication to shareholders, stated: “This past year, clients came to Goldman Sachs because of our ability to integrate advice, financing, market making and investing capabilities with sophisticated risk management … we believe that sensible and significant reforms that do not impair entrepreneurship or innovation, but make markets more efficient and safer, are in everyone’s best interests … our people remain as committed as ever to … the belief in their responsibility to help allocate capital for the benefit of clients ….”

Yet how well did some Goldman Sachs clients fare – as well as individual U.S. citizens? Fabrice Tourre, a Goldman Sachs executive facing an SEC fraud lawsuit in the sale of a mortgage-backed security, stated in a March 7, 2007 e-mail that “the poor little subprime borrowers will not last too long.” A few months later, in a June 13, 2007 e-mail, Tourre claimed: “I’ve managed to sell a few (mortgage-backed) bonds to widows and orphans that I ran into at the airport ….” In another November 18, 2007, e-mail released recently by the U.S. Senate Permanent Subcommittee on Investigations, another Goldman Sachs executive laments: “Of course we didn’t dodge the mortgage mess. We lost money, then made more than we lost because of shorts.”

Breach of fiduciary duty claims raise in arbitration complaints

In the meanwhile, FINRA, the self-regulatory organization composed of member broker-dealer firms, recently announced that complaints to it by investors in the first quarter of 2009 skyrocketed. Moreover, the most popular complaint was investors charging their brokers and dealers with failing to act in the best interests of their clients – i.e., breach of fiduciary duty.

FINRA has steadfastly argued against the application of the existing fiduciary standard to the advisory activities of broker-dealers. However, FINRA has advocated for a new federal fiduciary standard to be created by the SEC and/or Congress. Professor Bullard hypothesized a rationale for FINRA’s position at the recent ACCI conference, “FINRA exercises authority to oversee the advisory activities of broker-dealers. If FINRA decided to impose a fiduciary standard upon those activities, FINRA would face a rebellion from its members.”

Experienced arbitrators in FINRA arbitration proceedings, such as Mr. Evensky, frequently observe that broker-dealer firms fight hard in arbitration proceedings against their brokers being held to the fiduciary standard. As he noted at the ACCI Conference, “Financial advice is the world of the investment adviser. That is not what brokers provide. If brokers move into the advisory world, they should be held to the fiduciary standard found in the Advisers Act.”

The best interests illusion propagated by Wall Street: America deserves better

Broker-dealer firms and their representative organizations (FINRA, SIFMA), often claim that the firms operate in the “best interests” of their clients. Yet, at every turn the recent evidence strongly suggests actions that fall far short of the bona fide best interests fiduciary standard of conduct.

Congress deserves better. One can only wonder if the firms touting a “new federal fiduciary standard” (which is anything but) and claiming to act in the “best interests” of their clients (yet with so much recent evidence to the contrary) will ever be confronted by members of Congress. Or will the wolves (FINRA, SIFMA) continue to be able to pull the wool over the eyes of the sheep (Congress, and even the SEC, as well as individual consumers) in the weeks, months and years ahead?

Rather than a misinformation campaign orchestrated by FINRA and SIFMA and accompanied by huge contributions to the campaign accounts of so many in Congress by the broker-dealer and insurance lobbies, participants in the financial services industry deserve an honest, intellectual discussion of the issues involved.

And all recipients of financial and investment advice deserve the protections of the current bona fide fiduciary standard of conduct found in the Advisers Act.

Ron A. Rhoades, JD, CFP® serves as Chief Compliance Officer and Director of Research for Joseph Capital Management, LLC, a registered investment adviser with offices in New York, North Carolina, Georgia and Florida. This article represents his views only, and not necessarily the views of any organization to which he may be affiliated.

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Skip Schweiss

Skip Schweiss

April 28, 2010 — 9:13 PM

As with most things, it is both challenge and opportunity. I still believe the vast majority of investors have no clue about the difference between the suitability standard of brokers vs. the fiduciary standard of advisers. Recent mainstream press articles (NY Times) and the Goldman grilling (Sen Collins’ comments) I believe are beginning—just beginning—to open the public’s eyes to the distinction. Let’s keep fighting the good fight!

Stephen Winks

Stephen Winks

April 27, 2010 — 1:51 PM

Is Congress really interested in exposing the truth about Consumer Protection?

Does Congress know enough or even care enough to ask sufficiently penetrating questions to expose FINRA and SIFMA misinformation on their desire to act in the best interests of the consumer? Is there no one like Ron Rhoades who Congress can call upon to to penetrate this veil of obscuration to expose the truth and bring clarity? Of course there is, so why hasn’t Congress called on Ron?

Now we see how large campaign contributions loom. It is a perversion of Congressional legislative authority that will subvert the best interest of the consumer in deferance to the brokerage/insurance lobby. This is not even a close debate where there is room for principaled disagreement. The consumer’s best interests are clearily not being advanced by FINRA and SIFMA and it doesn’t take much to prove it.


Skip Schweiss

Skip Schweiss

April 27, 2010 — 7:15 PM

Ron, another excellent column on this topic! Stephen, of course you get to the heart of the matter: when Congress is faced with a choice between principle and money, they will choose the latter. Most unfortunate.

Ron Rhoades

Ron Rhoades

April 28, 2010 — 12:53 PM

Stephen, thanks for the suggestion to go to Congress. I can assure you that there are many good people working on this issue on behalf of both consumers and investment advisers – both in Washington and elsewhere. Unfortunately, those who seek to oppose and/or weaken the fiduciary standard of conduct possess about 100 times the manpower and 1,000 times the money. Hopefully, Congress will be wise enough to see through the smokescreen and – at the minimum – not permit the Advisers Act’s fiduciary standard to be weakened. Stephen, thank you for your continued writings on this topic, as well.

Skip, thanks for the comment. I hope that Congress is so “angry” with Goldman Sachs and other investment banking firms that they will forge ahead with true reform, despite the many political contributions. Hearing Goldman Sachs execs seek to explain to Sen. Levin yesterday how and why they take positions adverse to their institutional clients was interesting. I’m certain that if the purchasers of that MBS were individual investors, or smaller institutional investors, the hearing would have been even more tumultuous. Thank you, to TD Ameritrade, for continued support of RIAs and the fiduciary standard. Hopefully Congress will not enact any legislation which could effect a lowering of the current bona fide fiduciary standard. In that event, perhaps we can move the debate ahead, and instead of discussing WHETHER a fiduciary standard exists, we can address the specific requirements of the standard, as applicable to RIAs and financial planners.

I found it interesting that, yesterday, as Marketwatch reports, “Former and current bankers at Goldman Sachs Group Inc. disagreed Tuesday about whether the firm has a duty to act in the 'best interests’ of its clients, during a hearing Tuesday of the Senate’s Permanent Subcommittee on Investigations.” Seems to me that there are a LOT of people confused about the “best interests” standard is, when it should apply, and what it requires – including those in Congress. Is this confusion a challenge, or an opportunity?

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