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Regulatory Wire: Is it game-over for the fiduciary standard this year? Advocates say, maybe not

Johnson amendment, calling for study of harmonizing regulations, passes as part of 1,596-page bill

Friday, May 21, 2010 – 4:31 AM by Brian O'Connell
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Looking ahead to next week: a powerful new committee will have its first meeting

Brooke’s note: Brian O’Connell stepped into the big shoes left by Sara Hansard last week to take the reins of Regulatory Wire, the best weekly round-up available on Washington D.C.'s goings on related to financial advisors. He’s hit the ground running. With some showing of the ropes by Sara and, our editor, Elizabeth, O’Connell has successfully handicapped the chances for fiduciary reform in the face of a Thursday setback. He also gives some good preparatory thinking about a coming summit between the SEC and the Commodities Futures Trading Commission and analyzes Washington’s reaction to the crazy May 6 meltdown. O’Connell brings his own flair and passion to the topic and it’s apparent in reading this piece.

While Wall Street continues to grapple with the impact of the “Three G’s – Greece, Goldman Sachs, and the Gulf of Mexico – financial reform remains firmly planted on center stage in Washington.

And for now, at least, the push for a fiduciary standard on Capitol Hill isn’t gaining much traction.

The financial reform bill passed on a 60-40 vote late in the day on May 20th. The Menendez-Akaka amendment, which would have made broker-dealers and insurance agents who provide investment advice act in the best interests of their customers, never came up for a vote.

What was included in the bill, in section 913, was an amendment proposed by Sen. Tim Johnson (D-South Dakota) and Mike Crapo (R-Idaho), that calls for the Securities and Exchange Commission (SEC) to study the all-in-one fiduciary standard issue and propose to Congress changes in the law designed to address any gaps or overlaps in the way broker-dealers and advisors are regulated, and to determine if those gaps are harmful to investors.

Currently, investment advisors are required by law to act in a “best interest” fiduciary manner, but broker-dealers and insurance agents aren’t tied to such fiduciary standards. Instead, broker-dealers are held to a “suitability” standard that is regulated by the Securities and Exchange Commission.

Failure was [perhaps] not fatal

The failure of the Menendez-Akaka amendment was a blow to fiduciary reform advocates – but perhaps not a fatal one. The Senate bill still has to be reconciled with the U.S. House version passed last December, which does impose a fiduciary standard on broker-dealers.

Fiduciary reform advocates still have some strong supporters in the House of Representatives. “The game is not over. The conference is vital; Barney Frank is very supportive,” notes Knut Rostad, a leader of the Committee for the Fiduciary Standard.

Some powerful forces in Washington want broker-dealers to operate under the same fiduciary guidelines as investment advisors.

Securities and Exchange Commissioner Luis Aguilar certainly falls into that camp. In an April 29, 2010, speech at the Investment Advisor Association annual conference in Chicago, Aguilar said he wants Congress to “mandate” that all providers of investment advice be fiduciaries.

“Currently broker-dealers are providing investment advice without any requirement that they serve as fiduciaries. In other words, broker-dealers are being permitted to end-run the Advisers Act,” he told his Chicago audience. “While brokers are required by current law to make certain disclosures about securities that are offered to investors, they are not required to make disclosures about certain of their own conflicts of interest. As a consequence, investors are susceptible to receiving tainted advice from broker-dealers and they will have no way of knowing that the advice was tainted by an undisclosed conflict.”

Other amendments that would have expanded the fiduciary standard, from Sens. Barbara Boxer, D-Calif and Susan Collins, R-Maine (the later seemed to water down enforcement measures on insurance agents), also fell short in Congress, and were not attached to the 1,596-page financial reform bill.

But the fact that so many amendments targeting new fiduciary rules for broker-dealers have come up for a vote – albeit unsuccessfully – could well mean that such an amendment will wind up in the final version of the reform bill. With heavy-hitters like Menendez, Akaka, and Boxer pushing for tougher restrictions on investment advice for broker-dealers, it remains viable.

Joint CFTC-SEC Advisory Committee on Emerging Regulatory Issues to Meet on May 24

The advisor community might not have heard much about the new alliance between the Securities and Exchange Commission and the Commodities Futures Trading Commission – but they will by next week. The joint committee, stocked to the brim with Washington financial regulatory decision-makers, could influence policy at both powerful regulatory oversight agencies.

At the top of the list on the committee’s agenda is to evaluate and weigh the impact of investment risk on the public – and more importantly, recommend investment risk policy to the powers that be at the SEC and the CFTC (a few of whom already sit on the committee).
The committee is scheduled to meet for the first time in Washington, D.C., on Monday, May 24.

According to the CFTC, the agenda includes a discussion on the preliminary findings of the staffs of the CFTC and SEC related to the unusual market events of May 6, when the Dow Jones industrial Average plunged 1,000 points in a matter of seconds. Co-chair and CFTC Chairman Gary Gensler notes that “It is critical that the CFTC and SEC hear from the panel together because our markets are so intertwined. I am particularly interested in the Committee’s first focus: advising on courses of action in response to the lessons learned from the market events of May 6.”

Over the long haul, the joint committee will likely be hashing out more than just a response to a three-week-old electronic trading error. Officially though, according to a joint statement from both the SEC and the CFTC, the committee’s mission statement is as follows:

The Committee’s objectives and scope of activities are to conduct public meetings, submit reports and recommendations to the CFTC and the SEC and otherwise to serve as a vehicle for discussion and communication on regulatory issues of mutual concern and their effect on the CFTC’s and SEC’s statutory responsibilities. Subjects to be addressed by the Committee will include, but will not be limited to, identification of emerging
regulatory risks, assessment and quantification of the impact of such risks and their implications for investors and market participants, and to further the Agencies’ efforts on regulatory harmonization. The committee will work to develop clear and specific goals toward identifying and addressing emerging regulatory risks, protecting investors and customers, and furthering regulatory harmonization, and to recommend processes and procedures for achieving and reporting on those goals.

Next Monday’s agenda pretty much meets those criteria. The Joint CFTC-SEC Advisory Committee agenda, culled from the SEC’s web site, looks like this:

  • Identifying of emerging regulatory risks;
  • Assessing and quantifying of the impact of such risks and their implications for investors and market participants; and
  • Furthering the CFTC’s and SEC’s efforts on regulatory harmonization.

While it looks very much like the committee will focus on emerging regulatory issues, how much impact it will have on investment advisors is still up in the air at this point. That said, the committee is an arranged marriage – the product of one of the 20 recommendations included in both agencies’ “harmonization” report issued in early 2010. Just how much harmony rises to the top of the new committee also remains to be seen, but the committee should have the ear of influential SEC commissioners.

According to the SEC, here’s how the committee panel breaks down:

Co-Chairs: SEC Chairman Mary Schapiro and CFTC Chairman Gary Gensler


  • Joseph Stiglitz – Nobel Laureate and Columbia Business School Professor
  • Brooksley Born — Former Chair of the CFTC
  • Jack Brennan — Former Chief Executive Officer and Chairman, Vanguard
  • Robert Engle — Michael Armellino Professor of Finance at the NYU Stern School of Business
  • Richard Ketchum — Chairman and Chief Executive Officer, FINRA
  • Maureen O’Hara — Professor of Management, Professor of Finance, Cornell University
  • Susan Phillips — Dean and Professor of Finance, The George Washington University School of Business
  • David Ruder — William W. Gurley Memorial Professor of Law Emeritus, Northwestern University School of Law; Former Chair of the SEC

Monday’s meeting will be streamed live on the Internet at www.sec.gov.

Schapiro’s testimony to Banking Committee

Mary Schapiro and Gary Gensler under the spotlight appear yesterday in front of the Senate Banking Committee to air out the causes and impact of the May 6, U.S. stock market plunge.

Banking Committee spokesperson told RIAbiz.com that the committee was particularly interested in the flash crash, the cause of which is still unclear. One major topic of discussion in Washington since the crash is the role that electronic trading played in it, and the extent to which electronic trading endangers investors.

The Banking Committee has already asked Schapiro to answer some written questions related to the May 6 meltdown prior to the May 20 meeting.
In her response, Schapiro noted that the SEC was “looking at a wide variety of actions on May 6 involving the full range of market participants.”

“We will examine such things as whether market professionals fully met their obligations, including, where applicable, their best execution obligations, and whether the decision to bust trades was made and applied fairly and consistently among investors,” Schapiro wrote. “If we identify any activity that violates the securities laws, we will take appropriate action.”

Stop loss head fake

Of particular interest to the SEC were complaints from individual investors “who used stop loss orders to protect them from rapidly declining markets,” added Schapiro. “It appears that some investors’ accounts were liquidated as share prices plummeted only to have stock prices close significantly above their sale prices.”

Right now, that’s all the SEC and other regulatory agencies seem to know for sure – that there are no guarantees with computerized trading systems at the various exchanges. That’s especially true in the performance (or lack thereof) of real-time data inter-communication exchanges needed to operate seamlessly during a lightning-fast trading crisis like the one we saw on May 6. Schapiro, in her written testimony to the Banking Committee, acknowledges as much:

In conclusion, the events of last week are unacceptable. The SEC is engaging in a comprehensive review and will take necessary steps to implement additional safeguards to prevent the type of unusual trading activity that occurred briefly last week. The Commission is considering a number of proposals that will address key issues raised on May 6 and will move expeditiously to address all issues we determine caused or contributed to those events.

Elizabeth MacBride

Elizabeth MacBride

May 21, 2010 — 4:25 PM

Elizabeth’s note: Knut Rostad, chairman of the Committee for the Fiduciary Standard, sent me this note via e-mail:

The fat lady has not sung. Wall Street reform and the fiduciary issue move to the conference committee. The key question now is whether conference committee members agree with how the Senate has “picked winners and losers” as it essentially endorsed the “Goldman standard” for all clients of brokers who give investment advice

Public confidence in Congress today, by all accounts, is lower than was Richard Nixon’s public approval as he resigned from the presidency. The absence of a requirement that brokers who give investment advice be regulated like investment advisers is stupefying, but not surprising. Investors’ (voters) historically low expectations of Congress have been met.

Many members of Congress rail against heavy-handed regulation that “picks winners and losers.” Libertarians should take note. The financial reform legislation — legislation heralded as the “Biggest regulatory overhaul of Wall Street since the depression” — essentially concludes that brokers who talk like investment advisers and work like investment advisers and persuade clients to trust them like investment advisers should not, however, be required to put clients’ interests first as the law requires of investment advisers. Brokers who act like investment advisers can continue, if they wish, to not avoid conflicts, or to not disclose and manage conflicts, to not control investment expenses, and to not, of course, tell a client how much the client is actually paying the broker in compensation.

Twenty three days after Goldman Sachs explained to the entire world, in excruciating detail, that the suitability standard means its fine to conceal a huge conflict of interest from a client (because the client is very smart, and understands Goldman’s role as a market maker), the Senate effectively endorsed the “Goldman standard” for institutional clients for all retail clients of brokers. This is not the world’s greatest deliberative body’s proudest moment.

Stephen Winks

Stephen Winks

May 21, 2010 — 4:21 PM


Congress only operates in a crisis mode and Congressional authorization is required for the SEC to create and enforce the fiduciary standard for both brokers and advisors. It is hard to believe we have lost an exhausting decades old consumer protection fight for all advisors to act in the best interests of the consumer. The best interests of the broker/insurance lobby have prevailed over that of the consumer and the advisor.

Congress is not persuaded that literally acting in the best interest of the consumer is good public policy, its makes no difference if three of the five SEC Commissioners clearly see fiduciary standing and protection appling equally to the counsel being provided by brokers and advisors because it is Congress’s decision, the brokerage/insurance industry still does not see the importance of having the necessary enabling resources to (a) determine whether a recommendation is in the consumer’s best interest and to (b) make it possibe to determine of whether a recommendation added value or not. The buyer beware suitability standard has prevailed when a fiduciary standard in the best interest of the consumer has been denied to the consumer. Why is the fiduciary debate over? In short, if the legislative power of Congress is now not able to discern basic public policy so obviously in the best interests of the consumer— any finding of the Johnson/Crapo study will be lost in 24 months when all sense of urgency will have passed.

In hindsight, the death knell was not realizing how important the Collins’ Amendment was in establishing bi-partisanship in the Senate. Instead, the Collins Amendment, which established fiduciary standing for brokers but exempted mutual fund and annuity sales for mass market clients from fiduciary standing, was vicously attacked—thus shutting down an all important advocate. We could have handled the mutual fund and annuity exemption as being an inferior market position for brokers, capable of being fully exploited by advisors, painting brokers into the least attractive very low end of the market. Instead, Collins was attacked rather than being treated as an ally. Advisors were out gunned, out smarted and out maneuvered.

So now we just hopefully wait for Johnson/Crapo, which assures us of nothing.

Is the fight for fiduciary standing worth while, you bet. But the advisor market can no longer just be a segment of the larger financial services industry, it must become a seperate and distinct industry and not accomodate brokerage interests that fight fiduciary standing but still want the benefit of consumer advocacy and fiduciary standing.

After two decades of an exhausting fighting, fiduciary standing has to be taken up by a younger generation as their cause as it may not happen in my lifetime.

What we have learned is we win on merit in the best interests of the consumer, but that does not count. The vested interest of FINRA, SIFMA, FSI and other brokerage insurance groups will not give up on their “buyer beware” suitability standard just as we will not give up on the fiduciary standard. The brokers at 358,000 out number advisors at 35,000, ten to one.

Having taken the debate to Congress and lost, the way advisors win is not going through the brokerage gauntlet again and expect a different result but to take the fight to the free market where the best interests of the consumer will invariably prevail. We as advisors must find a way to bring large scale institutional support for fiduciary standing within the reach of all. This is beyond the reach of the individual practioner and importantly establishes an organized response to the deeply entrenched brokerage and insurance lobby to which we are vulnerable.

If the necessary enabling resources [(a) prudent process tied to statutory documentation to assure fiduciary standing for each of the ten major market segments advisors serve, (b) technology which supports accountability and transparency necessary for continuous comprehensive counsel required for fiduciary standing, (c) a functional divisioin of labor (Advisor, CAO, CIO) which simplifies the execution of fiduciary counsel, (d) conflict of interest management (not diosclosure)], were available that safely brought the full range of advisory services (transactions, planning, consulting, fiduciary standing) within the reach of every advisor to include easy to execute fiduciary standing—the entire industry would immediately evolve toward advisory services from commission sales, without Congressional approval or brokerage/insurance industry blessing.

In a free market, the best interests of the consumer will prevail, the vision, leadership and know how is there—we just need a large number of principled advisors and the capital to force the issue of fiduciary standing into the free markets.


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