The 7 government actions that could reshape the advisory business in 2011

Elizabeth MacBride writes weekly on regulatory and legislative matters of concern to advisors. Two weeks ago, she wrote about a new platform for clearing alternative assets. Schwab leads effort to create industrywide solution for alternative assets.

Rep. Darrell Issa, a conservative Republican from Vista, Calif., recently sent a letter to 150 business owners asking them for a list of onerous regulations that they’d like to see repealed. As the LA Times reported a couple of days ago, Issa plans to use new position as head of the House’s top investigative committee to tackle what he sees as government run amok.

Meanwhile, Rep. Michele Bachmann, the Tea Party candidate whose post-election interview got an MSNBC newsman into hot water, introduced an (unlikely to become law) bill to repeal Dodd-Frank financial reform.

Issa has the power of the public hearing on his side. Bachman’s bill is probably best characterized as a flash-in-the-pan. The chances that the Democrat-controlled Senate and President Barack Obama would agree to repeal Dodd-Frank seem just about nil.

Both pieces of news had something to say about the sea change in Washington, D.C., and the passion with which Republicans seem prepared to attack regulation in the name of job creation.

I asked a group of Washington watchers from across the industry for their lists of the top legislative and regulatory issues of 2011. Their answers are infused with the new reality of a Republican-controlled House of Representatives that stands ready to take pick-axes to all sorts of regulation and seems prepared to put advisor-regulators like the SEC and the DOL on a budget-starvation diet.

Here are the issues that rose to the tops of lists. Thanks to Lou Harvey, president of Boston-based DALBAR, Neil Simon, government relations vice president for the Investment Adviser Association, Barbara Roper, director of investor protection for the Consumer Federation of America, Ruth Easterling, managing director of member services for the Chicago-based Family Office Exchange, and Cathy Vasilev, vice president of Austin, Texas,-based Red Oak Compliance.

SEC

1. The SEC is due to issue a report by Jan. 21 on harmonizing regulation of broker-dealers and investment advisors – which might mean that the SEC extends the fiduciary standard to broker-dealers. This report has the potential to rewrite the business of investment advice, but the mixed signals out of the SEC over the past few years have left everyone guessing about how aggressively the agency will act.

“If the SEC adopts a tough, pro-investor rule imposing a fiduciary duty on brokers when they give investment advice, it could fundamentally transform the relationship between investors and the financial professionals they rely on for investment recommendations,” says Barb Roper of the Consumer Federation. “If the agency fails to act, or adopts a weak and ineffective rule, the opportunity for reform is probably lost for a generation.

See Why a swing-and-miss on fiduciary standards will haunt us for decades.

The report is, almost certainly, already complete and under review at the agency. The new pro-business tone in the air in Washington could play out in any number of ways on the fiduciary study, because there is no clear business position. Generally, investment advisors and planners favor the existing standard; big Wall Street firms say they favor a fiduciary standard, but have caveats; and the insurance industry is dead-set against a fiduciary standard. Dodd-Frank reform gave the SEC the power to go ahead and develop regulations after it finishes its study.

2. Just a few days earlier than the Jan. 21 study, the SEC is due to report on whether investment advisors should be governed by a self-regulatory organization. FINRA has been lobbying to become that organization. Late in the fall, lobbying on the issue heated up. Here, SEC’s starvation diet could come into play, as the SEC, Congress or FINRA could argue that the agency doesn’t have the funds to regulate the growing number of RIAs. Shifting oversight to self-funded FINRA is one way to get the RIA enforcement line out of the SEC’s budget. “The new budget process will strip funding out of the agencies that oversee the industry. The Obama budget with thousands of new enforcement staff is dead,” says Lou Harvey, president of Boston-based DALBAR, a firm that audits financial service firms, including investment advisers.

3. In one little-noticed development, the SEC has been gathering comments and information from the family office community about how it should be defined and regulated, says Ruth Easterling, managing director of member services for the Chicago-based Family Office Exchange.

DOL

4. The Department of Labor is expected to issue in late spring, a revision of the big disclosure regulations released last year. These require that plan participants be given information about the fees they are paying in the 401(k)s. Those disclosures may come as quite a shock to sheltered employees – and may spur massive shifts in the industry. What’s left for DOL? It may, in April/May, issue a ruling on whether plan providers have to go even further and issue summary disclosures when there are multiple service providers on a plan.

5. Also next year, the DOL is expected to issue final regulations on the requirements for IRA and 401(k) fiduciary advisors under the Pension Protection Act, Harvey says. These regulations may include a requirement that puts more weight on predictive factors, such as expenses, than on non-predictive factors, such as investment returns. That, in turn could steer more business to advisors who mostly already operating in a world of fee transparency. IRA assets could be ripped from the grasp of brokers if DOL has its way.

The States

6. The switch to state oversight of smaller RIAs happens this year. Cash-strapped states are unlikely to have the money to staff up on regulators, which may mean that the promised increase in audits doesn’t happen – or happens more slowly. Advisors should watch for developments in their states on the question off regulator staffing and new regulatory guidelines. There are still plenty of pitfalls awaiting advisors who mess up on such questions as how to use the new rules to calculate their AUMs, or misunderstand the regulations about which states they are supposed to register in. Wondering whether to register with the states or the SEC? It’s a moving target.. Also still hanging out there is the big question of what happens to advisors in New York. The questions are not esoteric.

“I know of one client that had an issue with a state registration, and he was fined $2,500. Having inconsistent documentation would probably receive a higher fine and possible include sending corrected documentation to the Adviser’s clients. Most Advisers would find that prospect embarrassing,” said Cathy Vasilev, vice president of Austin, Texas,-based Red Oak Compliance Solutions.

7. Finally, advisors should keep an eye on state-level tax initiatives that could affect their businesses. California and Florida have seen recent efforts to impose taxes that would affect advisors, including a sales tax on services and a transaction tax on securities. Though these could happen at the federal level, as well, a movement there would cause a greater outcry and likely face opposition in the new House of Representatives. The FPA has begun establishing state-level organizations in part to counter the threat. As state regulatory, tax battles loom, FPA is establishing statewide organizations to counter threat.

An earlier version of the story included an incorrect deadline for the SEC’s fiduciary standard study.