The debate over a new level of protection for investors in their dealings with brokers may finally be nearing a resolution. And some investor advocates worry about the direction it seems to be taking.
The debate centers on whether brokers should be required to act in the best interest of their clients when giving personalized investment advice, including recommendations about securities, to retail investors.
The “best interest” standard is known as a fiduciary duty. Financial advisers registered with the Securities and Exchange Commission already are held to this standard. But brokers for the most part are held to a different standard, of “suitability,” which requires them to reasonably believe that any investment recommendation they give is suitable for an investor’s objectives, means and age.
The Dodd-Frank Act, signed into law in 2010, directed the SEC to study the matter, and permits the regulator to establish a fiduciary standard for brokers. In late February, SEC Chairman Mary Jo White said the commission would make a decision by year-end.
Meanwhile, the Labor Department is working on a separate proposal that could establish a fiduciary standard for brokers who give advice on retirement investing. It hopes to offer a proposal by August.
Dangerous Confusion
Advocates of a fiduciary standard for brokers argue that investors don’t understand the current rules. That leaves the door open to abuses bybrokers intent on selling products that pay them a commission, whether those investments are the best option for the buyer or not, these advocates say.
“Those dealing with a broker are under the misconception that they’re dealing with a financial professional legally obligated to put their best interests first; that’s not the reality,” says Barbara Roper, the director of investor protection at the Consumer Federation of America.
The problem with the suitability standard is that “you can satisfy a suitable recommendation by recommending the worst of what’s suitable,” she says. “If a variable annuity is suitable, you can recommend a variable annuity offered by a shaky insurer with sky-high fees and poor investment choices.”
But applying the fiduciary standard to broker-dealers as it is now applied to investment advisers would add to brokers’ compliance and liability costs, with no certainty of additional protection for investors, says Gary Sanders, vice president of securities and state government relations for the National Association of Insurance and Financial Advisors in Falls Church, Va.
In fact, he says, such a universal fiduciary standard could end up hurting many investors. Lower- and middle-income investors often turn to brokers who are compensated through product commissions, he says, because such clients are less attractive to financial advisers who are compensated based on a percentage of assets under management. Higher costs could prompt some brokers to drop commission-based accounts in favor of more-lucrative accounts that charge a percentage of assets under management, leaving many lower- and middle-income investors without anyone to turn to for investment advice, Mr. Sanders says.
Critics also say a universal fiduciary standard would narrow the range of products brokers could offer, by limiting their ability to recommend investments that earn them a commission.
Plea for Flexibility
At the least, some in the brokerage industry say, any fiduciary standard for brokers should be more flexible than the one investment advisers now operate under.
“The SEC needs to be sensitive that not every relationship is the same and they need to preserve customer choice” by not constricting the range of products brokers can offer, as a standard like the one that now applies to registered investment advisers would, says Ira Hammerman, executive vice president and general counsel of the Securities Industry and Financial Markets Association, the major lobbying group for large broker-dealers.
He says he is also concerned that the Labor Department will act to treat brokers as fiduciaries when they give retirement advice. He says that could jeopardize the sale of commission-based products as retirement investments while permitting fee-based advising. “It becomes very expensive for rank-and-file retail investors,” he says.
But Tim Hauser, deputy assistant secretary for the Labor Department’s Employee Benefits Security Administration, says the department is working on a package of exemptions that would permit advisers to receive many of the forms of compensation they now receive, while also offering protections to make sure conflicts of interest don’t bias the advice they offer.
Some fiduciary-standard advocates are worried that regulators are heading for a middle ground that these advocates fear will fall far short of what’s needed. Those concerns were fueled in March of last year when the SEC issued a public request for data and analysis on the issue. The request set out assumptions and parameters for comment, including the assumption that a fiduciary duty would permit a broker-dealer to continue to receive commissions and compensation for principal trades. Another assumption: The offering of only proprietary products or a limited range of products wouldn’t in and of itself be considered a violation of the fiduciary standard.
The request also said a broker-dealer at least would need “to disclose material conflicts of interest, if any, presented by its compensation structure.”
Not Happy
The SEC said those assumptions and parameters don’t suggest the ultimate direction of any proposed action. Yet critics worry that a fiduciary duty following those parameters wouldn’t offer adequate protection for investors. And some say it would be more confusing for investors than existing standards.
“The concern is that the argument of the [brokerage] industry has been generally accepted,” says Knut Rostad, president of the Institute for the Fiduciary Standard. “If that’s the case, then to proceed, we will have the worst of all possible worlds. We will have a situation where every single broker and adviser will be able to say they’re a fiduciary, when the rule making would essentially be a commercial sales standard with a little bit of extra disclosure requirements.”
Ms. Roper of the Consumer Federation of America says, “If this is what an SEC rule would look like, it would weaken protection for investors and they should not move forward.”
SEC Commissioner Daniel Gallagher fueled worries when he said in March that the commission is concerned that new rules could have the unintended consequence of limiting investor choice, because broker-dealers could scale back full-service brokerage accounts for retail investors. But he also said the topic was “very much an open issue.”
“I haven’t given up hope,” says Ms. Roper.
By: Daisy Maxey (The Wall Street Journal)
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