Proposed Rules for Brokers May Remake Industry

By Alexis Leondis and Elizabeth Hester
Bloomberg News
Sunday, June 21, 2009

President Barack Obama's proposal to require brokers recommending investments to put clients' interests ahead of their firm's is long overdue, according to Barbara Roper, a consumer advocate.

The proposal aims to help individual investors who are confused about the obligations of broker-dealers, according to the administration's plan for financial regulatory overhaul released Wednesday. Brokers currently must meet a legal "suitability standard," while most investment advisers and financial planners have a fiduciary duty to their clients.

"Investors haven't been able to distinguish between someone who's acting in their best interest and someone pitching them a product for the last several decades," said Roper, director of investor protection at the District-based Consumer Federation of America. "If properly implemented, the plan has the potential to finally tilt the scale in the investor's favor."

The Securities and Exchange Commission would be given the authority to establish a fiduciary duty for broker-dealers who offer investment advice. The regulator would also be able to ban compensation for products that are not in the investor's best interest and to enhance disclosure agreements.

"When investors receive similar services from similar financial-service providers, they should be subject to the same standard of conduct," SEC Chairman Mary L. Schapiro said last week at an event held by the New York Financial Writers' Association.

The "regulatory regimes" that govern brokers and investment advisers who are providing similar services should be "virtually identical," she said.

U.S. brokerages are subject to rules, inspections and fines by the Financial Industry Regulatory Authority, which is funded by securities firms and has executives from those firms on its board. Schapiro was chief executive of the group before becoming SEC chairman in January.

The plan will result in lower fees and costs for investors because abiding by a fiduciary duty will require brokers to put their clients in the lowest-cost products and most tax-efficient investments, said Ron Rhoades, director of research and chief compliance officer at Joseph Capital Management in Hernando, Fla.

Obama's proposal may face opposition from firms such as Morgan Stanley and Bank of America, which both bought brokerages to expand their businesses.

Morgan Stanley paid $2.75 billion this month to complete a joint venture with Citigroup's Smith Barney brokerage unit, making the investment bank the industry leader in providing retail financial advice. Bank of America's completed acquisition of Merrill Lynch in January added 16,000 brokers to sell products to the 2 million households they already serve and take advantage of the bank's ties to another 55 million Americans.

Christine Pollak, a spokeswoman at Morgan Stanley, declined to comment. Matt Card, a spokesman at Bank of America, said the company was still reviewing the plan.

Legislation that makes the fiduciary obligations explicit may cut the industry by half, said Charles Trzcinka, a finance professor at the Indiana University Kelley School of Business.

"This will contract the brokerage business, because it will become too expensive for banks due to compliance and liability issues," Trzcinka said.

If fewer financial institutions have brokers that provide investment advice, investors will seek out cheaper "fly-by-night" brokers who aren't affiliated with regulated companies, said Wayne Abernathy, executive vice president for financial institution policy at the American Bankers Association.

A reduction in the number of people giving investment advice isn't a bad thing if the quality of advice given improves, according to Diahann Lassus, chairwoman of the National Association of Personal Financial Advisors. Lassus said having a single standard for advisers and brokers may result in banks lobbying for a "watered-down version" of fiduciary duty.

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