Financial reform bill likely to lose measure to protect Main Street investors
Sunday, March 7, 2010
When financial reform legislation finally lands on the Senate floor, a provision that advocates call the single most important item for Main Street investors will probably have been banished from the ponderous bill.
That provision -- a requirement for stock brokers and insurance agents to act in the best interest of their clients -- was part of a 1,100-page draft bill unveiled by Senate banking committee Chairman Christopher J. Dodd (D-Conn.) in November. Since then, industry and consumer groups have quietly lobbied members on the issue, even as much of the public debate has focused on oversight of big banks and the creation of a consumer protection agency.
And now, with key senators wrangling over an agreement, the provision is widely expected to be replaced with legislative language directing the Securities and Exchange Commission to study the varying rules that govern brokers and registered investment advisers today, according to industry officials and legislative aides involved in the process. Investor advocacy organizations worry that such a move -- backed by Sens. Tim Johnson, a centrist Democrat from South Dakota, and Mike Crapo, an Idaho Republican -- would diminish chances of meaningful reform and vowed to keep fighting.
"It happens to be the single most important provision in the legislation to enhance protection for average investors," said Barbara Roper, director of investor protection for the Consumer Federation of America. "It's not done until the bill is finally written. . . . Operating against us is the fact that this is not number one on any of these members' list of priorities, and with everything to be negotiated, it could easily become a trading chip."
The effort is the latest attempt to close a regulatory gap governing brokers, traditionally defined as salespeople who charge a commission to buy and sell securities for clients, and registered investment advisers, who often are paid an annual fee of a percentage of assets for financial planning and money management services.
As it stands now, investment advisers are required to act as "fiduciaries," legally and ethically bound to put a client's interest ahead of their own. In comparison, brokers are required to have "reasonable grounds" to believe that a product they are recommending is "suitable" for the customer. Typically, brokers do not have to make as many disclosures about conflicts of interest, fees and past infractions as investment advisers.
The different standards exist because the Investment Advisers Act of 1940 makes an exemption that spares brokers from registering as advisers as long as the advice provided to clients is "solely incidental" to selling products.
But the line distinguishing brokers and investment advisers has blurred over the years. Industry officials and observers said many brokers today wear two hats, sometimes with the same client, offering "suitable" recommendations and switching to a fiduciary role when dispensing paid investment advice. At the same time, it is not uncommon for registered investment advisers to be paid in a mix of commissions and asset-based fees. Members of both groups can go by different names -- financial advisers, wealth management specialists and retirement planning counselors.
The White House, in proposing its guidelines for financial reform last year, said the services the two groups provide are often identical from the perspective of consumers and that the distinction between a disinterested investment adviser and a broker agent is no longer "meaningful." An SEC-commissioned study in 2008 by the Rand Corp. found that investors were confused about the differences among the financial professionals.
The House version of the reform bill passed in December would create what analysts agree would be a more limited fiduciary duty for brokers, one that would apply only when they are giving "personalized investment advice."
But the original proposal in the Senate's financial reform bill would bring brokers into the fiduciary fold by eliminating the exemption in the Investment Advisers Act. Investment adviser groups back the change, but broker trade organizations have argued that such a fix could hurt investors. Unless the provision is stricken, they say, big brokerages such as Morgan Stanley Smith Barney and Merrill Lynch may no longer be able to offer clients access to the full range of products sold by other parts of the firm. They also say that the proposal if passed could throw the industry into chaos by raising liability costs and regulatory burdens.
"Most of us operate under contracts with a broker-dealer or insurance company, and you have an agreement that you're going to look after the interests of the company," said Thomas Currey, president of the National Association of Insurance and Financial Advisers. The original proposal "puts a person with a contract like that in a really untenable situation. There is really no way you can equally serve those purposes."