Fiduciary: To Be or Not To Be

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Comment by Richard Ferlauto on September 1, 2009 at 10:35am

The WSJ article reference by Mercer is below


WSJ: Fiduciary Duty Hits the Street -- Sort Of
By JANE J. KIM
Wall Street finally has agreed to put its brokers under the tougher fiduciary standard for their dealings with customers. Now a fight looms over how tough that standard will be.

As part of its regulatory overhaul, the Obama administration proposed holding brokers who give investment advice to the higher fiduciary duty -- a legal standard that would compel them to act in their clients' best interests. Currently, brokers are held to a more lenient "suitability" standard, which means they can't put clients in inappropriate investments. Many investment advisers, by contrast, have operated under the fiduciary standard for nearly 70 years.

The changes could transform the brokerage industry by changing the way products are sold and marketed and even how brokers are paid. Requiring brokers to operate under the existing fiduciary standard could force them to recommend more investments that are less costly and more tax-efficient.

They would have to tell clients about any potential conflicts of interest, such as when they stand to gain personally by favoring one product over another. For example, a broker who recommends a mutual fund with a higher fee -- and one he gets a bigger commission for selling -- would have to disclose that potential conflict upfront.

Congress isn't likely to tackle the fiduciary-standard issue until later this fall, but lobbying already is under way to shape it and how it is applied. In July, the Securities Industry and Financial Markets Association, Wall Street's main lobbying group, provided testimony about what it would want in such a standard.

Sifma asked that the fiduciary standard be defined by federal law and that it "supersedes and improves upon the existing fiduciary standards, which have been unevenly developed and applied over the years, and which are susceptible to multiple and differing definitions and interpretations under existing federal and state law."

"What we're calling for is a high standard of care that is clear and uniform across the board -- where it doesn't matter what certificate is hanging on your office wall," Ira Hammerman, Sifma's general counsel, said in an interview this past week.

To many people, Sifma's approach might seem reasonable. But not to investment advisers, state regulators and others who favor the existing standard.

For years, most investment advisers have been deemed fiduciaries under the Investment Advisers Act of 1940. Brokers were excluded from that definition of advisers as long as they didn't get paid special compensation for that advice, and gave it as "solely incidental" to their brokerage services.

Investor groups say the existing fiduciary standard has been defined and upheld by over four decades of legal precedence, including a 1963 U.S. Supreme Court case, Securities and Exchange Commission v. Capital Gains Research Bureau.

"If you have a precise definition of fiduciary duty, what that does is exclude a number of features of fiduciary," said Rex Staples, general counsel at the North American Securities Administrators Association Inc., which represents state securities regulators.

Trying to define what constitutes a fiduciary duty is like trying to define the duty not to commit fraud -- any application of it depends on the client's particular facts and circumstances, say adviser groups. Proponents say a fiduciary standard can't be defined given the complexity and changing nature of the business.

Also, advisers and consumer advocates say that Sifma's request for a federal fiduciary standard could pre-empt stronger state common-law standards.

"For years, they've opposed the fiduciary duty," said Barbara Roper, director of investor protection at the Consumer Federation of America, a consumer-advocacy group. "Now they've embraced it in order to gut it."

Still, Wall Street's support of a fiduciary standard boosts the odds that it will eventually apply to brokers. Now, the fight is over the standard itself.

Investment advisers want to extend the current standard under the Investment Advisers Act to all financial professionals who give investment advice, while the brokerage industry wants a new, federal standard to apply to any broker-dealer or investment adviser that provides personalized investment advice to clients.

Under the Treasury's proposed Investor Protection Act of 2009, the SEC would have the authority to "promulgate rules" establishing a fiduciary duty. SEC Chairman Mary Schapiro said she favors a fiduciary standard that would that would be applied uniformly to all financial professionals.

Some advisers and consumer advocates are concerned that the SEC might favor the brokerage industry. Over the years, brokers have switched their focus from brokerage to investment advice, but rather than regulate them as advisers, the SEC has generally exempted brokers from fiduciary and other obligations under the Investment Advisers Act, said Mercer Bullard, president of Fund Democracy.

The proposed fiduciary standard from the Obama administration wouldn't apply to brokers who execute transactions but don't dispense advice. That raises the possibility that some brokers could still operate under a fiduciary standard when doling out investment advice but under a lower suitability standard when selling products.

In order to preserve investor choice, the brokerage industry also is proposing that customers be able to allow potential conflicts -- such as for principal trading -- as long as those conflicts are clearly disclosed up front in plain English. Clients could then decide whether they want to waive a particular conflict in exchange for potentially better pricing or access to more products.