A Publication of WTVP

With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the financial advisory industry appears to be on the brink of undergoing the most significant restructuring of regulatory laws governing investment advice since 1940. The financial crisis that began in 2007 led to widespread calls for changes in the regulatory system. The purpose of the new law is to create a sound economic foundation to grow jobs, protect consumers, reign in Wall Street, end bailouts that are a result of “too big to fail,” and prevent another financial crisis.

The Dodd-Frank Act contains a number of provisions that are intended to improve investor protection, prevent securities frauds and scams, and strengthen the regulation of broker-dealers. Congress authorized the Securities Exchange Commission (SEC) to conduct a six-month study to help write rules that would create a uniform standard of conduct for anyone who gives financial advice to retail clients. The law says this standard must be “no less stringent” than the standard currently applicable to registered investment advisors (RIAs). For the first time, the brokerage and insurance industries may have to abide by a fiduciary standard that requires them to put their clients’ interests first.

What is a fiduciary? In practical terms, a fiduciary relationship represents the highest standard of customer care imposed by either equity or law. A fiduciary owes a duty of loyalty to its clients and is expected to be above reproach in carrying out its duties. A fiduciary must not put its personal interests before its clients, and it may not profit from its position as a fiduciary without the consent of the person to whom it has pledged these fiduciary duties.

The SEC’s Office of Compliance Inspections and Examinations further identifies five responsibilities of fiduciaries:

  1. To put clients’ interests first
  2. To act with utmost good faith
  3. To provide full and fair disclosure of all material facts
  4. Not to mislead clients
  5. To expose all conflicts of interest to clients.

While investors often assume their advisor is held to such a standard, in reality, most in the brokerage and insurance industries are not. They follow the “suitability standard.” Simply put, they are not “required” to recommend the most appropriate investment in any given situation. While they cannot make unsuitable recommendations they know to be inappropriate for you, they have no duty to seek out the “best” recommendation.

The suitability standard is measured by its inverse…they ask, “Is my product suitable?” If a product is not unsuitable, they can sell it to you.
We believe that all investment providers should be held to the same fiduciary standard that RIAs have long been required to follow. We are not alone. A recent poll conducted in August 2010 by ORC/ Infogroup found 91 percent of respondents answered “yes” when asked whether stockbrokers and investment advisors who provide similar investment advice should follow the same investor rules. In addition, 85 percent “strongly agreed” and 12 percent “somewhat agreed” with the statement that financial professionals providing investment advice should put the client’s interest ahead of their own and that all potential conflicts of interest should be disclosed up front.

Most consumers do not understand the important differences between advisors, brokers and insurance agents. When survey respondents were told what the fiduciary standard means and then asked which financial professionals are required to uphold that standard, 66 percent incorrectly said it applies to stockbrokers, and 60 percent incorrectly said it applied to insurance agents. Clearly there remains a good deal of misunderstanding about which financial professionals abide by the fiduciary standard.

Of course brokerage and insurance industry lobbyists are doing their best to derail or water down the mandate of a “fiduciary standard.” They prefer to continue following the suitability standard and essentially call it their version of the fiduciary standard. We think this would be a big mistake.
The fiduciary standard created by the Investment Advisers Act of 1940 is very well established, and the SEC should not weaken it or water it down. The brokerage and insurance industries should be required to follow a true fiduciary standard in order to sell advice. Those who prefer to avoid a true fiduciary relationship and earn commissions should fully disclose such conflicts of interest and no longer claim to offer advice.

The SEC submitted the results of the survey on fiduciary duty to the Chairmen of the House Financial Services and Senate Banking, Housing, and Urban Affairs Committees in January. While it’s still unclear what the final regulations will be, one thing is certain—2011 is likely to be a year of significant change in the financial services industry. iBi