Anyone who says elections don’t matter hasn’t been paying much attention. The chasm between Republican and Democratic visions is about as wide during this cycle as it’s ever been.As always, the outcome will have untold ramifications. One of them could be whether the investment advice you get helps you or hurts you.
Though not apparent to most voters, the financial-services industry has been divided in the past few years by a debate over what’s known as the “universal fiduciary standard”—that is, whether people who sell advice and investment products to retail investors should be required to put client interests before their own.
There is, after all, a conflict of interests inherent in relations between investors and their broker/advisers: What’s good for the client is not necessarily what’s most profitable for the person providing the advice. At the very least, unsophisticated investors usually don’t know if they’re dealing with an adviser who has their best interests at heart, or with a broker looking to sell products and maximise fee income.
Here’s a quick review of how adviser responsibilities to investors look today: Registered investment advisers (RIAs) already operate under a fiduciary standard required by the 1940 Investment Advisers Act, backbone of investor protection in the United States and purview of the Securities and Exchange Commission (SEC). But there are plenty of brokers and people who are allowed to call themselves “advisers” who are not RIAs. They are held to the much vaguer “suitability” standard of service—meaning they’re obligated to consider what’s suitable for their clients, assuming anyone can define what suitable means. Exempted by the 1940 Act, broker/dealers are regulated by the Financial Industry Regulatory Authority (FINRA), a private “self-regulating organisation” authorised by the SEC.
This may sound like some angels-on-pinheads distinction important only to lawyers and regulators, but it matters to investors too. Two things have happened over the years that make fiduciary standards critical for everyone. First, you are responsible for your own investments in a way your parents probably weren’t. The supplanting of traditional, defined-benefit pensions by defined-contribution plans has transferred investment risk to workers, who are thus reliant on investment advice like never before.
Second, since the 1990s, the roles of broker, dealer, and adviser have become virtually indistinguishable to the average investor, thanks to the evolution of financial services and the rise of “dual registrants”—people registered both as brokers and advisers.
“One of the reasons [the fiduciary issue] is important is that we no longer call broker/dealers broker/dealers,” says Barbara Roper, director of investor protection for the Consumer Federation of America and an advocate for a universal fiduciary standard. “We call them financial advisers, and we call the services that they offer retirement planning or investment planning, and they market themselves to customers based on the advice they offer. To the average investor, they look like advisers.”
(Retail investors aren’t the only ones vulnerable to this conflict of interests. It was large institutional investors—banks, pension funds, insurers—on whose behalf the SEC sued Goldman Sachs in 2010 for allegedly understating the risk of a complex instrument, called a synthetic CDO, that blew up after Goldman sold it to them. Goldman later settled for $550 million.)
Regulators were grappling with the broker/client conflict long before the financial crisis, but the discussion intensified with the lamentable case of one Bernard L. Madoff, a broker/adviser whose interests, it turns out, were not particularly well-aligned with those of his clients. In 2009, the fiduciary issue became part of negotiations over the Dodd-Frank financial reforms, which authorised an SEC study on the effectiveness of existing fiduciary standards in protecting investors.
In early 2011, the SEC recommended adoption of a “uniform” fiduciary standard covering brokers and advisers. In short, anyone “providing personalised investment advice” would have to “act in the best interest of the customer without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice.”
That might seems like a reasonable measure to most people, but then most people aren’t financial-services interests with a stake in the status quo. Parts of the industry, especially insurers, resisted fiercely, arguing that tighter rules would raise compliance costs and introduce litigation threats, pricing many investors out of the advice market. Others note, fairly, that even a universal fiduciary standard would not provide infallible protection from harmful advice (Madoff was a RIA).
Whatever the merits of these arguments, the push for a uniform standard has hit a brick wall at the SEC. Though Obama-appointed SEC Chairwoman Mary Schapiro took office vowing to make the fiduciary standard a priority, the commission’s two Republican members dissented from the 2011 recommendations, arguing that the issue needed more analysis.
Republicans on the House Financial Services Committee have pressured the SEC to halt its fiduciary-standard efforts, saying there’s no clear evidence that a new rule is required. They’re demanding a cost-benefits analysis, which the SEC is considering authorizing.
But would a Romney victory preempt the effort altogether? As president, he would be expected to appoint a new SEC chair (subject to Senate approval). If candidate Romney has a position on the fiduciary issue, it wasn’t clear to campaign spokesperson Amanda Henneberg as of Friday afternoon. What is clear is that Romney has vowed to repeal Dodd-Frank, which some say puts him at odds with the goal of transparency that’s at the heart of the fiduciary movement.
If Romney wins, “I think it’s off the table for the next four years. It’s not going anyplace,” says Ron Rhoades, a SUNY professor and leading proponent of a universal fiduciary standard. “Romney is so pro-Wall Street I cannot fathom that he would not appoint someone to the SEC chair who will also be pro-Wall Street—and Wall Street is dead set against the fiduciary standard.”
Rhoades expects a Romney administration would “chip away” at Dodd-Frank, noting that, unless the Senate’s composition shifts dramatically, “it doesn’t take much to get three votes to undo some of Dodd-Frank.” He’s not sure Congress would repeal the law’s section 913, which authorised the SEC rule-making. “They may not feel the need to do that if they control the SEC, but it’s certainly something that they would like to see repealed and they would try to fit into some type of bipartisan bill.”
Not every proponent of a universal fiduciary standard thinks a GOP victory would be the end of the road. While conceding that a Romney victory could mean a “material difference” in the composition of the SEC, Knut Rostad, president of the Institute for the Fiduciary Standard, says public disgust at Wall Street just might trump conventional Wall Street-GOP relations even if Romney wins.
What we could see, he suggests, is a Nixon-goes-to-China moment. Just as it took the street cred of a fervent anti-communist to broach relations with Red China, so it might be easier for a former private-equity guy to do something Wall Street doesn’t quite like.
Surveys showing popular mistrust of Wall Street “clearly suggest that this might be a place to step out of the conservative Republican mould,” says Rostad. “I think we’re in new territory in terms of the level and the intensity and the depth of investor disgust with Wall Street. I think that creates an opportunity.”
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