By James Hamilton, J.D., LL.M.
The securities industry supports Obama Administration legislation imposing a new federal fiduciary standard for broker-dealers and investment advisers and essentially harmonizing the regulation of brokers and advisers. The Securities Industry and Financial Markets Association (SIFMA) said that the proposed uniform set of regulatory standards is designed to strengthen safeguards for investors. Under the new fiduciary standard it won’t matter who is giving the advice, broker or adviser, noted SIFMA, since investors will be protected by the exact same federal fiduciary standard when receiving the same services.
Currently, the standard of care provided to individual investors by broker-dealers and investment advisers can be different because the two groups are regulated by different legislation. Studies show this has created confusion for investors. The draft legislation states these two groups should act solely in the interest of the customer without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice.
After nearly 70 years of confusion, with separate broker and adviser regulations, we have an opportunity to start anew, said John Taft, chair of SIFMA’s Private Client Group, with a new fiduciary standard that will provide clarity to consumers while expanding investor protection to a broader range of personalized investment advice.
SIFMA believes that the SEC is best positioned to ensure that a federal fiduciary standard is clearly and equally applied so that all individual investors receive the same protections when receiving the same kinds of personalized investment advice. The term "personalized investment advice" was described by SEC Chair Mary Schapiro in a June 18, 2009 speech to define the circumstances under which a fiduciary duty should apply to both brokers and advisers. This view is consistent with the Administration’s plan to overhaul the nation’s financial regulation.
Investment advisers, however, do not offer the same broad range of services as broker-dealers, such as raising capital for business or mergers and acquisition activity. Therefore, when broker-dealers operate in business areas where advisers do not, and where personalized advice is not involved, SIFMA believes the current standards and rules should apply.
Currently, investment advisers and broker-dealers are regulated under different statutory and regulatory frameworks, even though the services they provide often are virtually identical from a retail investor's perspective.
Retail investors are often confused about the differences between investment advisers and broker-dealers. Meanwhile, the distinction is no longer meaningful between a disinterested investment advisor and a broker who acts as an agent for an investor. Current regulations are based on antiquated distinctions between the two types of financial professionals that date back to the early 20th century. Brokers are allowed to give incidental advice in the course of their business pursuant to an exemption in the Investment Advisers Act, and yet retail investors rely on a trusted relationship that is often not matched by the legal responsibility of the securities broker. In general, a broker-dealer's relationship with a customer is not legally a fiduciary relationship, while an investment adviser is legally its customer's fiduciary.
From the vantage point of the retail customer, however, an investment adviser and a broker-dealer providing incidental advice appear in all respects identical. In the retail context, the legal distinction between the two is no longer meaningful. Retail customers repose the same degree of trust in their brokers as they do in investment advisers, but the legal responsibilities of the intermediaries may not be the same.
Thus, the Administration proposes legislation allowing the SEC to align duties for intermediaries across financial products. Standards of care for all broker-dealers when providing investment advice about securities to retail investors should be raised to the fiduciary standard to align the legal framework with investment advisers. In addition, the SEC should be empowered to examine and ban forms of compensation that encourage intermediaries to put investors into products that are profitable to the intermediary, but are not in the investors' best interest.
The Investor Protection Act of 2009 would direct the SEC to facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with investment professionals, including consultation with other financial regulators on best practices for consumer disclosures and to adopt rules prohibiting sales practices, conflicts of interest, and compensation schemes for financial intermediaries, including brokers, dealers, and investment advisers, that it deems contrary to the public interest and the interests of investors.
As the worlds of brokers and investment advisers increasingly converge, the SEC has been attempting to calibrate the regulation of these securities professionals in a flexible and innovative manner consistent with investor protection. More practically, the SEC has been trying to accommodate a regulatory regime erected in the 1930s with the realities of 2009.
The draft legislation comes against the backdrop of the SEC-commissioned Rand Report on investor and industry perspectives on investment advisers and broker-dealers. The report, entitled Investor and Industry Perspectives on Investment Advisers and Broker-Dealers, was released in December 2007.
The Rand Report took on a sense of urgency after a federal appeals court struck down SEC Rule 202(a)(11)-1, permitting non-adviser broker-dealers to charge fees to investors based on account size without registering as investment advisers. Financial Planning Association v. SEC, (CA DofC 2007), CCH Fed. Sec. L. Rep. ¶94,185. Rule 202(a)(11)-represented the new reality of fee-based brokerage accounts.
The SEC believes that the Rand Report provides useful data about the ways in which broker-dealers and investment advisers market, sell, and deliver financial products, accounts, programs, and services to individual investors. The Report’s essential conclusion was that the regulatory environment for broker-dealers and investment advisers is eroding along with the distinctions between the two types of financial professionals on which it is based, which after all date back to the early 20th century.
More broadly, the Report found that the current regulatory regime treats brokers and advisers differently when, in practice, their role is essentially the same, especially from the viewpoint of the investor. This regime was essentially erected during the New Deal and, while amended many times over the years, is still organically rooted in the last century.
The Report found that the bright line between brokers and investment advisers that may have existed in the 1930s has become increasingly blurred. Indeed, the Report found that whether a financial services professional is a broker or an investment advisers is indistinguishable to most investors. Many investors think that brokers and advisers offer the same products and services. Moreover, they do not know the differences between a broker and an investment adviser, nor do they know that their regulatory burdens may be different.
One reason cited in the Report for the blurring of the line between brokers and investment advisers is that much of the marketing by brokers focuses on the ongoing relationship between the broker and the investor as brokers have adopted such titles as financial advisor and financial manager.