Thursday, September 02, 2010

SIFMA Comments to SEC on Dodd-Frank Uniform Fiduciary Standard for Brokers and Advisers

In a comment letter to the SEC, SIFMA said that Dodd-Frank driven SEC regulations establishing a uniform federal fiduciary standard for brokers and advisers should be broadly guided by the dual principles of individual investor protection and individual investor choice. The SEC regulations should put the interests of retail customers first and such customers should receive the same standard of care when receiving the same services irrespective of the regulatory status of the entity with whom they have a relationship. The uniform standard of care should also be business model neutral, said SIFMA.

Section 913 of the Dodd-Frank Act, in addition to requiring the SEC to study the effectiveness of existing regulatory standards of care for brokers and investment advisers when providing personalized investment advice about securities to retail customers also authorizes the SEC to adopt rules to provide that the standard of care for all brokers and investment advisers is to act in the best interest of the customer without regard to the financial or other interest of the broker or adviser providing the advice. This standard of care must be no less stringent than the fiduciary duty standard applicable to investment advisers under Sections 206(1) and (2) of the Investment Advisers Act.

The Dodd-Frank authorization is propitious, noted SIFMA, since it gives the SEC the opportunity to create a uniform federal standard of care for retail investors through rulemaking, which will avoid disparate judicial opinions interpreting a common law standard and the investor confusion that results from the same services being subjected to different standards based on technical legal distinctions.

The SIMFA letter goes on to urge that SEC regulations establishing a uniform fiduciary standard to embody the principle that brokers and advisers should deal fairly with retail customers when providing personalized investment advice about securities and appropriately manage conflicts by providing investors with full disclosure that is simple and clear and allows them to make an informed decision about a particular product or service. Moreover, the standard of care should be clearly defined by the SEC and the Commission should provide guidance as to how the standard of care can be implemented by brokers and investment advisers, tailored to their respective business models.

It is imperative, said SIFMA, that investors have access to a wide range of products and services after the uniform fiduciary duty regulations are adopted. The standard of care should allow brokers to continue to offer products and services that are available today, such as providing retail customers liquidity as principal, proprietary products and advice regarding sophisticated investment strategies, and the standard should allow retail customers to choose among various models for compensating their financial services provider.

When products and services involve material conflicts of interest, continued SIFMA, brokers and investment advisers should be able to provide disclosures to clients in a pragmatic way to clearly and effectively communicate, and receive consent to, these conflicts of interest. Also, the standard of care should apply to personalized investment advice about securities, for example, investment recommendations that are made to meet the objectives of a specific retail customer after taking into account the customer’s specific circumstances, and not affect client directed or other ancillary services in a brokerage account.

Investment advisers and brokers currently provide advice and services under distinct operating models providing protection and services to investors in different ways. The Dodd-Frank Act recognizes these differences, said SIFMA, and contemplates that with simple and clear disclosure such business models could continue to offer such products and services. In that regard, according to SIFMA, Section 913 authorizes the SEC to adopt rules requiring a broker to disclose if it sells only proprietary or a limited range of products and facilitate the provision of simple and clear disclosure regarding the terms of an investor’s relationship with a broker or investment adviser.

Because the uniform standard will apply to both investment adviser and broker business models, reasoned SIFMA, it is essential that the SEC clearly express the standard that will so apply. It is also essential that the Commission provide guidance as to how this duty can be satisfied by brokers when they offer the wide range of products and services that today are not offered under the investment adviser model. This duty will be satisfied in a different manner for a fully discretionary trading account than for a trade-by-trade recommendation of an individual security, for example. SIFMA said that brokers will need guidance from the SEC regarding the disclosure and consent requirements under the standard regarding these various products and services in order to prevent brokers from curtailing the products and services available to investors.

SIFMA also noted that many retail customers currently seek to consolidate various types of accounts with a single financial services provider such as a dually-registered investment adviser/broker-dealer, or a broker-dealer affiliate of an investment adviser. Thus, SIFMA urged the SEC to facilitate the ability of retail customers to maintain multiple types and accounts and relationships with the same individual representative within a single financial services provider, such as a discretionary advisory account, a non-discretionary advisory account, and a commission-based transactional brokerage account in which the broker may provide personalized investment advice in connection with some transactions but not others.

The Dodd-Frank Act authorizes the SEC to develop a uniform standard of care, observed SIFMA, even though Congress simply could have eliminated the broker-dealer exception to the Advisers Act definition of “investment adviser” and applied to both broker-dealers and investment advisers the standard of care under the Advisers Act. By not taking that path, said SIFMA, Congress appears to have recognized that eliminating the broker-dealer exception would ultimately harm retail investors by limiting their access to and choice among financial products and services.

Eliminating the broker-dealer exception would have swept broker-dealers wholesale into an Advisers Act that was never intended to apply to the incidental advice offered in connection with specific non-discretionary, commission-based transactions that brokers frequently provide. Although a uniform standard of care with disclosure and consent to material conflicts can be applied to such incidental advice in connection with brokerage transactions, said SIFMA, this should be done through focused rulemaking.

More specifically, the rulemaking should offer consistent protections to individual investors, and preserve an investors’ rights to choose the services, products and payment methods they believe meet their investment goals. The standard should also preserve investor choice of the range of cost-effective investment products and services they can access via their brokers or advisers. And, in cases where brokers provide services not offered by investment advisers and where personalized advice is not involved, SIFMA believes the current standards for brokers should continue to apply.

An SEC mandated uniform standard of care would give retail customers an opportunity from the very outset of their relationship with their broker or investment adviser to understand clearly the duties defining the relationship and make informed investment decisions. In addition, a uniform standard would reduce confusion about existing regulatory regimes by being the exclusive standard that applies to brokers and investment advisers when providing personalized investment advice about securities to retail customers. Thus, SIFMA recommended that the standard of care should subsume the investment adviser duty for personalized investment advice to retail customers about securities under Sections 206(1) and (2) of the Advisers Act.

In SIFMA’s view, the best interest of retail customers requires preserving the choice among services and products offered by their financial services provider. In order to maintain retail customer access to a broad array of beneficial products and services offered by brokers that may exceed those offered by investment advisers, SIFMA believes that the uniform standard of care must be business model neutral and provide for investor choice as to how to pay for the various products and services.

If a uniform standard of care cannot be applied and supervised in a practical manner, posited SIFMA, brokers may curtail offering commission-based services and securities sold as principal, including initial and follow-on public offerings and other underwritten offerings. A loss of access to these products and services would have the unintended consequence of seriously disadvantaging retail customers rather than protecting them. In order to maintain retail customer access to these products and services, said SIFMA, the regulations must make it possible for brokers to pragmatically disclose material conflicts of interest and obtain consent from retail customers in order to provide them the opportunity to make an informed choice.

SIFMA also noted that the uniform federal standard of care and conflicts disclosures must address the capabilities and investment objectives of a broad range of retail customers. The Dodd-Frank definition of retail customer does not exclude persons based on high-net worth status or any other indicia of market sophistication. Yet, reasoned SIFMA, the standard of care may involve different outcomes for an inexperienced investor than for hedge fund managers trading for their own account in a product in which they are experts.

As the SEC contemplates how to address the needs of a broad range of retail customers, SIFMA believes that it would be useful to consider a framework that allows brokers and investment advisers to implement the standard of care based upon investment objectives and terms and conditions that have been agreed upon with a particular customer, supported by procedures and disclosure of conflicts of interests to assure that the firm’s relationship with that customer is consistent with such terms and conditions.

Section 913(g) of the Dodd-Frank Act does not require the standard of care to include the
principal trading restrictions of Section 206(3) of the Advisers Act. In SIFMA’s view, Congress did not include these restrictions because it would have inappropriately deprived retail customers of the benefits of access to broker inventories of a range of securities. Thus, SIFMA urged the SEC not to apply the trade-by-trade disclosure and consent requirements of Section 206(3) to principal transactions that are subject to the uniform standard of care where the broker or investment adviser does not have discretionary authority regarding the customer account.

SIFMA also emphasized that a federal duty of care that does not allow for disclosure and customer consent to material conflicts of interest in a pragmatic way would harm retail investors. If client consent cannot be provided in a practical way, said SIFMA, retail clients could be effectively locked out from purchasing or selling securities on anything other than an unsolicited basis and brokers could severely limit the products and services they are willing to offer to retail customers to whom they provide personalized investment advice.
Also, products and services may be offered at a significantly higher cost to account for the additional costs of complying with regulations and brokers may only offer advisory accounts, which would be more expensive than necessary for customers who infrequently purchase securities. Thus, SIFMA said it is critical that the uniform standard of care provide pragmatic methods for disclosure and consent from retail customers.

SIFMA also urged the SEC to adopt a standard of care allowing retail clients to have ready access to investments that are sold on a principal basis. Many broker-dealers provide liquidity and best execution to retail customers by acting as principal in securities transactions. SIFMA described this as a cornerstone of the equity securities markets. Broker-dealers also provide substantial liquidity and best execution in the fixed-income market by transacting on a principal basis. If retail customers lose access to this liquidity, cautioned SIFMA, their execution costs will in many cases substantially increase and markets will lose a significant source of liquidity.

Moreover, retail customers seek access to underwritten offerings for many reasons. In these offerings underwriters have performed due diligence, customers are provided with extensive disclosure, and investors can apply their own business judgment to the investment. Thus, SIFMA cautioned that the uniform standard should not adversely impact retail clients’ access to these underwritings.

For a variety of reasons, a retail customer may seek advice in connection with a sophisticated investment strategy. For example, some customers may wish to hedge risk on a concentrated position in their employer’s stock or hedge a portfolio using options or use other complex strategies. Thus, SIFMA urged the SEC to clarify that under the new uniform standard of care a broker is not prohibited from providing advice in connection with an aggressive or sophisticated investment strategy for appropriate and consenting retail customers. Otherwise, warned SIFMA, retail customers could be forced into a one-size-fits-all model, precluding many customers from availing themselves of the broad array of financial products and services that are beneficially available to them.

Similarly, many retail customers use a brokerage account as a way to consolidate their financial services needs with a single provider. For example, retail customers may use their brokerage account to pay bills or use a debit card linked to a brokerage account to make everyday purchases. Thus, the new federal standard should also clarify that these services could be offered to all customers without triggering the standard of care. In addition, these types of account features are offered to retail customers irrespective of a particular retail customer’s specific circumstances, and therefore should not be interpreted as being offered pursuant to personalized investment advice unless a broker specifically advised a retail customer to, for example, purchase securities on margin.

In SIFMA’s view, it is integral to preserving customer choice and access that the SEC define the scope of the term ``personalized investment advice’’ as used in Dodd-Frank. If the term is interpreted too broadly, reasoned SIFMA, retail customers could be cut off from investment opportunities even if they are making the investment decision without a specific recommendation. In order to simultaneously protect retail customers and provide them access and choice, SIFMA recommended that the term “personalized investment advice” be defined to mean and apply only to investment recommendations provided to address the objectives of a specific retail customer after taking into account the customer’s specific circumstances.

Under this rubric, personalized investment advice should not include financial planning tools and calculators that do not recommend specific securities, general research and strategy literature, seminar content, marketing and general education materials that do not offer or recommend specific securities, or broker-dealer investing web sites where retail customers use tools to make self-directed investment decisions. SIFMA believes that this construct is consistent both with the US Supreme Court’s 1985 decision in Lowe v. SEC, holding that a newsletter does not provide personalized investment advice where it does not provide individualized advice attuned to any specific portfolio or to any client’s particular needs, and Advisers Act Rule 203A-3(a)(3), which defines the term “impersonal investment advice” as investment advisory services that do
not purport to meet the objectives of specific individuals or accounts.

Finally, SIFMA urged the SEC, in crafting its disclosure and consent guidance, to recognize that some firms are dually registered as both broker-dealers and investment advisers. Some dually registered firms may find that it is most effective to disclose material conflicts of interest to retail customers by using a single document, opined SIFMA, while other firms may find that it is more effective to provide separate disclosure for broker-dealer activities and investment adviser activities. Thus, the regulations should give firms the flexibility to combine disclosures.

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