The old adage, ‘History Repeats Itself,’ threatens to prove its validity once again at the SEC. For those of us who remember the halcyon days of the longest-serving SEC chairman, Arthur Levitt, one of his biggest headaches was finding a quorum for an SEC meeting. Forget for a moment that he oversaw the agency during one of the longest running bull markets in U.S. history. That undoubtedly made his job a lot easier. Levitt liked to joke about needing to avoid running into another commissioner in the halls of the SEC and inadvertently violating the public meeting notice requirement. At the time, it seemed more attention was paid to keeping the five seats on the Commission filled than what the independent agency was actually doing.
Less noticed were Levitt’s diligent efforts to achieve consensus before a public vote by the commissioners. Levitt was carrying on an unstated tradition at the agency that a unified front was vital, and that it was far better to delay a vote and resolve differences behind closed doors than air them in a public forum.
Efforts at civility collapsed after hard-charging New York Attorney General Elliott Spitzer upstaged the SEC in 2003 by filing complaints against several SEC-regulated mutual fund groups for late trading. The SEC, suddenly awake and irritated by Spitzer’s grandstanding, uncovered front-running practices as well and, as is typical after a scandal, turned to the policy front to prevent any future embarrassments.
It was here that fissures in the bipartisan wall at the Commission started to appear when Donaldson, a Wall Street executive and Bush family friend appointed to calm the agency, sided consistently on major rules with the two appointed Democrats in 3-2 votes.
Bipartisanship hit a low point with the SEC’s independent fund director’s rule in 2005, which would have required an independent chairman for each mutual fund. The U.S. Chamber of Commerce immediately challenged the SEC in federal court. It was at this juncture that some observers first noticed subtle overtones of a fiduciary dispute in the background of the commission spats. If you were for the independent director’s rule, you were pro-fiduciary and pro-shareholder; if you were against, you were pro-management and anti-fiduciary. Donaldson was called to testify by the Senate Banking Committee, where Republican senators found the new divisions “troubling” and “disturbing.” The Republican commissioners who opposed the director’s rule called for more economic study and claimed the SEC ignored a Fidelity study favoring management directors.
The political rift was further exacerbated by the SEC’s subsequent rule to register hedge fund advisors. Again, a partisan 3-2 vote resulted, with the debate playing out in a lawsuit by hedge fund manager Phillip Goldstein, including a related argument over whether the fiduciary duty of the advisor was to the fund or the fund’s investors. The U.S. Court of Appeals for the D.C. Circuit flatly stated advisors were fiduciaries to the fund, not its investors, although its primary basis for vacating the rule was something else.
Following this split-vote trend, after the Financial Planning Association sued the SEC over the so-called “Merrill Lynch rule” permitting brokers to offer fee-based advisory programs without being subject to the fiduciary requirements of the Advisers Act, one would have thought the same voting pattern would have been repeated. For once, however, this same Commission pulled together in the midst of their public feuding and voted unanimously for the final rule. Here again, though, new fissures opened, this time on the staff level. After the FPA filed suit, shortly thereafter the SEC re-opened the proposed rule for additional comment. When the final rule was adopted, several commissioners publicly scolded SEC staff involved in the re-drafting for undisclosed turf disagreements between the division overseeing brokers and the division overseeing advisors. This rule, like the fund governance and hedge fund rules, was thrown out by the D.C. Circuit court.
Fast forward to 2009. Enter the Obama Administration and financial services reform in the midst of a financial crisis. All new faces on the Commission since the Donaldson regime, and presumably a clean slate to work from, except for a surprising emphasis by the Administration on a fiduciary requirement for brokers. Almost as if a magic wand had been waved and memories vanquished, two earlier critics of a fiduciary duty, incoming chairman Mary Schapiro and her FINRA colleague Elisse Walter, were now strong supporters on the Commission, with no apparent explanation for their sudden conversion. Along with Commissioner Luis Aguilar, who was the first commissioner ever to unequivocally support a fiduciary mandate for brokers providing retail advice, the political dynamics had suddenly changed. But similar to the earlier partisan disputes in 2004-2006, the new Republican commissioners, Kathleen Casey and Troy Paredes, called for delays and more study on a fiduciary standard’s economic impact.
This brings us to the present. The good news, as we all know, is the fiduciary issue is no longer in the policy closet gathering dust. The bad news is that it has become a partisan football where reasoned discussion over its merits is an unwanted stranger. Certainly studies filling an information void should be welcomed by policymakers, and a cost-benefits analysis is certainly lacking in the fiduciary debate. But prematurely assuming the worst --that a fiduciary standard will displace clients, reduce the number of advisors, and increase cost of services, as the Republican commissioners and Members of Congress have implied -- is wildly speculative. Forestalling a fiduciary standard without any grounds for doing so is a weak excuse when it would be far easier to closely examinine the existing fiduciary advisory practices that have flourished over the years.
Yet today the SEC and Congress find themselves in redux on this and many other issues, with frequent public dissents by commissioners, an activity once called a “rare display of conflict” by the trade press. Conversations with insiders at the agency indicate significant policy differences remain between the two SEC division staffs in addition to the more public ones among the commissioners.
It is still very likely that the Commission will proceed and adopt a fiduciary standard for brokers’ retail advice, if not by the end of this year, then definitely by the end of 2012 if a Republican Administration is elected. Witness the quick 3-4 day turnaround by the SEC under Donaldson in adopting a revised fund director’s rule only a few days after an adverse ruling in U.S. Chamber v. SEC, and on the day of his resignation.
Or, what is also possible – although it is too early to detect rumblings about a lawsuit – would be if the Chamber, SIFMA, or a large broker-dealer challenged the SEC fiduciary rule for brokers in court, alleging ‘arbitrary and capricious’ conduct by the SEC in ignoring the lack of economic data. Presumably this would buy time until a new Administration repeals the rule. Something of the reverse has happened before, but under ERISA and without the pressure of a lawsuit. A controversial fiduciary adviser rule was adopted by the Bush administration within days of President Obama’s inauguration but strongly opposed by consumer and labor groups. Shortly after the administration change, the newly appointed leadership at the Department of Labor suspended it and re-proposed a modified rule one year later.
Shakespeare’s famous quote, “What’s past is prologue,” was never more true in the rough and tumble politics that are becoming all too common at the SEC. 'Fiduciary' is just the latest political football to be caught in the vortex.
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