fi360 Blog

Draft SRO Bill not in best interests of investors or advisers

Yesterday, the House Finacial Services Committee released a discussion draft SRO bill for investment adviser oversight. The bill would authorize the creation of one or more self-regulatory organizations. This was one of three options presented by the SEC staff in January, the others being SEC self-funding and the authorization of a single regulator for dual registrants.

Fi360 opposes the bill and still believes that a fully funded SEC is the most cost effective and least conflicted option. If there is a silver lining, it is that the bill calls for one or more SROs, opening the door for an alternative regulator to FINRA that gives investors the choice of advisors who are being held accountable to a true fiduciary standard.  

For more information, consult the following resources:

• Text of the draft bill
• The House Financial Services Committee's page for Tuesday's hearing on the bill. Expect testimony to be linked to this page in the coming days.
• fi360's official statement on the bill
• fi360's executive summary of the bill
• The Advocacy page of fi360.com.  The most recent section is related to the release of the draft bill. We will be posting more information there soon, including an executive summary of the bill. You can also view materials related to the SEC's study on investment adviser examinations in the fifth section from the top.
• While the bill opens the possibility for multiple SROs, bill sponsor Representative Bachus said in a press conference yesterday that he endorses FINRA as regulator.
• fi360's Blaine Aikin gives his first reaction to the bill in an AdvisorOne article, Draft Bill Calling for SRO for Advisors Introduced in House
• Duane Thompson discusses the House proposed bill that would give SROs oversight of investment advisers with Registered Rep
• The website of SROIIA, the startup self-regulator for advisers that hopes to gain authorization as the higher standard alternative to FINRA
• Financial Planning Coalition press release and statement
• Duane Thompson speaks out about his reaction to the House hearing on SRO, fiduciary standard

Lack of Dodd-Frank progress reflects politics being put ahead of duty

Recently during a business meeting I referred to myself as the “doomsday girl” of the office.  As in-house counsel, it’s my job to expect the worst out of any situation, even the most amicable of business relationships.  And so I go down the path of imagining the worst case scenario and put into place any measures that I believe will prevent the worst or at least assist with cleaning up a messy situation as quickly as possible.  In other words, I do what I can to fulfill my fiduciary responsibilities as an attorney and act in the best interests of my client.  It’s something investment advisers who serve as fiduciaries can certainly relate to.  But as I was driving to work today reflecting on where we were a year ago when the Dodd-Frank Act was signed into law and where we are now, I came to the scary realization that although a lot of very smart people work in Washington, there appears to be a fundamental lack of fiduciary conduct and understanding in the lawmaking and regulatory world.  

During my time at the SEC, I can vividly remember senior staff asking “how is this good for investors” anytime we discussed a potential solution to a policy issue or a new rule proposed by an SRO.  We were keenly aware that our work was for a greater good and that we had a duty to fulfill the mission of the agency to protect investors.  Of course, our attempts to do so weren’t always successful once special interests and politics inserted their noses, but at the core, we still tried our best to focus on investor interests.  These days, as I watch Washington from the outside, it’s astounding just how political things have gotten.  Party lines are drawn, lobbyists’ arguments win the day over the opinions of industry experts, and the American people are left without the protections needed to prevent future abuses of their trust.

"The price of reform is a small one compared to the cost of crisis"

Throughout the comment periods for the SEC staff's fiduciary study and the DOL's recent proposal to update the definition of fiduciary, it has been perplexing to hear the increasing rhetoric claiming that expanding fiduciary protections will kill business. Over and over again, we have heard the request for a thorough cost-benefit analysis followed by a summary conclusion that such analysis likely will show that costs outweigh the benefit of fiduciary reform. 

This leaves us asking what exactly is the cost of principles?  Should we only adhere to fiduciary principles and putting the client’s interest first when it is good for business?  Congress certainly didn’t think so when it passed the Investment Advisers Act in 1940 and ERISA in 1974, and it's hard to imagine why Congress or anyone else would take a different view now at a time when our economy is still recovering from severe market failures and investors are sitting on the sidelines holding their money outside of the market. 

Influencing fiduciary law in 2011

Last year as we looked ahead to 2010, it was clear Congress and regulators were laying the groundwork for a big year for fiduciary law.  As we now reflect on 2010 and look forward to a new year, it's clear that fiduciary law moved forward on several fronts, but the question remains how much further it will move and how big of an impact fiduciary advocates will continue to have in 2011.

This past year, we saw the passage of the Dodd-Frank Act and the SEC proceed with a study comparing the standards of care for broker-dealers and investment advisers.  The SEC is set to deliver a report on its study to Congress by January 21, 2011, and observers anxiously await for the results and recommendations that will be put forth.  Around the same time, the SEC will also deliver the results of its study on investment adviser oversight, including whether an SRO is needed.  What is important to note about both of these studies, is that while several comments have already been filed on the fiduciary duty and adviser oversight and the SEC's reports will be delivered early in the new year, the debate surrounding fiduciary issues will not end and the opportunity to comment on the public record will continue.  We here at fi360 will continue our part to advocate for fiduciary responsibility and encourage our fellow fiduciaries to do the same.  Therefore, it is important that you continue to send your comments to the SEC in 2011 on the fiduciary duty or any other provisionsof the Dodd-Frank Act that impact you.

In addition to the many initiatives associated with the Dodd-Frank Act, DOL advanced several initiatives of its own that impact fiduciary practices under ERISA, several of which are still under open comment periods.  Just yesterday, DOL announced that it is extending the comment period on  its proposal to expand the definition of fiduciaryto February 3 and that it will now hold a public hearing on March 1.  In addition, the DOL recently released additional guidance and proposed disclosures for target date funds and qualified default investment alternatives (QDIAs) and will be accepting comments until January 14.

With industry groups like NAIFA and FINRA continuing to push forward their views on fiduciary issues, it is important for those representing the fiduciary community to make their voice heard just as loudly (if not louder) to balance out the record.  2010 was a transformational year for fiduciary law, but 2011 may shape up to be an even bigger year as long as the fiduciary fellowship does its part to present a united and vocal front.   

House Rules

Soon after the holidays, the new Congress will come back to Washington, its mandate to fix Wall Street seemingly done.  With passage of any major bill, though, there are sometimes technical corrections that follow.  A massive 2,000 page law affecting the entire financial services industry will represent opportunities to do more than fix typos in the 112^th Congress.  In particular, the Republican-controlled House Financial Services Committee will be active.

Come January, the catalyst will be key reports submitted by the Securities and Exchange Commission to the Financial Services and Senate Banking committees.  These reports include several related to fiduciary standards that were set aside last year as too contentious when the Dodd-Frank Wall Street Reform and Consumer Protection Act became law.  Studies and reports are often the bone yard for controversial or failed proposals, but one of the few studies that may translate into serious legislative activity is the hotly debated self-regulatory organization, or SRO, for investment advisors.

In this regard, the incoming chairman of the House Financial Services committee, Spencer Bachus, R-Ala., nearly connected on a long ball at the height of the debate over financial services reform.  That would be Amendment No. 31, which Rep. Bachus offered in a last-minute flurry of committee votes.  The Bachus amendment passed the committee with little notice or debate, but failed on the House floor after Democrats were alerted to its controversial nature.  A single paragraph, the Bachus proposal would have allowed the Financial Industry Regulatory Authority to set rules for investment advisers affiliated with broker-dealers.  In practical terms, its impact would have been enormous: FINRA would have become the de facto SRO for nearly 90 percent of all investment adviser representatives, or the 241,000 individual stockbrokers who are dually registered as fiduciary investment advisers.  Only 34,000 investment adviser reps are independent.

With the SRO recommendation by the SEC due January 17^th, the stage is set for Congress to take up Rep. Bachus’ amendment, or a version of it, once more.

fi360's Comments to the SEC on the fiduciary study

Yesterday, fi360 submitted our comments to the SEC on their study analyzing the effectiveness of existing regulatory standards for brokers, dealers, and investment advisers and identifying any gaps or overlap in regulation.

In short, we believe that too much confusion exists on the part of investors as to how financial service providers' functions differ and how these differences affect investor protection. Over time, the services provided by broker-dealers and investment advisers have come to more closely resemble each other in a way that wasn't envisioned when the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 were passed. This has made it necessary to introduce new regulations that clearly demarcate the roles of product providers versus advice providers.

Some of the specific recommendations for the SEC's study and eventual rulemaking that we suggest are:

• That Congress remove the exemption for incidental advice from the Advisers Act
• Create uniform disclosure requirements for brokers and advisers that emphasize avoiding and managing conflicts of interest, but that do not bog down the provision of investment advice
• Define "fiduciary," "best interests of the customer," and "personalized investment advice" in line with the Committee for the Fiduciary Standard's five core principles and existing SEC regulations

Our full comments can be downloaded here.

All comments submitted on this issue can be found on the SEC's website.

How to write an effective comment letter to the SEC

Have you submitted your comments to the SEC on its Study Regarding Investment Obligations of Brokers, Dealers, and Investment Advisers?  If not, I highly encourage you to take the time to get involved in the SEC's efforts to bring clarity to the regulation of investment professionals and provide greater protection to investors.  You must act fast as the deadline for comments is this Monday, August 30.

In writing and submitting comments, it's important to recognize the unique opportunity being provided to investment professionals and the investing public with this comment period.  First, it's an opportunity to provide input to the SEC that will be incorporated into its overall study and the final report that it must submit to Congress in January.  Second, it is also an opportunity to potentially shape future rulemaking by the SEC that will codify the existing fiduciary standard for investment advisers in SEC regulations and extend the same fiduciary duty to broker-dealers who provide investment advice.  With this in mind, I would advise those that would like to submit comments to take the time to consider the type of input that will both allow you to voice your opinion on the regulation of investment professionals, but also asssist the SEC in fulfilling its duties and exercising its authority under the Dodd-Frank Act.  

As a former SEC attorney, I speak from experience when I say that the most helpful comments are the ones that take the time to address issues and questions presented by the SEC, provide specific examples of how regulations play out in professional practice, cite to concrete numbers and statistics (and their source), and offer potential solutions on how to address a regulatory issue. 

Looking at the current request for comment, it's important to note that the SEC has been tasked with analyzing fourteen specific topics.  To the extent commenters take the time to comment on any or all of these areas, it will be extremely helpful to the SEC. In addition, SEC Chairman Schapiro stated in a speech in July that "Comments that recognize the primary and central importance of investor protection, but offer suggestions on implementing fair and flexible regulation, will help us craft rules that increase investor confidence while preserving brokers' ability to offer a full spectrum of services." Thus, the agency essentially has provided a roadmap to commenters on what information will be most useful.

In viewing comments that have already been submitted to the SEC, I would note that a form letter, referred to as Type A, submitted by over 200 insurance brokers provides a good example of a letter that could be useful to regulators.  While I don't necesarily agree with all of the viewpoints expressed in the letter and I also question the effectiveness of only submitting a form letter, the format of the letter itself is good because it addresses both issues raised by the study and addresses potential rulemaking.  The letter could be improved by including some of the examples and concrete number or statistics I mention above.  

Fi360 is diligently working on finalizing its comments for the SEC, and our hope is that other supporters of the fiduciary standard will take the time to submit comments as well and provide the SEC with the information and support it needs to effectively implement regulations that promote fiduciary principles.  

Yes, the fiduciary standard debate does matter

An interesting article came out yesterday that made the case that the fiduciary debate was basically meaningless because brokers can already be held to fiduciary standards through ERISA and various state laws. The author is of course correct as it applies to the cases and laws he cites. However, the article omits the gap around which the entire debate is centered. As Kristina explained to RegisteredRep yesterday, the big controversy and the target of the current reform efforts is about federal securities laws and the confusion among retail investors as to what standard of care they are receiving.

As the RAND Report on Investor and Industry Perspectives on Investment Advisers and Broker-Dealers illustrated, the services offered by brokers have come more and more to resemble those traditionally provided by investment advisers while both sets of professionals have continued to be regulated based on traditional definitions of their roles. More importantly, investors often can't tell the difference between the two. Brokers will often refer to themselves as "financial advisors" and investors typically assume a relationship of trust with investment professionals. Yet, the report reflects investors' doubt or surprise that a fiduciary standard doesn't necessarily apply. In addition, investment advisers and brokers themselves don't always know where the dividing line is between the recommendations and "incidental" advice that falls under the fair dealing (suitability) standard and individualized advice that falls under the fiduciary standard.

It's not hard to see why some would oppose a fiduciary standard to protect their interests or to find fault with the legislative and regulatory process. But it is much more difficult to believe that the pursuit of closing gaps and providing clarity and consistency in the interest of investor protection isn't a cause worth pursuing.

Senate-House conference committee fiduciary decision coming tomorrow

The process of reconciling the Senate and House versions of financial regulatory reform bills begins in earnest today, as the first provisions are up for consideration by the conference committee to decide what will be included in the final version of the combined bill. The agenda for today does not include the portion relevant to the fiduciary standard, though the Committee for the Fiduciary Standard is reporting on their LinkedIn page that the fiduciary discussion should occur tomorrow.

Some good resources for those of you following at home include the Senate Banking Committee's Key Issues page, which is updated with new materials as they develop, the Banking Committee's Newsroom, which is where the agenda for today was first printed, and the House Financial Services Committee's page dedicated to the conference, where they post all relevant materials. C-SPAN is also covering the conference live.

The fiduciary provision is contained in Title IX, subtitle A. So when that appears on the agenda for consideration by the committe, we will know exactly when that discussion is to take place.

UPDATE: The House Financial Services website now confirms that the Title IX, subtitle A (i.e., the fiduciary provision) is on the agenda for tomorrow. And, the House is proposing to replace the Senate provision to study the issue with their own provision to enact the fiduciary standard.

In the meantime, the Committee is calling on anyone who wants to see a fiduciary standard for all investment advice to call the offices of the conferees to express their support for the House provision for establishing the fiduciary duty, rather than the Senate's provision for an SEC study. Here is the complete text from the Committee's announcement:

Announcement from The Committee for the Fiduciary Standard

Last Call! Conference Committee Scheduled to Act on Fiduciary Provision on Wednesday.

The Conference Committee is scheduled to meet on Wednesday on the fiduciary provision. The Senators on the Conference Committee are the key votes.

Calls from constituents do matter. Please call your Senator and urge him or her to vote for the House provision establishing a fiduciary duty for brokers providing investment advice to retail investors, NOT for the Senate’s version which proposes a “study” of whether brokers should have to put client’s interests first.

Christopher J. Dodd Chairman (D-CT) - 202-224-7391
Tim Johnson (D-SD) - 202-224-5442
Jack Reed (D-RI) - 202-224-4642
Charles E. Schumer (D-NY) - 202-224-6542
Richard C. Shelby Ranking Member (R-AL) - 202-224-5744
Mike Crapo (R-ID) - 202-224-6142
Bob Corker (R-TN) - 202-224-3344
Blanche Lincoln (D-ARK) - 202-224-4843
Patrick Leahy (-VT) - 202-224-4242
Tom Harkin (D-Iowa) - 202-224-3254
Saxby Chambliss (R-TN) - 202-224-3521
Judd Gregg (R-NH) - 202-224-3324

Regards,
Knut

Knut A. Rostad
Chairman
The Committee for the Fiduciary Standard
www.thefiduciarystandard.org

A comparison of responses to the 2010 investment advice rule

The deadline for submitting comments to the DOL on the 2010 Investment Advice Rule was May 5th and sixty-eight comment letters were submitted by individuals or organizations.  The expectation is that the comments will be analyzed in short order and the final rule published later this year. To get an idea of how the final rule might go, we'll take a look at two of the comment letters submitted.

The American Benefits Council, the American Council of Life Insurers (ACLI), and the Investment Company Institute (ICI) submitted joint comments. Their comments recommended the following:

• State that historical performance is an appropriate factor to consider
• Refrain from defining generally accepted investment theories
• Refrain from favoring one investment style
• Clarify the fee leveling condition by stating that fees cannot vary, but remove the suggestion that the fiduciary adviser is not permitted to receive any compensation based on the investment chosen

In fi360's submitted comments, it's interesting to see how our thoughts compare with respect to the four overall recommendations submitted by the American Benefits Council, ACLI, and ICI.  Specifically, fi360 stated:

• A fund's past performance relative to the average for its asset class is an appropriate criterion for allocating assets to the fund; especially risk-adjusted returns.
• Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMH) should be specified as generally accepted investment theories.  Others may be permitted as well, but there is a need to be specific to (a) assure that the processes used to formulate the asset allocation and investment selection recommendations are reasonable and (b) make certification of the computer model practical.
• The model should not assign different levels of risk to passively versus actively managed investment options because this would be neither practical nor reliable.
• The fee neutral (leveling) requirements in the proposed rules will provide significant benefits to participants and beneficiaries.

For three of the four, the organizations are pretty much on the same page; a sampling of comments submitted by others indicate that most agree on these issues as well, although there are differing views on specifics related to the fee neutral approach.  Where we find differences is with respect to generally accepted investment theories.  The American Benefits Council, ACLI, and ICI favor letting the market determine how and what generally accepted investment theories are applied to computer models and fi360 called for more specific guidance.  Fi360 also stated that the fee neutral approach is preferred because the complications and possible manipulation related to the computer model with respect to managing conflicts of interest will make it much more difficult to implement and enforce.

Clearly there is interest in this final rule and most agree that implementation is necessary in order to give participants better access to professional investment advice.  We're hoping that we see the final rule very soon.