fi360 Blog

Slow progress, but more support for a fiduciary standard

With political momentum shifting on the heels of Scott Brown's victory in Massachusetts last week, the future of financial regulatory reform and how quickly it can get done is becoming a bigger question mark with each passing day. While many hoped the Senate Banking Committee would be ready to tackle financial reform issues by late January or early February, recent reports indicate that it likely will be spring by the time the the committee has a bill ready. Committee Chair Christopher Dodd is still working through several issues with Committee Ranking Member Richard Shelby in hopes of gaining the bipartisan support that will be needed for financial reform to pass in the Senate.  However, reports from the Hill are that no final decisions have been reached on key provisions in a proposed Senate bill.  

Despite the slow progress in the Senate and increased lobbying by the insurance industry, remarks made by Goldman Sachs CEO Lloyd Blankfein and Bank of America's Sallie Krawcheck last week make it clear that support for applying a fiduciary standard to all professionals who provide investment advice is widespread.  What remains unclear, however, is whether these industry leaders support extending the existing fiduciary standard recognized by groups such as the IAA, Financial Planning Coalition, and the Committee for the Fiduciary Standard, or whether their views fall in line with SIFMA's call for a new federal fiduciary standard.  

And even if a new fiduciary standard is what is being referred to, it's still uncertain what SIFMA and its members think such a standard should look like or why such a new standard is needed.  Throughout the fiduciary debate, SIFMA and others have argued that fiduciary law lacks clarity due to the presence of state common law and a lack of understanding of when a fiduciary duty applies.  However, such arguments ignore the fact that requirements under the securities laws, including the Investment Advisers Act of 1940, are federal standards.  In fact, an outline on the SEC website describing regulation of investment advisers by the SEC explains that the fiduciary standard applied to investment advisers at the federal level does not rely on state law and is therefore a uniform standard (you'll find the explanation of fiduciary duty on pages 13-16 and the reference to the federal standard in footnote 80).  Even the Supreme Court has stated more than once that the anti-fraud provisions of the Investment Advisers Act establish "federal fiduciary standards" to govern the conduct of investment advisers.

Bottomline, the federal fiduciary standard is established and has been applied by federal courts and the SEC for years.  And though political momentum has shifted in Washington, it is still clear that the individuals in the investing public  are concerned about the economy, their financial futures, and their ability to rely on financial professionals.  It may take more time and compromise to make financial regulatory reform a reality, but both political and public pressure is mounting to make it happen and to ensure investor protection is a key part of reform.   

The year of reform is upon us

December was a big month for agenda setting in Washington as legislators and regulators looked ahead to making reform a reality in 2010. On the legislative front, Senators Christopher Dodd and Richard Shelby of the Senate Banking Committee issued a joint statement indicating progress was being reached on a financial regulatory reform package and that they hoped to resolve all issues prior to reconvening this month. In addition, Senator Herb Kohl, Chairman of the Senate Special Committee on Aging, announced plans to introduce legislation requiring target date fund managers to assume fiduciary responsibilities. 

Meanwhile, the House Ways & Means Committee was granted an extension until later this month to consider the 401(k) Fair Disclosure and Pension Security Act of 2009 (HR 2989), which would cover both investment advice and 401(k) fee disclosure. Consideration of the bill has been delayed to date as a result of reports that the investment advice provisions may be pulled from the bill.  Moreover, Congress appears content for now to defer these issues to the DOL, which posted its semi-annual agenda in early December. Under the agenda, DOL is expected to release final 408(b)(2) disclosure rules in May, and fee and expense disclosure rules for all 401(k)-type plans in September. DOL also will issue newly proposed investment advice rules in the next few months, and plans to issue a proposal in June to expand the definition of "fiduciary" under ERISA.

The SEC also appears ready to pursue aggessive reforms in 2010. In addition to preparing for initiatives adopted by Congress, including hedge fund manager registration, improved oversight of OTC derivatives, and extending the fiduciary standard to brokers providing advice, SEC Chairman Mary Schapiro added to her list of regulatory goals a review of 12b-1 fees and target date funds.  

Of course, questions remain on how quickly legislators and regulators will act in 2010. With much of the leg work completed in 2009, it appears that Congress may be poised to finalize financial regulatory reform legislation by early Spring.  The House has passed its bill, and the Senate seems closer to achieving the bipartisan support that will be necessary for its bill to pass. The SEC has been viewed by some as slow to respond to needed to reforms, but legislation improving its funding could allow it to act faster.   Moreover, the agency showed its ability to act by adopting new investor advisor custody rules and enhancements to proxy disclosures at the end of 2009.  DOL also reportedly has been hard at work behind the scenes drafting rules in order to stay on target with its agenda.  With all of this positive momentum, reforms are likely to begin taking shape by mid-year and many significant rule changes could be implemented by year end.

Fiduciary provision takes a hit in the House

The passage of the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173) by the House last week brought with it small victories for the advisor industry in the form of the removal of a provision that would have allowed FINRA to gain oversight of firms dually registered as investment advisors and broker-dealers, and the inclusion of provisions extending the fiduciary standard to broker-dealers who provide personalized investment advice.  However, a closer look at the final House provision regarding broker-dealers' fiduciary duties reveals quite a few shortcomings that have all been the result of legislative compromises and may chip away at core fiduciary principles. 

As reported this week, a manager's amendment introduced by Barney Frank last week added a limitation to the extension of the fiduciary duty. In particular, the provision that would require the SEC to adopt rules applying a fiduciary standard of care to broker-dealers now states: "Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities." 

While the new language seems to have taken the advisor industry by surprise, it is actually the result of a compromise in the making since late October.  Similar language was introduced by Rep. Jeb Hensarling (R-TX) in October during the House Financial Services Committee markup of the Investor Protection Act, a bill that was rolled into the comprehensive legislation approved last week.  At the time, Hensarling voiced concern about certain business models, such as discount brokerage, that don't involve the provision of advice.  The Hensarling amendment was withdrawn at the committee level, but only with the understanding that Hensarling's concerns would be addressed by the time the legislation made it to the House floor.  Hence, the new limiting language in the final House bill.

Several other limiters have also been inserted into the House bill over time, such as the addition of language addressing commissions and proprietary products. Despite Congress' apparent desire to delegate the fiduciary issue to the SEC as the expert agency, such limitations in any final bill will likely tie the commission's hands in how far its rule making can go. Moreover, such qualifying language appears to be a roadblock to true harmonization of the standard of care and rules that apply to all professionals who provide investment advice. 

So where does financial, and in particular fiduciary, regulatory reform go from here?  It's becoming clearer that on the Senate side even more compromise will be required for reform to pass, and even once it does, a conference committee will be required to resolve any differences that emerge between the Senate and House bills, an activity that will require even more cooperation.  While there are other provisions in the comprehensive financial legislation that will require more compromise than others, the longer that reform takes, the greater the likelihood that fiduciary provisions may change more, for better or worse as was seen this past week. 

House set to debate financial reform

Last week, the House Financial Services Committee completed its work on proposed financial regulatory reforms and released The Wall Street Reform and Consumer Protection Act (H.R. 4173), a comprehensive bill that incorporates nine major pieces of legislation, including the Investor Protection Act, which would extend the fiduciary standard to broker-dealers providing investment advice. The full House will begin to debate the comprehensive reform bill today. House Financial Services Committee Chair Barney Frank expects debate to continue over the next three days with a vote on the bill taking place on Friday.  Frank and others have been working behind the scenes to resolve any outstanding issues and opposition to the bill, but still expect several amendments to be introduced on the House floor.  For now, it appears that provisions related to fiduciary issues will survive, but oversight of investment advisers remains an area of concern, including a current provision that would give the SEC the authority to delegate to FINRA examination authority over firms dually registered as investment advisers and broker-dealers. 

Despite the progress on the House side, the pace of financial reform has slowed down substantially in the Senate as a result of sharp criticism from Republicans and Democrats alike aimed at a proposal issued last month by Senate Banking Committee Chair Christopher Dodd.  As a result of opposition to his bill, Dodd announced a new plan for addressing the legislation to his Committee right before the Thanksgiving break in hopes of reaching workable compromises and gaining bi-partisan suport.  While the new approach will hopefully aid the eventual success of financial reforms, it has also created a delay that will prevent the Senate from considering a complete financial reform bill until the new year.  

With financial regulatory reform looming in 2010, regulators appear to be gearing up for the large amount of work that will be required to implement legislative changes.  In a speech delivered earlier this week, SEC Chairman Schapiro outlined her agency's efforts to improve investor protection and restated her belief that "all securities professionals [who provide advice] should be subject to the same fiduciary duty" as well as an "effective oversight regime."   Meanwhile, NASAA President Denise Crawford, voiced support for a legislative approach that  preserves the "authentic fiduciary standard" and also announced the signing of a Memorandum of Understanding that will allow states to work with each other to regulate additional investment adviser firms if the threshold for federal registration is raised to $100 million assets under management.  Such statements seem to confirm that regulators are laying the groundwork and will be ready to act quickly once Congress enacts the much anticipated financial reforms.

New Investment Advice Rule Expected in 2010

Many industry observers were left scratching their heads after the Department of Labor first delayed and then canceled just a few days later the investment advice rule that it finalized at the beginning of the year. However, as reported earlier this fall, DOL has every intention of putting new rules into place.  While it was originally thought a new rule proposal would be ready for public comment by mid-November, the administrative process has taken longer than expected. According to recent reports, DOL has sent new proposed rules to the Office of Management and Budget for approval and will likely release those rules for a short comment period in December or January.   

Meanwhile, investment advice provisions being considered on Capitol Hill also appear to be set for the chopping block.  Earlier this year, House Education and Labor Committee combined two separate bills to create the 401(k) Fair Disclosure and Pension Security Act of 2009 (HR 2989), which would cover both investment advice and 401(k) fee disclosure.  The bill was voted out of committee over the summer and referred to the House Ways & Means Committee, which held a hearing in October to consider the legislation.  During the hearing, the bill received sharp criticism from Rep. Earl Pomeroy for proposing to reduce independent advice presently available under DOL's SunAmerica advisory opinion, which allows advice to be offered by providers through an affiliate using an independently developed computer model.  As a result of the criticism and decreased support, the Ways & Means Committee likely will remove the advice provisions from the bill later this month, but no official decision has been made yet.   

Though new legislation could be introduced in the future, for now, Congress appears to be clearing the way for DOL to take the lead on providing guidance on investment advice. And DOL appears to be determined to move forward with a new rule without further delay.  What remains unclear, however, is what the new rule will look like and how it will compare to the legislation or the rule proposed by the Bush Administration.  So for now, the industry must wait until the proposal is released in the coming weeks.

Laying the groundwork for a big 2010 for fiduciary law

With the final month of 2009 fast approaching, 2010 is looking to be a big year in the fiduciary arena as regulators and legislators prepare to pass key regulations and legislation, and the high court delivers a key ruling and also considers whether to take up more fiduciary issues. 

This week, the Department of Labor announced another delay in the effective date of the investment advice regulations that were originally published in January.  The delay is in line with a previous announcement made by Phyllis Borzi, the Assistant Secretary of the Employee Benefits Security Administration, that the agency would pull the rules finalized in January and issue new rules.  With a new effective date of May 17, 2010 set, DOL will likely seek to release new proposed investment advice rules for public comment in early 2010 and finalize the rules by May.  DOL is also expected to finalize its long awaited 408(b)(2) plan fee and expense disclosure rules in early 2010. 

Meanwhile, on Capitol Hill, House Financial Services Committee Chair Barney Frank announced that the House vote on financial regulatory reform will likely not occur until the second or third week of December.  The House Financial Services Committee is still working this week to finalize pieces of the comprehensive legislation the House will consider.  Once the legislation is ready, the House is expected to take at least three days to consider the package of financial reforms, including the extension of the fiduciary standard to all investment professionals who provide advice, as detailed in the Investor Protection Act (HR 3817). 

In the other chamber of the Capitol, the Senate Committee on Banking will hold its first hearing this morning to consider opening statements on the Restoring American Financial Stability Act of 2009, which is the Senate version of a comprehensive financial regulatory reform package.  As I explained in my post last week, the proposed bill also seeks to extend the fiduciary standard, but would take a different statutory approach.  Following today's hearing, the Senate Banking Committee is expected to continue its consideration of financial regulatory reform right after Thanksgiving.  With the House and Senate separately considering similar financial reforms and time in 2009 quickly running out, it is becoming increasingly likely that a final consolidated bill enacting financial regulatory reforms will not be ready for President Obama's signature until early 2010. 

Finally, this past month, the high court was presented with another opportunity to consider fiduciary issues related to fund fees with the filing of a petition for review by employees of Deere & Co.  The employees are seeking review of a decision by the U.S. Court of Appeals for the 7th Circuit, which ruled against the employees and found that Deere did not violate its fiduciary duty under ERISA by imprudently selecting investment options with excessive fees.  The 7th Circuit denied a petition for rehearing earlier this year, clearing the path for the Deere employees to seek review by the Supreme Court.  It remains unclear whether the Supreme Court will take up Hecker v. Deere, and its decision could hinge on its final ruling in Jones v. Harris Associates, which the court heard arguments on earlier this month.  Although the Jones case involves fiduciary duties under a different law, the Investment Company Act of 1940, it is tied to the Heckercase because both cases rest on a premise that fund fees are the result of market competition and both cases were decided by the 7th Circuit.  A ruling in Jones is not expected until summer of 2010, which could mean the court will not decide whether to take up the Hecker case until then as well.  

Senate Banking Committee ready to address fiduciary and oversight issues

Yesterday, the Senate Committee on Banking released more than 1,100 pages of draft financial regulatory reform legislation, over 200 pages of which addresses investor protection and securities regulation.  While the Senate's Restoring American Financial Stability Act of 2009 seeks to address the same issues as the House's Investor Protection Act, the Senate has taken a very different approach to responding to the Obama Administration's mandate to raise the standard of conduct for broker-dealers providing investment advice to the fiduciary standard.

Specifically, the Senate Banking Committee proposes to remove the exemption from the Investment Advisers Act of 1940 for brokers who provide advice that is "solely incidental" to their brokerage activities.  With the removal of this exemption, any broker who fits the definition of an "investment adviser" under the federal securities laws would be required to register as such with the SEC and be subject to investment adviser requirements, including the fiduciary standard. 

The Senate committee's approach is markedly different from the House Financial Services Committee's proposal, which would keep the broker exemption in place and add a requirement to the Securities Exchange Act of 1934 that brokers providing advice to retail customers follow the same standard of conduct as investment advisers.  However, the approach has proven to be messy because it keeps two separate sets of rules in place for brokers and investment advisers making the ultimate goal of "harmonizing" investor protection rules for financial professionals harder to achieve.  It also has presented opportunities for legislators to add amendments to the House's proposed bill that could chip away at the fiduciary standard on the broker side rather than bringing the standard for brokers up to the same stringent level as the standard currently applicable to advisers.

Overall, the Senate committee's proposal provides a much cleaner way to provide consistent protections to investors who receive advice by keeping the established fiduciary standard in place and extending it more broadly to brokers.  Moreover, the committee's draft bill has recognized the need to accomodate certain aspects of the broker business model by proposing amendments to the Advisers Act that would allow professionals to receive asset management fees and commissions and would give the SEC the authority to exempt persons and transactions from the current prohibition against principal trading if in the public interest.  Again, such concessions still keep the fiduciary standard in place while making it possible to bring more consistent regulation to all professionals providing advice.  In addition, the Senate has proposed additional investor protections that would require professionals to properly manage conflicts of interests and disclose to clients limitations on the range of investment products that they offer and recommend.  

Of course, increasing investment adviser registrations at the SEC begs the question of how will an already strained adviser examination program take on additional responsibilities.  The Senate committee has tried to address that issue through a proposed provision that would raise the assets under management threshold for federal registration to $100 million shifting some responsibility to the states.  In addition, other proposed provisions would allow the SEC to transition to a self-funded model allowing it to set its budget each year without Congressional approval and retain fees it collects from registered entities to fund the budget.  Such a model would give the SEC more access to funding and resources needed to effectively run its programs. 

The Senate Banking Committee is expected to hold hearings and start marking up the proposed legislation in the coming weeks with the goal of completing the bill by December and sending it to the Senate floor.  The full House is also expected to vote on comprehensive financial reform legislation in early December. 

Financial Services Committee, Supreme Court both consider fiduciary issues

Today, the House Financial Services Committee will continue its consideration of the Investor Protection Act.  Several amendments were considered by the Committee last week that have been viewed as weakening investor protections including the fiduciary standard, prompting several advisor industry and investor advocacy groups to express their disappointment to the Committee.  The legislation is expected to be voted out of committe this week and referred to the full House.  However, even if financial reform continues its smooth progression through the House, there are indications that it may face an uphill battle in the Senate, potentially slowing down Congress' agressive timetable for executing change.

Meanwhile, fiduciary issues took center stage in another type of hearing room on Capitol Hill as the Supreme Court heard oral arguments related to compensation for mutual fund advisors. The issues came before the court in the case of Jones v. Harris Associates, in which three shareholders sued Harris Associates, LP, the advisor to the Oakmark Funds.  The shareholders claim that Harris Associates charged excessive fees and violated its fiduciary duty under Section 36(b) of the Investment Company Act of 1940, as amended in 1970.  

During oral arguments, the parties and justices mostly focused on the appropriate legal standard and analysis that should be used by courts to determine if fees are fair.   However, it's also notable that Justice Kennedy started off questioning by exploring the meaning of "fiduciary" and the scope of the fiduciary duty under the federal securities law.  Other justices joined in this line of questioning, which focused on how the fiduciary duty of Harris compares to that of corporate officers and directors, guardians, and trustees.  The shareholders' counsel answered that fiduciary duty in these circumstances meant "fair result through full information and good-faith negotiations."

Ultimately, a few justices questioned the role of courts in regulating rates, suggesting that the SEC and market competition should be the key drivers in ensuring rates are fair.  Market competition was a key factor in the 7th Circuit's decision to let a ruling against the Oakmark Fund shareholders stand, but many, including mutual fund icon, John Bogle, have thrown their support behind the shareholders and argued that funds are not competitive with one another. 

With oral arguments concluded, the mutual fund industry and shareholders can only sit by and wait for the Supreme Court to issue a decision in June.  For those looking for more immediate action on the fiduciary front, Congress appears ready to deliver in the coming months.

Fiduciary duty and adviser oversight remain regulatory hot topics

The House Financial Services Committee continued to make progress in moving along key regulatory reform legislation yesterday by approving the Private Fund Investment Advisers Registration Act.  If approved by the full House and Senate, the bill will require advisers to hedge funds and other private pools of capitals to register with the SEC.  Today, the Committee will get started with a vote on the Accountability and Transparency in Rating Agencies Act.  It will then move on to completing its markup of the Investor Protection Act, which seeks to extend the fiduciary standard to broker-dealers who provide personalized investment advice to retail investors. 

In her opening address at the SIFMA annual meeting this week, SEC Chairman Mary Schapiro continued to voice support for applying "a high fiduciary standard" to investment professionals providing advice rather than "watered-down, 'fair and reasonable' commercial standard."  FINRA CEO, Richard Ketchum, also gave remarks at the meeting, stating that his organization "wholeheartedly embraces the Administration's goal of harmonizing regulation of [broker-dealers and investment advisers]." 

In addition to the fiduciary issue, investment adviser oversight  appears to be another burning topic on legislators' and regulators' minds this week.  In particular, Congressman Paul Kanjorski is expected to offer an amendment to the Investor Protection Act that would seek to raise the $25 million assets under management threshold for investment adviser federal registration to $150 million in order to reduce the number of investment advisers subject to SEC regulation.  It's not clear, however, how much support the amendment will garner from other legislators.  State securities regulators previously advocated to Congress that the threshold be raised to $100 million, a change the SEC appears to be interested in considering and could make if legislators fail to act. 

Meanwhile, Ketchum again stated FINRA's desires to bring investment advisers under its oversight.  Despite these bold claims of FINRA's readiness to step up, NASAA, the main lobbying body for state regulators, has raised strong concerns that "SROs are inherently conflicted and are not independent." 

While it remains unclear whether and how Congress will ultimately address the adviser oversight issue, today's markup session could shed more light on legislators' thinking as well as mark a major milestone in the long debated fiduciary issue as the House Financial Oversight Committee moves closer to a vote.

Fiduciary Discussions Push Forward in Washington

The House Financial Services Committee is set to continue its markup of key regulatory reform legislation and specifically will meet next Tuesday to consider the Investor Protection Act, key legislation that would extend the fiduciary duty to broker-dealers who provide investment advice.  In anticipation of the markup, a manager's amendment to the Investor Protection Act was released earlier this week. 

The amendment seeks to remedy "drafting errors" and "improve the intent of the bill." Most notable to the proposed expansion of the fiduciary duty is a clarification to the statutory language that would ensure that any standard of conduct adopted by the SEC for brokers, dealers, and investor advisors will be as strong as the current fiduciary standard applied to investment advisors. In addition, any disclosure rules adopted by the SEC would also need to address disclosure of conflicts of interest between the investment professional and the investor.   

Despite significant movement by the House Financial Services Committee to complete a legislative package by November, observers are still questioning whether financial reform will get done this year due to the Senate's focus on healthcare reform. In response to these concerns, Senator Carl Levin stated he believes there is enough momentum in the Senate to complete regulatory reform by year end. Levin specifically cited the strong leadership of Senate Banking Committee Chair Christopher Dodd and public anger over Wall Street abuses as the driving forces that will move regulatory reform toward completion.

Once legislation is complete, it will be up to regulatory agencies to carry the torch next year and implement changes. The SEC, in particular, provided another signal this week that it is willing take up the fiduciary issue and adopt a consistent standard for all investment professionals who provide personalized advice to investors. Indeed, in a joint report issued with the CFTC, the SEC called for a fiduciary duty to be applied to advisors who recommend commodities to investors. The recommendation specifically seeks to further reduce confusion in the marketplace about financial professionals' duties and apply a uniform fiduciary standard of care to all professionals providing similar services. Thus, it appears that legislators and regulators are eager to move the broad implementation of a fiduciary standard forward.