The Adminstration Seeks Fiduciary Duty for B/Ds — Is the SEC Chairman Advocating the Establishment of an SRO for RIAs?

June 20, 2009

In the white paper, “Financial Regulatory Reform: A New Foundation,” recently released by the U.S. Treasury Department, the Obama Administration proposes the establishment of a fiduciary duty for broker-dealers offering investment advice and harmonization of the regulations of broker-dealers and registered investment advisers.

Although there were only six paragraphs concerning the broker-dealer v. registered investment adviser issue in the white paper consisting of eighty-nine pages, the few details provided by the Administration are worthy of review.

In particular, the Administration takes the position that “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.” Moreover, the Administration urges that the U.S. Securities and Exchange Commission (“SEC”) be empowered to prohibit forms of compensation that allow an intermediary (a broker-dealer or registered investment adviser) to put a client in a product profitable to the intermediary and not in the best interests of the client. Finally, the Administration proposes that legislation should provide simple and clear disclosure to investors regarding the scope and terms of the relationship with the intermediary and ban certain conflicts of interest and sales practices contrary to best interests of an investor.

It’s noteworthy that the Obama Administration’s white paper on financial regulatory reform only identifies what appear to be as deficiencies with broker-dealer regulations and its standard of care. There were no references within the Treasury Department’s release to the establishment of a self-regulatory organization (“SRO”) for registered investment advisers.

Although the term “harmonization of regulations” is used in the title for this broker-dealer versus registered investment adviser section of the white paper, there is actually little explanation by the Administration within the white paper as what is actually meant, except for the prohibition of certain broker-dealer conduct described above. However, the day after the Administration’s white paper was released Mary L. Schapiro, Chairman of the SEC, commented about the harmonization of these regulations:

While I believe that a consistent fiduciary standard of conduct should be applied to all financial professionals providing personalized investment advice, I also understand that the fiduciary standard is not a panacea to deter all fraud against individual investors.

Unfortunately, malevolent behavior still occurs, even by those who owe a fiduciary obligation to their clients. Since I became Chairman, the SEC has brought 26 actions against Ponzi or Ponzi-like schemes, which on average is more than one action per week. Roughly one-third of those actions involved investment advisers that were subject to the fiduciary standard of care. Thus, we cannot build an effective regulatory regime around the fiduciary standard of conduct alone.

That is why more needs to be done to effectively harmonize our regulatory structure for broker-dealers and investment advisers and meaningfully protect investors. If both broker-dealers and investment advisers are providing virtually identical services to retail investors, then the regulatory regimes that govern those activities should be virtually identical as well.

Is Chairman Schapiro suggesting that an SRO should be established for the regulation of registered investment advisers or is she laying the ground work for the case that the SEC needs more resources to regulate registered investment advisers? This ambiguity could be intentional during this early stage of the legislative process and may provide the SEC Chairman more options and flexibility at a later point. Time well tell.

Posted by Bryan Hill
Labels: Fiduciary, SEC, SRO