Sinon IV: Does the financial reform law threaten to empower lobbyists to weaken the 'fiduciary' standard of customer care for every investor?

The Dodd-Frank Wall Street Reform and Consumer Protection Act appears to open the doors for the Securities and Exchange Commission (and those that lobby them) to gut or weaken the "fiduciary" standard for everyone, essentially by being told to reexamine the whole notion, or definition, of the standard of customer care that's been applied under the Investment Advisers Act of 1940 and in the courts.

"Fiduciary duty" essentially means always acting in the best interests of customers, something which registered investment advisers (RIAs) are required by regulation to do, but brokers are not.

While the act asks the commission to probe the opposite of the following question, it also asks the SEC to study whether "the regulation and oversight of brokers and dealers provide greater protection to retail customers than the regulation and oversight of investment advisers." (And yes, vice versa, as we said prior.) Regardless, look for the industry to be all over the SEC to convince them oversight of brokers and dealers is stronger, which if they're successful, could serve to undercut the notion that the fiduciary standard of customer care as applied to RIAs - or anyone - serves to optimally protect investors, when an existing or nuanced alternative, they might argue, could supply what they also might call equal, or better, protection.

Sure, The Street loses that argument as long as the customer care standards on the books continue to be legally interpreted as they have been, and they are quite simply stronger as written for RIAs than those facing the broker-dealers: "Fiduciary duty" means that RIAs must show continual loyalty to a customer's best interests; brokers need only show "suitability" when advising clients, meaning deem the products they're selling to customers are appropriate in each case to each type of investor buying them.

Yet, if regulators are reexamining the entire value, and hence the strength and therefore the merits of these different standards of customer protections for RIAs and broker-dealers, particularly when the act also asks regulators to study whether essentially to "harmonize" these rules covering investor advising might be beneficial, the regulators' conclusions from the study can easily be used to change the level of customer care protections, and how they're applied, to any and all concerned. Whether they will, we don't yet know. However, we advise those concerned with advisor regulation or investor protection to watch the process closely as it unfolds: The SEC has to submit its report on advisors' customer care standards by Jan. 20, but must seek public comments in the meantime to complete its analyses and to inform the report.

Background: Unlike registered investment advisers (RIAs), brokers do not, nor have they ever, been required by regulation to have a "fiduciary duty," meaning act in the their clients' best interests. Nor have brokers necessarily been made to disclose conflicts of interest they may have in advising investors about a certain security available for purchase. The Investment Advisers Act of 1940 provided the exemption and laid the foundation for the practice; the SEC tried and failed to make the broker exemption to fiduciary more explicit in fee-based accounts in 1999. The Financial Planners Association sued the SEC over the exemption and won on appeal in 2007, a case that would seem to have barred what was a more explicit broker exemption to fiduciary standards than that of the 1940 Act. Yet in practice, fiduciary-exempted broker advising, long the norm, continued and remains.

The brokers, however, while it may seem counterintuitive, could find allies in weakening the definition or application of customer care in RIAs. If they do, the fiduciary duty could easily be weakened overall in how it's applied, especially if the SEC decides to harmonize customer care standards as the act essentially asks it to examine doing, among brokers and RIAs.

Note again that brokers are able under long-standing regulations to market products to investors under a lower customer care standard than RIAs. Thus it could be argued that brokers have a sales edge in moving their products, because they can engage in more "salesmanship" - meaning they can push their products harder, without fiduciary duty, meaning with less concern or less care for their customers' best interests - under the rules, than RIAs, which is at least in part why the RIAs have found the different regulatory requirements for standards of customer care unfair. While RIAs can claim they take the higher road, meaning apply the higher standard of taking clients' best interests into account, selling products is more difficult under such an onus, because sales under such a fiduciary filter is harder than requiring mere suitability, in which the brokers need only prove the products they're recommending to clients are appropriate for the type of customer with which they're dealing.

However, it's important to note that RIAs may find more value in remaining held to the higher standard of customer care. Plus, teaming with brokers risks zapping the credibility or level of trust RIAs have managed to build with the investors who actually know the difference between fiduciary duty and suitability, in required customer care levels between RIAs and brokers, even though many customers do not, according to studies including an oft-pointed to SEC-sponsored report by the Rand Corporation.

Time, per usual, will tell.

But know the act also preemptively weakens the SEC's ability to apply fiduciary duty in its full legal strength on brokers, as it precludes them from having any ongoing duties of "loyalty" to their customers in putting said customers' interests ahead of their own after giving said customers investment advice. It's a once-in, once-out, conversation-by-conversation (or transaction-by-transaction) deal if the SEC ever decides post-study to mandate it. This may become important to anyone whose broker manages as well as advises their investments. The fiduciary duty to which RIAs are held to requires they maintain an ongoing "loyalty" to their customers; to essentially always act in their best interests.

And regarding any rules covering brokers' conflicts of interest or "prohibited transactions," should the SEC decide to promulgate them post-study, the act says any material conflicts of interest shall be disclosed but "may be consented to by the customer." And, the rules' standard of conduct "shall be no less stringent than the standard applicable to investment advisers" when providing personalized investment advice about securities, but only under the first two provisions of section 206 of the Investment Advisers Act of 1940, which say no "device" should be employed or transaction done to commit fraud. So Congress, by leaving out the two other provisions in the prohibited transactions section - one which bans engaging in "any act" considered "fraudulent, deceptive, or manipulative," and another, which mandates disclosure of any trading that poses a conflict with a customer's trading (or money management) - means any rule the SEC may decide post-study applied to brokers, could in fact be less stringent than that applied to RIAs.

Further background: Congress chose to proceed with a modified iteration of the weaker Senate version of the broker fiduciary proposal. The compromise would call for a year-long study by the Securities and Exchange Commission to determine whether requiring a fiduciary duty for brokers when giving investing advice to retail investors is appropriate. The SEC would be empowered to promulgate rules if moved by the study to do so, but proponents for establishing such a requirement complain the study will lead to naught.