Dodd-Frank: As a rule, the going has been slow

More so than most other legislation, the 849-page Dodd-Frank Wall Street Reform and Consumer Protection Act reached the president's desk on July 21, 2010, as a work in progress. In the initial year of the law, which reaches its first anniversary Thursday, regulators overseeing banking, commodities and securities have been pressed to conduct 73 studies and write 400 new rules. As of July 1, only 38 of those rules — which are intended to regulate systemic risk at major banks and nonbank financial companies, bank liquidations, proprietary trading, capital requirements, clearing and settlement, and the trading of derivatives — have been finalized, according to Davis Polk & Wardell LLP, which is tracking the legislation. Another 121 rules have been proposed, while deadlines have been missed on 26 others, the firm noted. That means that nearly three years after one of the nation's worst financial traumas, little has been implemented to protect taxpayers from another billion-dollar bailout or investors from the steep losses that can accompany market disruptions. How, when — or even if — those rules will see the light of day is a story of how the tectonic plates of Washington power in today's partisan political environment have the ability to create as well as crush important legislation. The shifting of those plates began last Election Day, when Republicans won control of the House of Representatives and whittled away at their minority status in the Senate, upping their count to 47 seats. “Dodd-Frank was put in place under one set of political philosophies and it is being implemented under a different set of political philosophies,” said Marilyn Mohrman-Gillis, managing director of public policy and communication at the Certified Financial Planner Board of Standards Inc. “That puts a lot of pressure on the agencies that are obligated under the statute to move forward.” But Dodd-Frank is more than a story of give and take among Republicans and Democrats. Rather, it is a tale of how our nation's political system, which some have started to call dysfunctional, grapples with critical policy issues while split ideologically and reliant on special interests for campaign funding.

COST BENEFIT ANALYSIS

For financial advisers, the story is particularly noteworthy because an issue that was raised in the fight over one small part of Dodd-Frank — the portion enabling the Securities and Exchange Commission to consider imposing a single fiduciary standard of care for all advisers — has spread to cloud the future of the entire law and illustrates why Washington lawmaking has become such a muddle. Right now, there are two standards of care among advisers. Registered investment advisers, who generally charge fees rather than commissions, are bound by the Investment Advisers Act of 1940, which calls on them to provide advice in the “best interests” of their clients. Brokers, who are compensated largely on the commissions from the investments they sell, are exempt from the law and the advice they give their clients merely has to be “suitable.” That allows some brokers to recommend high-commission products that may be suitable for an investor, but not necessarily in their best interests. The issue that has stalled the universal fiduciary standard — as well as other parts of Dodd-Frank — centers on the phrase “cost benefit analysis,” which was first used publicly by the SEC's two Republican members, Kathleen Casey and Troy Paredes, in January. In voicing their dissent to a Dodd-Frank-mandated SEC staff report that recommended a universal fiduciary standard for brokers and advisers that would conform to the 1940 law, Ms. Casey and Mr. Paredes urged the SEC staff to go back and perform a detailed cost benefit analysis on the suggested rule change. “The study unduly discounts the risk that, as a result of the regulatory burdens imposed by the recommendations on financial professionals, investors may have fewer broker-dealers and investment advisers to choose from, may have access to fewer products and services, and may have to pay more for the services and advice they do receive,” Ms. Casey and Mr. Paredes wrote. “Any such results are not in the best interests of investors; nor do they serve to protect them.” That was the first time that critics of Dodd-Frank raised the cost benefit issue. In making their case, the pair cited what would become an all-too-familiar refrain among Dodd-Frank critics in the months ahead: It's better to get the law done right than to get it done quickly. Supporters of the universal fiduciary standard regarded the argument as a smokescreen to stall the implementation of the legislation. They argued that many studies had already been done, that they clearly showed that investors were confused as to why there were different standards of care and that investors favored a universal fiduciary standard. In basing their opposition on a lack of financial analysis, the two commissioners echoed a concern expressed months earlier by a powerful advocate for broker-dealers, the Securities Industry and Financial Markets Association. On the day before the November elections, SIFMA released a study suggesting that a universal fiduciary duty would be costly to investors and limit their investment choices if it didn't accommodate the broker-dealer business model. While SIFMA is in favor of a uniform fiduciary standard, its study essentially warned the SEC not to impose the Investment Advisers Act's fiduciary standard on brokers and laid the groundwork for the trade group's efforts to shape a new standard to its liking. Predictably, advocates of extending the current fiduciary standard to all investment advisers expressed dismay about the SIFMA report. It was misguided, they said, in part because its conclusions were based on the assumption that brokers would not be allowed to accept commissions under a new fiduciary standard — an assumption that the authors of Dodd-Frank had already made clear was not necessarily the case.

“FIDUCIARY FRAMEWORK”

SIFMA last Thursday called upon the SEC to create a new fiduciary duty rule based on a “fiduciary framework.” While still endorsing the idea of imposing fiduciary requirements on broker-dealers, the SIFMA proposal would protect broker activities such as charging commissions, selling proprietary products, selling from a limited menu of products and engaging in principal trading. In December, the National Association of Insurance and Financial Advisors — which has been resolute in its opposition to a universal fiduciary standard — released a report of its own in which it warned that the imposition of a fiduciary standard would increase compliance costs by at least 15% for its 50,000 members. As a result, it claimed that 65% of NAIFA members would reduce their services to less wealthy customers, stop offering securities or start increasing their fees. The report, which was produced by LIMRA International Inc., became central to NAIFA's argument that average investors would suffer if a universal fiduciary standard came to pass. Critics, of course, dismissed the NAIFA report, charging that the group was simply trying to undermine the push for a universal standard. But it was not those critics who the insurance lobbyists were trying to persuade. NAIFA officials, and their counterparts at SIFMA, were more interested in winning over an audience of five: the SEC commissioners. The worries of the two organizations resonated with Ms. Casey and Mr. Paredes. NAIFA's president, Terry Headley, recalls conveying his organization's concerns during visits with each of the SEC commissioners in mid-December. They began on Dec. 15 with Ms. Casey, a politically savvy Washington insider who served as chief of staff for the Senate Banking Committee when the GOP was in the majority.

"A VERY FAIR HEARING'

The meeting lasted for about and hour and 20 minutes, during which NAIFA officials mostly answered questions from the commissioner. They also explained the hybrid business model of the organization's members, all of whom sell insurance. Ms. Casey maintained her game face and gave no hint that she would become co-author of a dissent that echoed NAIFA's skepticism about universal fiduciary duty. “She listened intently to our primary points of emphasis and the findings and conclusions of our LIMRA study,” Mr. Headley said. “I do think our LIMRA study made an impact and shined a light on this middle-income market. We got a very fair hearing [from all the commissioners].” Since Dodd-Frank does not require the SEC to promulgate a fiduciary rule by a specific date — or at all, if it chooses not to do so — the agency should take advantage of its latitude to craft an original standard that “can be new and fresh,” said Ira Hammerman, SIFMA general counsel. “To the extent the [Casey-Paredes dissent] leads to further study, analysis and deliberation, that's only to the good as far as I'm concerned,” he said. “That will benefit investors and everyone else interested in this topic.”

"VALID POINTS'

“Casey and Paredes made valid points consistent with what we've said throughout the debate: There does not need to be a one-size-fits-all approach,” said Dale Brown, president and chief executive of the Financial Services Institute Inc., which represents independent broker-dealers. “A thoughtful approach [involves] rigorous analysis of the impact.” Although her public statements — and those of Mr. Paredes — can sometimes be laden with legalese that blunts the sharp points she makes, Ms. Casey was likely not surprised that the call for more rigorous economic analysis of potential Dodd-Frank rules would be picked up by Capitol Hill Republicans. In March, GOP members of the House Financial Services Committee wrote a letter to the SEC telling the agency not to move forward with the fiduciary duty rule until it had done a cost benefit analysis. Two months later, Republicans on the Senate Banking Committee echoed the refrain by asking the inspectors general at five financial regulatory agencies to review the economic analyses being done on Dodd-Frank implementation. In June, Rep. Scott Garrett, R-N.J., ranking majority member of the House Financial Services Committee, introduced a bill requiring the SEC to conduct cost benefit analyses on all regulations, including those of Dodd-Frank, to “ensure that the regulatory consequences on economic growth and job creation are properly accounted for.” Cost benefit analysis, a seedling of an issue when first raised by Ms. Casey, who did not respond to an interview request, and Mr. Paredes, who declined to be interviewed, had taken root and grown in fertile partisan soil. Whether intended or not, it was now being used to slow down almost all elements of the Dodd-Frank legislation. Annette Nazareth, a partner at Davis Polk & Wardwell LLP and a former member of the SEC, dismisses the notion that the call for more economic analysis by Ms. Casey and Mr. Paredes set the stage for delaying the implementation of a universal fiduciary standard. “There's been a focus on economic analysis for years,” she said. “I don't believe it was emphasized in the dissent to be a roadblock.” Robin Bergen, a partner at Cleary Gottlieb Steen & Hamilton LLP, agrees. “It wasn't delay for delay's sake,” she said. “It was: "We have a lot more to do here. Let's turn to higher priorities.'” But others are not so sanguine. Advocates of the current fiduciary standard's being extended to all financial advisers worry that the more the SEC mulls over fiduciary duty, the more likely it is that the outcome will be disappointing. “It would be tragic if the price paid for a uniform standard is a watered-down standard,” said David Mendels, director of planning at Creative Financial Concepts LLC and president of the New York chapter of the Financial Planning Association. “I'd rather see them do nothing than do it badly,” Mr. Mendels said. “I am concerned that the tide may be turning in the wrong way.”

FRANK'S LETTER

In June, Rep. Barney Frank, D-Mass., ranking minority member of the House Financial Services Committee, wrote a letter to the SEC reminding it not to apply the Investment Advisers Act to broker-dealers. “The new standard contemplated by Congress is intended to recognize and appropriately adapt to the differences between broker-dealers and registered investment advisors,” Mr. Frank wrote. The guidance seemed incongruous coming from the Capitol Hill champion for fiduciary duty. But Mr. Frank's state is home to powerful financial industry players such as Fidelity Investments and State Street Corp. Mr. Frank said he was trying to make the legislative intent clear. “Sometimes you've got to repeat yourself because people don't hear you the first time,” he said. “There is a tendency for lawyers and practitioners at the SEC to say, “Oh, [fiduciary duty] means the [Investment Advisers Act of 1940].' We don't mean the "40 Act.” E-mail Mark Schoeff Jr. at mschoeff@investmentnews.com.