Parsing the industry's F word

So much rides on the meaning of “fiduciary,” a word alien to the vast population and, at least until recently, to a good part of the financial world. But with Congress about to take up the Obama administration's regulatory-reform proposal in earnest, advisers and brokers should be prepared for an onslaught of definitional spinning by opponents seeking, in large part, to preserve competing status quos. In a recent Wall Street Journal Op-Ed piece, Charles R. Schwab warned that imposing “fiduciary liability” on brokers puts at risk the entire discount-brokerage model he helped create, along with the freedom of mom-and-pop clients (he calls them “independent investors”) to buy the financial products they want at a reasonable price. The logical outcome of having to guarantee every decision an investor makes “would be that individual investors would be constrained to a small set of plain-vanilla investments — Treasuries for all — or would be forced to pay us a fee to manage their account,” he wrote. Mr. Schwab was taking up arms as much against New York Attorney General Andrew Cuomo, who is suing the discount brokerage for refusing to repurchase auction-rate securities sold to its clients, as against new regulation. But regulation is clearly on his mind.
The Charles Schwab Corp. fears that imposition of a fiduciary standard of care will make discounters responsible on an continuing basis to self-directed investors who merely check with their call center or branch-based brokers for “validation” of investment ideas, according to Jeff Brown, the firm's chief lobbyist. Current law carves out fiduciary-standard exceptions for brokers who give advice that is “solely incidental” to their primary duty of selling financial products and executing orders. “We're worried about the unintended consequence of a broad application of fiduciary duty,” said Mr. Brown, who sits on the Securities and Exchange Commission's new investor advisory committee. At the top of that panel's agenda is a discussion of fiduciary duty. “We want to make sure that in-vestors with limited assets who can't afford to pay fees to an adviser have an ability to invest the way they want and to obtain validation or guidance when they want it,” he said. William Baldwin, the new chairman of the National Association of Personal Financial Advisors, is equally troubled by unintended consequences. But his biggest challenge, he told InvestmentNews reporter Sue Asci last week, is being able to preserve the traditional, court-interpreted principles-based meaning of “fiduciary,” as outlined in the Investment Advisers Act of 1940. “We are fighting against changing the definition of fiduciary,” said Mr. Baldwin, who is also president of Pillar Financial Advisors, a registered investment adviser. As Diahann Lassus, his predecessor in the NAPFA post, ex-plained, independent financial advisers fear that Congress will authorize the SEC to unleash a flurry of fiduciary standard-of-care rules that “have the perverse consequences of diluting protections for investors, because you are bound to miss something and create loopholes.” The proposed legislation would amend both the Advisers Act, regulating independent advisers, and the Securities Exchange Act of 1934, regulating broker-dealers, by permitting the SEC to set uniform rules requiring all financial intermediaries “to act solely in the interest of the [retail] customer or client without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice.” “You could argue that you couldn't have a client and get paid under that standard,” Mr. Brown said. “I'm not sure anyone, brokers or advisers, could comply.” What's status-quo-bending for broker-dealers about the White House's proposed investor protection rules is that brokers are currently subject only to a “suitability” standard. As long as they sell investments that are appropriate for the client — even if it's not the best thing — their sales practices are considered kosher. What's revolutionary for independent financial advisers and planners is that under the Advisers Act they are not subject to written federal rules governing their practices outside of a broad responsibility to meet high fiduciary standards. Their fear, of course, is that the SEC will subject them to oversight from the rules-minded Financial Industry Regulatory Authority Inc., which oversees brokers. Perhaps the greatest irony of the situation is that the independent adviser community appears to be on the verge of winning a large part of what it has long been asking for — a regime subjecting brokers who give advice to the higher fiduciary standard of care. The securities industry in general, which has fought that standard for years, has now ostensibly embraced it. “After the terrible financial crisis of 2008, with regulatory reform being talked about everywhere, we have a unique opportunity to better protect investors and rebuild everyone's trust and confidence in our financial system,” said Ira Hammerman, general counsel of the Securities Industry and Financial Markets Association, the main trade group of the brokerage industry. “We are calling for new legislation that will require a new fiduciary standard of care at the federal level for investment advisers and broker-dealers. The independent and broker-dealer sides have converged.” But skeptics say the securities industry simply wants to water down the fiduciary standard by having Congress amend the rigors of the Advisers Act. “SIFMA talks about a fiduciary standard, but it really wants to codify exceptions so that brokers can provide investment advice, but avoid investor protections built into the Advisers Act,” said David Tittsworth, executive director of the Investment Adviser Association, which represents SEC-regulated independent advisers. “Everyone agrees that brokers have migrated into the advisory profession, not the other way, but they don't want to play by the same rules.” SIFMA members, he added, don't want to have to disclose conflicts of interest about compensation for certain products or forgo some profitable businesses that would be eroded if subjected to strict fiduciary standards. Broker-dealers are indeed seeking some exceptions to accommodate businesses of its full-service member firms, Mr. Hammerman said. For example, they want to give clients the option of having a firm fill their orders from its own inventory (principal trading) rather than acting solely in an agency capacity. But SIFMA's larger agenda is to have a set of written rules that would guide its members, many of which are multinational firms, in running their businesses. In contrast to the five- to 10-person shops that make up the bulk of the independent adviser community, many brokerages operate complex businesses that provide broad benefits to corporations and national economies, Mr. Hammerman said.

"MOVING PARTS'

Critics such as the IAA, NAPFA and the Financial Planning Association, Mr. Hammerman added, are fighting the prospect of more intense regulation and increased vulnerability to client lawsuits. “They like the fact that Finra doesn't come around for inspection, that statistically they're visited by the SEC only once a decade and that customers can't sue [under federal law] for breach of fiduciary duty,” he said. What's really at stake for all parties is control of the legislative and regulatory agenda, and that's not easy. “There are lots of moving parts here,” said Dan Barry, director of government relations at the FPA. The House Financial Services Committee is expected to begin considering the Investor Protection Act of 2009 at the end of this month, after it deals with commercial-banking customer protection rules, with hopes of reporting a bill to the full House by late October. But some Washington lobbyists cautioned that the fiduciary standard may be bumped aside by more pressing issues. That gives the warring parties more time to make their arguments, or to reach a compromise. “It might be overly optimistic to think people can come together, but things are happening” said Mr. Barry, who noted that his group and others in the Financial Planning Coalition have hired an outside lobbyist. “We all want something that works, that is practical and functional.” J. Thomas Bradley Jr., president of TD Ameritrade Institutional, said all parties have an interest in a resolution. “What it comes down to is making sure that the regulators and the lawmakers craft the rules and laws so they are appropriate for the different models,” said Mr. Bradley, whose unit is the adviser custody arm of TD Ameritrade Holding Corp., which, like Schwab, both services direct retail investors and acts as an asset custodian for independent financial advisers. E-mail Jed Horowitz at jhorowitz@investmentnews.com.