Wall Street reform and your investment adviser



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On Dec. 11, 2009, the U.S. House passed the Wall Street Reform and Consumer Protection Act, an effort to rein in the excesses in the financial system that contributed to the current economic malaise. The debate over financial reform now continues in the Senate, which is not likely to act on its version of the bill until later this year. In addition to provisions that would end taxpayer bailouts of firms considered “too big to fail,” the House bill seeks additional protections for retail investors by imposing a fiduciary duty on anyone providing personalized investment advice to retail customers. This provision would harmonize the current patchwork of rules governing the services provided by broker-dealers and registered investment advisers.When the laws regulating these two groups were enacted 70 years ago, broker-dealers primarily provided transaction-based services. These were arm’s-length relationships that required that customers be treated fairly, but the resulting legal standard for brokers’ recommendations required only that the products sold be suitable for the client based upon a reasonable assessment of the client’s situation.In contrast, the Investment Advisers Act of 1940 imposes a more stringent fiduciary duty on registered investment advisers, requiring undivided loyalty to the client.The client’s best interests must be considered above those of the adviser or his employer. In addition, the adviser must act with the skill, care and diligence of a professional, provide full and fair disclosure of all important facts and fully disclose conflicts of interest.Under current law, broker-dealers are exempt from adhering to the fiduciary duties imposed under the Investment Advisers Act, as long as the advice they provide is solely incidental to their primary function of selling products. Telling the difference Clearly, the delivery of financial services and products has evolved immensely since the first standards were put in place to protect investors.Broker-dealers have increasingly moved away from sales of commission-based products, increasing their focus on investment and financial planning advice. Since the introduction of fee-based or wrap accounts at brokerage firms in the 1990s, the services offered by brokers and advisers have effectively merged. Because representatives at broker-dealers and investment advisers may use similar titles, holding themselves out as “financial consultants,” “financial advisers” or “wealth managers,” it is difficult for investors to determine when their adviser is required to act in their best interest, and when they are ultimately serving themselves and their employer.This confusion was confirmed by a 2008 RAND Corp. study, commissioned by the Securities and Exchange Commission, which found that, although investors have a general understanding about differences in service between brokers and investment advisers, the differences in their legal obligations to customers are not well understood.The House reform bill continues to exempt broker-dealers from the Investment Advisers Act but calls on the SEC to develop rules that would expand the fiduciary standard to brokers when they offer personalized advice. This approach leaves doubt about what form the fiduciary standard will ultimately take and allows for interpretation about when advice becomes “personalized” versus merely informational in nature.In effect, the House bill allows an adviser to switch hats, acting as a fiduciary when providing personalized advice, such as retirement planning, and then removing the hat to effect transactions that would be subject to the lesser suitability standard.The broker or registered representative’s duty of care or loyalty to the customer ends once the personalized investment advice has been provided.Sales of proprietary products and incentive-based compensation — long standards of the broker-dealer business model — would not violate the fiduciary standard under the House bill, though the law gives the SEC power to prohibit compensation schemes if deemed necessary to protect investors.If brokers sell only proprietary products or a limited range of products, they can avoid violating the fiduciary standard by obtaining informed consent of the customer.The Senate’s proposed reform goes further by striking the broker exemption from the Investment Advisers Act, bringing all advice under its well-established fiduciary rules.This more sweeping reform would no doubt bring greater change to the industry, forcing product manufacturers to redesign their offerings to better align the interests of the adviser and investor.Whatever the outcome of the congressional debate, consumers of financial planning services and investment advice will need to continue performing their own due diligence when selecting advisers and financial products.The National Association of Personal Financial Advisors (focusonfiduciary.com) and the Certified Financial Planner Board of Standards (cfp.net) both offer useful tools for evaluating advisers on their Web sites. In addition, consumers can learn more about the fiduciary standard by visiting fiduciarynow.com.David T. Mayes, a certified financial planner and IRS enrolled agent at Mackensen & Company Inc., a fee-only advisory firm in Hampton, can be reached at 603-926-1775, david.mayes@mackensen.com or by visiting mackensen.com. Edit ModuleShow Tags