Broken Brokerages: Finance Luminaries Join Fight Over Uniform Fiduciary Standard

The signatories to the declaration are joining the battle at a moment when the action has ground to a halt. An SEC study released in early 2011 recommended the creation of a uniform standard, and agency chairman Mary D. Schapiro has called the standard a priority. A late-2011 ETA for a proposed rule came and went, however, and in January, the SEC said it would be conducting a survey in support of a cost-benefit analysis for the rule. In support of the declaration, some of the signatories are visiting the SEC next month to argue for a fiduciary standard that would require investment advisers and broker-dealers to serve clients’ best interests and avoid conflicts.

Still, the SEC’s cost-benefit survey has yet to come out, and we couldn’t find anyone who would hazard a guess at when a rule will ultimately be proposed. “The longer it languishes, the more difficult it gets to move things along,” Dan Barry, head of government relations for the Financial Planning Association, told us, adding that he doesn’t expect to see a proposal this year.

Not only is the rule-making in a holding pattern, but there are some involved in the debate who think the sides aren’t so far apart. “SIFMA agrees something should be done, we think something should be done,” Mr. Barry told us. “There’s an unusual degree of support across a broad population of stakeholders,” agreed Barbara Roper, director of investor protection at the Consumer Federation of America.

Which isn’t to say that broker-dealers and investment advisers are joining hands and singing Kumbaya on the issue. “The investment adviser community, to my way of thinking, wants to take that statute that was designed to their business model and export it to the broker-dealer community,” Ira Hammerman, SIFMA’s general counsel, told us. “SIFMA is trying to take a more pro-investor, a more realistic approach,” he said, adding: “Customer choice is really at the center of what we’re saying.”

For their part, some investment advisers think SIFMA is trying to redefine the concept of the fiduciary standard to fit its current business model. “They say that all products now available through brokers should be available through the fiduciary standard,” said Knut Rostad, founder and president of the Institute for the Fiduciary Standard, which drafted the declaration signed by Ms. Frankel, Mr. Malkiel and others. “They are changing what the fiduciary standard means, and the additional point is that they’re changing the meaning to what the suitability standard currently is now.”

The parallel regulatory frameworks governing investment advisers and broker-dealers grew out of the stock-market crash of 1929. Broker-dealers were regulated under the Securities Exchange Act of 1934, while the Investment Advisers Act of 1940 and a series of court decisions set the standard of behavior of investment advisers registered with the SEC.

The dual structure was less of an issue in the early days, when the securities available to investors were fewer and far simpler. When a stockbroker called a customer to tout a company, the customer had a reasonable understanding of what the broker stood to gain—a commission on the securities bought and sold—and a sense that the broker would promote good investments—or risk losing future business.

As the financial products became more complex, incentives were harder to discern. Mutual funds, for instance, offered varying fee structures, allowing investors to decide how they wished to pay for the product: With an up-front sales charge that took an initial bite out of the principal, or with ongoing fees. An investment adviser registered with the SEC was required to recommend the product in a client’s best interest. A broker-dealer, on the other hand, could offer a client either one.

“If the branch manager tells you one product gets you 3 percent commission and that one gets you 7 percent, it’s the nature of human beings and capitalism and life that you’re going to sell that one,” Josh Brown, author of the blog The Reformed Broker and the book Backstage Wall Street, told The Observer. “There’s nothing illegal about it. As long as the product is suitable for the client, it can be done.”

Mutual funds, Mr. Brown said, are a tame example: “Principal protection funds, high-fee annuities. Private REITs, fucked IPOs, secondary offerings. There’s a litany of shit that you won’t find a fiduciary adviser selling.”