Financial Reform for the Retail Investor?

Should broker-dealers be required to act in their clients' best interests?


In politics, questions are rarely as simple as they appear. As such, it should hardly come as a surprise that one of the more contentious issues in the financial reform debate has assumed the disguise of a seemingly unassuming query: Should broker-dealers be required to act in the best interests of their clients?

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For the wide array of retail investors who saw their nest eggs vanish during the recession, the answer is an overwhelming "yes." The same goes for a number of congressmen. "This is not rocket science that we're dealing with here," says Rep. Paul Kanjorski (D-Pa.), who along with Rep. Barney Frank (D-Mass.) has been a key architect of the House of Representatives' proposals. "This is pretty rudimentary stuff."

Not so fast, say a number of concerned financial industry representatives. Currently, the debate is centered around the difference between broker-dealers and registered investment advisors. As their title suggests, RIAs' main duty is to advise investors about securities. Broker-dealers, on the other hand, actually sell the securities. RIAs have a fiduciary duty to their clients, which means that they must act in their clients' best interests. For their part, broker-dealers don't have to sell the best products that are available to their clients. Instead, their responsibility is to sell products that are deemed to be "suitable."

So far, both the Senate and the House have approved financial reform legislation, and representatives from both chambers are currently in the process of reconciling the two bills. The bill passed by the House calls for broker-dealers, in cases where they are giving retail investors personalized advice regarding securities, to be held to the same fiduciary standard that RIAs must adhere to. The Senate bill, however, isn't as direct. Instead of imposing the standard outright, it calls for the Securities and Exchange Commission to study the issue.

Tom Currey, president of the National Association of Insurance and Financial Advisors, supports the Senate's conservative approach. While advocates of the House version say there is little to study, Currey insists that the issue is far from clear. "Our concern is that applying such a subjective standard to broker-dealers … who, unlike registered investment advisers, sell products makes it difficult to identify clearly which product is 'best.' Is best cheapest? Is it best premium relative to the benefit of the product? Is it best return on the investment? Is it the product with the best historic underwriting and service standards? It is a very uncertain standard," he said in a statement.

As members of the House and Senate mull over ways to reconcile their bills, U.S. News spoke with Kanjorski about the broker-dealer issue, as well as about the SEC's lawsuit against Goldman Sachs and about a proposal to allow the SEC to be self-financed. Currently, the SEC collects fees, but the agency isn't allowed to hold onto them. Instead, it relies on Congress for funding. Regulators would prefer to change that arrangement, both to symbolically distance themselves from the political process and to ensure the availability of resources.

[See What Financial Reform Means For Consumers.]

Why should Congress impose a fiduciary standard on broker-dealers?

Nothing really has been fundamentally done in the last few years since the crisis of confidence occurred in the marketplace. And we're now in the process of writing the material to rebuild confidence and trust in the market. This issue goes directly to the retail market. Right now, most people, if you ask them, would think that there is a fiduciary relationship or a standard owed to a customer by a broker-dealer. They don't realize that there isn't. … This is a good opportunity to say, "Look … customers should be protected and know that there are no conflicts of interest out there, no adverse positions out there, that people, whether they're wearing the hat of a broker-dealer or whether they're wearing the hat of a financial planner, owe their customer a fiduciary duty.