Broker-Dealers Beware

When enacting Dodd-Frank, Congress sought guidance from regulatory agencies to help assess what it, in many instances, could not: The real impact of the reforms that it sought to implement. One such reform related to the provision of personal investment advice by financial institutions to retail customers. In particular, Section 913 of the Dodd-Frank Act directed the SEC to conduct a study to evaluate the effectiveness of the current legal and regulatory standards of care governing the provision of that advice, and to assess whether there are gaps, shortcomings or overlaps in the applicable standards. The report that was issued last week by the SEC staff raises critically important questions for all brokers, dealers and investment advisers - and, of course, for their in-house counsel.

The report advocated that the Commission implement a uniform fiduciary standard for all broker-dealers and investment advisers when they give individualized investment advice to retail customers: "The standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice." The report also considered two alternatives: (i) the repeal of the broker-dealer exclusion to the definition of an "investment adviser," and (ii) the imposition of the requirements of the Investment Advisers Act on broker-dealers. Although the report concludes that it would not be proper to broadly impose the requirements of the Investment Advisers Act on broker-dealers, it does recommend that the Commission "harmonize" the rules that apply to both types of entities. In short, the report recommends sweeping changes to the current regulatory environment for broker-dealers.

But will Congress act on these recommendations? The recent election certainly casts doubt on the future of these proposed regulations, and a statement by Commissioners Kathleen Casey and Troy Paredes make clear that the Commission - which voted to release the report - is hardly speaking with one voice. Casey and Paredes opposed the release, noting that the report's "pervasive shortcoming" is that it fails to adequately justify such a fundamental change in the regulatory regime for broker-dealers and investment advisers. According to the report, the principal support for a unified fiduciary duty is that investors are not aware of the different standards of care that are imposed on each type of entity. Although there may be some evidence of that, according to the two Commissioners, the evidence is equally strong that investors are generally satisfied with their financial professionals. According to Casey and Paredes, the report fails to identify any gaps in the current regulatory scheme, or provide any compelling evidence that investors have been harmed or disadvantaged in any way by the application of existing standards. But the two Commissioners didn't stop there. They argued that the report fails to consider, as an alternative, that enhanced disclosures about the applicable standards and/or investor education might help remedy the problems with the current scheme, and they noted that the report fails to define in any meaningful way the term "personal investment advice." Without understanding the scope of the proposed rule, they argued, it is impossible to determine its potential impact.

Finally, Casey and Paredes noted the importance of economic analysis in determining whether the proposed changes are, in fact, in the best interest of investors: "Regulation based on poorly-supported recommendations runs the risk of restricting retail investors' access to affordable personalized investment advice and the range of product and services they currently enjoy." In implementing any change, regulatory or not, there is always a trade-off between cost and benefit. Without a thorough analysis, they argued, it is impossible to tell whether the incremental benefits of enhanced regulation will outweigh the costs to the investors that the regulations are intended to protect.

The bottom line, it seems, is that the implementation of the staff's recommendations is far from certain. But in-house counsel working in this space needs to be aware of the recent report, its potential consequences, and the opportunities during any rulemaking process to address the important question of whether the goals of reform actually would be satisfied by the recommendations put forward by the SEC's staff.

Read Matthew Ingber's previous column. Read Matthew Ingber's next column.

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