"Honest Broker " Provision of Financial Regulatory Reform

A major finance regulatory reform overhaul came one step closer to reality May 20 when the Senate approved the "Restoring American Financial Stability Act of 2010 in a 59-39 vote. The senate must now be reconciled with H.R. 4173, the House version of financial regulatory reform passed last December.


Although the House version of Wall Street reform offers an "Honest Broker" provision to obligate financial professionals to act in the best interests of their clients by imposing a fiduciary duty on brokers, the provision that would apply a fiduciary standard to broker-dealers failed to pass the Senate. The 'Honest Broker" rule would require brokers to disclose fees, conflicts of interests, and recommend investment products and solutions based on the clients' best interests. Currently, brokers and agents are rewarded by their firms for pushing higher commission inappropriate products so the firms can maximize profits.



Brokers have the same conflict of interest Goldman Sachs is acused of in its civil fraud case by the Securities and Exchange Commission (SEC): financial incentives to steer clients toward bad investment products that brokers make more money on. The recent hearing on Goldman Sachs showed that that firm repeatedly put its own interests and profits ahead of its clients. American consumers are often subject to similar abusive practices when they receive investment advice from brokers and agents who recommend a product because of higher commissions or revenue sharing payments with a third party.



The concept of a fiduciary standard for investment professionals is not new. The Investment Advisor Act of 1940, which regulates registered investment advisors and broker/dealers imposes a fiduciary duty upon investment advice providors. Registered investment advisors have been held to this standard of conduct for more than fifty years. Under the so called "Merrill Lynch rule, broker/dealers were exempt from registering as investment advisors and from acting as a fiduciary and only held to a "suitability" standard. In other words, an investment advisor must always act in the clients' best interest whereas a broker can choose an investment that is marginally acceptable but pays a higher commission than the investment that would have been "best" for the client.



The Financial Planning Association sued the SEC and in 2007, the U.S. Court of Appeals, DC Circuit held that the SEC does not have the authority to exempt brokers/dealers from registration and accompanying fiduciary duty. The SEC commissioned the RAND Corporation to conduct factual research and analysis to study how the different regulatory systems that apply to broker/dealers and investment advisors affect consumers and how consumers understand the differences between advisors and broker/dealers. The SEC released the results of the study in 2008. The RAND study shows consumers don't see any difference between the services provided by brokers versus those provided by investment advisors. What's more, consumers expressed high levels of satisfaction with the services they receive from their own financial service provider. In other words, retail investors pay a premium for broker provided financial services but don't know and don't care that they are being gouged.



The original version of the Senate bill included the "Honest Broker" provision. Under pressure from the insurance industry, the provision was replaced by an amendment to study the issue and propose to Congress changes in the law designed to address gaps or overlaps that are found to be harmful to consumers.



Neil Simon, a vice president for government relations at the Investment advisor Association said, " The issue has been studied more than enough, and it is time for all investors, whether they buy from an investment adviser or a broker/dealer, to be afforded the high level of protection afforded by the fiduciary duty standard." I concur.



The 'Honest broker" provision is supported by AARP, Americans For Financial Reform, Consumer federation of America, Investors' Working group, Council of Institutional Investors, Investment Advisor associatiomn, National Association of Secretaries of State, North American Securities Administrators Association, and the National Governors Association.



People don't invest their hard earned money just to line the pockets of their stockbrokers. They should be able to invest with the peace of mind that they are dealing with trustworthy investment professionals. The fate of a universal fiduciary standard for brokers and investment advisors hinges on the outcome of the House-senate negotiations over the most dramatic overhaul of financial regulations since the 1930's. Any hope for a universal standard now rests with the conference memers who this week began reconcilingh the differences between the House and Senate versions of the bill. Stay tuned.