In January I wrote a post in which I expressed some concern as to whether new Securities and Exchange Commission chair Mary Schapiro would move the investment industry into a regulatory environment that is more favorable for investors. So far, the signs seem encouraging.
One of the regulatory issues that many financial planners are concerned about is the current disparity between the rules governing Registered Investment Advisers and those that govern brokers. Registered Investment Advisers, who are regulated by the states and/or by the SEC, are normally required to act in their clients’ best interests; they are fiduciaries.
Under current regulations, brokers are usually held to a different standard called “suitability.” They’re required to make recommendations that fit a client’s risk tolerance, objectives, financial status, etc. The suitability standard does not require that brokers advise their clients to buy the least expensive investment option available to them, nor does it necessarily oblige a broker to disclose when a recommendation involves a conflict of interest. Suppose that there are a twenty mutual funds and ETFs with nearly identical holdings (an index fund, for example). If the fund marketed by a broker’s firm has the highest expenses among all those similar products, he’s not obliged to disclose that there are cheaper options available; if the fund is “suitable,” he’s free to recommend his firm’s product.
Prior to Ms. Schapiro’s appointment as SEC head, she worked for FINRA, the brokerage industry’s self-regulatory authority. Four years ago, as vice-chair of the NASD (FINRA’s predecessor), Ms. Schapiro wrote a letter to the SEC in which she was harshly critical what she described as “this much-vaunted fiduciary” standard under which Registered Investment Advisers operate. Calling the standard “imprecise and indeterminate,” she argued that FINRA’s standard for brokers was superior to the fiduciary standard.
This aspect of Ms. Schapiro’s past disturbed many consumer advocates and financial planners when she was first appointed to the SEC. But WSJ columnist Jason Zweig reported over the weekend that Ms. Schapiro responded to an inquiry about fiduciary duty by saying, “I wear a new hat now. I completely get that I work for America’s investors, so my perspective has changed. I think investors would rationally say that they prefer fiduciary duty as the standard of care. And they are entitled to have their interests come first, always.” Ms. Schapiro is singing a very different tune, and that’s great.
There’s considerable discussion now as to whether the regulation of brokers and investment advisers should be united under a single agency. If the regulations move in that direction, as Zweig notes, there will be a turf battle to determine which regulator gets that role. FINRA would doubtless like to extend its authority over a wider realm. Zweig quotes Boston University professor of securities law Tamar Frankel as saying, “It would be lethal if FINRA becomes the only regulator. FINRA has an inherent conflict of interest, because it’s the same people regulating themselves.” Indeed, when whistleblower Harry Markopolos testified before a House committee on his attempts to alert regulators to Bernard Madoff’s Ponzi scheme, he indicated that he made no attempt to alert FINRA because the Madoff family’s close involvement with FINRA made him afraid to approach the agency.
The news that Mary Schapiro “gets it” that she works for America’s investors now is terrific; now Congress needs to move regulations in the right direction without being swayed by Wall Street’s lobbying juggernaut.