The Standards of Financial Reform

On July 21, 2010, President Obama signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act, which he said, “was born in the failure of responsibility from certain corners of Wall Street.”  The Act attempts to provide safeguards against the financial excesses that thrust the American economy and its people into the worst recession in 80 years.  Congressman Barney Frank, credited with bringing about this reform, said, “For the first time, every financial entity of any size in America will be covered by a regulator and will have to report to that regulator.”

The implementation of the new Act will take months, if not years, as regulators write in the key provisions and rules of operation that the law provides.  They also face the immense task of combining several different government agencies, and establishing the new Consumer Protection Bureau, which some consider to be the cornerstone of the Act.

How effective will the new legislation be in actually regulating our system and offering real protections?  On one hand, as the adage states, “Be careful what you wish for.”  Financial institutions will be required to divulge more information to the consumer and be “transparent” in their dealings— yet the responsibility to review and understand the information provided will ultimately fall upon the consumer.

Ironically, there will be more regulations on financial institutions to provide information, but that means that consumers will be less able to place the blame for a financial deal gone awry on someone else.  They no longer can claim that they were unaware of the products in which they were investing. Individual investors will need to become their own advocate and act as perhaps they always should have acted; that is, as active and knowledgeable participants in the decision-making processes of their finances.

Where does that leave the role of the financial advisor?  Under the new act, the SEC has the authority to place broker-dealers who provide investment advice under a fiduciary standard of care.  This would mean that broker-dealers who provide investment advice would be legally obligated to act in the best interests of their clients.  During the recent financial meltdown, broker-dealers were not held to such a standard. They were under no obligation to recommend products that would benefit the customer, so products such as interest-only and jumbo mortgages for people who could not afford them became the norm.

If the SEC fails to require such a standard, investors will still be susceptible to believing a firm is acting in their best interest. Take, for example, an investment advisory firm that offers both “commission-based” and “fee-based” services.  Advisors at these firms often confuse clients by integrating both sides of their practice under a single platform called “client-based”.  This misleading practice is also known as the “Two Hat Syndrome”.  By labeling themselves as “client-based,” such firms attempt to appeal to investors when in reality they are acting in fiduciary capacity one minute and a non-fiduciary the next.  This leaves investors blind to conflicts and expenses, which is part of the problem that the new reforms are attempting to regulate.  Modera believes in a “one-hat” approach—that is, acting as a fiduciary and placing clients’ interests first at all times.

As the country continues toward economic recovery in 2011, the new regulations from the Dodd-Frank Act are a reminder for all of us—from Washington, Wall Street, and Main Street— of the high standards against which we should all measure ourselves moving forward.

About the author

Tom Orecchio, CFA, CFP®

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