Congress recently passed the long debated 2,300 page Financial Reform bill, created in response to the abuses leading up to the recent financial crisis. “Sweeping” is an understatement for this bill, as it not only creates new agencies with broad powers, it includes some 243 rules that have yet to be fleshed out.
The biggest thing to come out of the bill is the creation of the Bureau of Consumer Financial Protection, which will have a $550 million budget (the FDA budget is $784 million by reference) to oversee any number of financial products such as mortgages and credit cards. Notably, the auto industry lobbied out of regulation by the agency, and pawn brokers are also exempt (I know, I don’t make sense of it, I just report it). The agency will have broad responsibilities that have not quite been defined yet. It will be headed by a single person rather than a board. Elizabeth Warren, a consumer advocate currently serving as chair of the Congressional Oversight Panel, is a top candidate for the position, although others are being considered as well. In my opinion, Elizabeth Warren is a champion of middle class consumer protection and would do a great job. She may even replace Ralph Nader as my favorite celebrity.
The bill does contain some specific protections and changes for consumers: Now if you are rejected for a loan, or offered an interest rate that is too high, you may see the credit score the lender used (in the past you were entitled to a free copy of your credit report, but had to pay for your credit score). Prepayment penalties will be a thing of the past for adjustable rate and complex mortgages. No income verification loans will also be history; lenders will be required to verify income.
Mortgage originators will not be allowed to earn bonuses based on the type of loan you choose, eliminating financial incentive to put you into a riskier loan. While these reforms are good, and make credit safer, they may also have the effect of making credit harder to get, as it will be less profitable for lenders.
On the retail end, merchants will be allowed to give a discount for cash or debit cards, but not for choosing one type of credit over another, such as a discount to use Visa versus American Express. However, merchants can impose a $10 minimum or less for debit card purchases. If you are a shareholder in a corporation, you will now be given the opportunity to vote on executive compensation. But companies don’t actually have to listen (refer to comment about pawn brokers above).
One provision I’m very pleased about: The bill creates an Office of Financial Literacy, which aims to educate people to protect them from becoming victims of financial abuse. And a provision I’m not so sure about: The Office of Financial Research, which, in the name of monitoring Wall Street, will be a central repository of financial transaction records the agency deems necessary to look for systemic risk. It is not clear exactly what records will be kept and who will have access to them. Could your ATM receipts end up there? We’ll have to see.
The Office of Financial Research is part of the Financial Stability Oversight Council, which could require financial institutions to keep higher capital requirements if the council sees a problem. The council will monitor companies that become “too big to fail,” and impose stricter regulation upon them. Should it appear that a company’s health is seriously suffering, the government will have the ability to liquidate the company and pass the cost along to the industry.
Now, about that “F word;” I’m talking about Fiduciary. For months, the Financial Planning Coalition has been working behind the scenes to include a fiduciary requirement for financial advisors in this bill. It has faced opposition from brokers and the insurance industry, and ultimately was included only as a call for the SEC to study the issue for six months, make recommendations and impose a fiduciary responsibility on financial professionals if it chooses.
What is a fiduciary, and what is the big deal? According to The Committee for the Fiduciary Standard, fiduciaries:
- Put the client’s best interests first.
- Act with prudence; that is, with the skill, care, diligence and good judgment of a professional.
- Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts.
- Avoid conflicts of interest.
- Fully disclose and fairly manage, in the client’s favor, any unavoidable conflicts.
Currently, Certified Financial Planners and Registered Investment Advisors are held to a fiduciary standard, while brokers and registered representatives are held to a suitability standard (must act in a way that is suitable for client versus best for client). This is not to say that no brokers or registered representatives act in the best interest of their clients, but only that they are not required to. The debate centers around whether or not all who hold themselves out to be financial advisors, whether representatives, insurance agents, or planners, should be held to a fiduciary standard, or if instead there should be some demarcation between the two.
In my opinion, it would be difficult to change the way the industry does business by requiring all to adhere to a fiduciary standard; if a no-load (no sales charge) mutual fund is best for a client, but the company gets paid by selling mutual funds with sales charges, as a fiduciary would that representative then send his or her client to Vanguard? That doesn’t make sense. What would make sense would be full disclosure that the advisor is in a sales position with the company, making a sale rather than giving ongoing advice, and held to a suitability standard, so that the consumer would have clear expectations about the transaction.
However, if a financial professional acts in the capacity of giving advice, rather than information about a product, I do believe a fiduciary standard of care should be required. It will be interesting to see what the SEC recommends.