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Investors and Congress don't mix

Commentary: Political interests aren't aligned with financial consumers


04/27 03:50 PM

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BOSTON (MarketWatch) -- When Congress can't solve a problem without upsetting political supporters, it typically kicks the issue down the road, coming up with some alternative idea that is less politically toxic but also less effective.


This week, that's precisely what politicians did with rules for the oversight of financial advisers.

House Financial Committee Chairman Spencer Bachus (R.- Ala.) introduced legislation that would create a self-regulatory organization for retail investment advisers.

The "Investment Adviser Oversight Act of 2012" was co-sponsored by Rep. Carolyn McCarthy (D-N.Y.), giving it bipartisan support that will be essential in an election year.

The bill would authorize one or more self-regulatory organizations to oversee investment advisers, funded by membership fees.

What's prompting this legislation is the difference between investment advisers and broker-dealers.

Registered investment advisers are fiduciaries, meaning they operate under a standard where they must put a client's interests first. Functionally, an investment adviser is compensated for their counsel, rather than for making trades.

Broker-dealers, by comparison, must only provide advice that is "suitable" for the client, and are paid for making transactions.

In recent years, however, many brokers blurred the lines, providing counsel and advice and making it hard for the consumer to figure out their loyalties, and what they were paying for.

Suits and suitability

Congress and the SEC have looked at this issue and purportedly wanted to fix it with a fiduciary standard that basically applied to everyone. The brokerage industry fought that move, and the idea has stalled in the regulatory rules-making process, where it appears that interested parties are hoping it will bog down and ultimately prove unworkable.

Meanwhile, the brokerage industry has been fighting back, suggesting that in fact it's investment advisers who are not as well-regulated and are creating the bulk of the issues.

In announcing the legislative proposal this week, Bachus said: "Customers may not understand the different titles that investment professionals use but they do believe that 'someone' is looking out for them and their investments. For broker-dealers that is true, but for investment advisers, it is all too often not true and that must change."

Interesting comments. Bachus suggests that the broker-dealers - who operate under suitability standards -- are the good guys and the registered investment advisers are the bad guys. That would be the position taken by the lobbying interests in the brokerage world.

Bob Veres, a veteran observer of and outspoken commentator on the financial-planning industry noted that, in the 2011-2012 election cycle, commercial banks, finance/credit companies and mortgage bankers and brokers gave a lot of money to Bachus's re-election effort. His top 10 contributors include "commercial banks, insurance companies, securities and investment firms, and 'miscellaneous finance'" to the tune of $670,000.

It certainly smells as if Bachus' has been hearing from the Financial Industry Regulatory Association (FINRA), where the leaders are hoping they will get the nod to become the self-regulatory group for the business if the bill passes.

Double standards

Building on Bachus' logic, supporters of the legislation suggest that while advisers and brokers are providing services that the public can't really differentiate, they're not being regulated the same way, because 58% of broker-dealers were examined by the SEC last year, compared to just 8% of investment advisers.

The problem with that thinking is that regulatory authority of investment advisers is shared between federal and state authorities, and there's no real proof that the state securities administrators haven't been doing their job. While there's an argument that federal regulation has been lax -- judging from the SEC-examination statistic -- it doesn't hold at the state level.

Moreover, by squeezing out the state regulators when it comes to smaller investment advisers and creating a new national standard, the legislation would increase the cost and regulatory burdens faced by small investors. Moreover, it doesn't change the fact that the states are still best suited to regulate the industry's small fry.

That's only marginally solved by the one big loophole in the legislation, namely that the process could involve the creation of two separate self-regulatory groups. That means there could be one for the broker-dealers and another for the investment advisers, the former sticking with its suitability standard while the later adopts fiduciary rules and effectively ends the debate over that issue with a two-headed solution that only the working politicians in Washington could love.

The benefit to consumers in this case would be simple; once you see which agency is regulating your financial intermediary -- information that must be disclosed in meetings with clients -- you will know which type of adviser you've got, and whether it's the business model you want to work with.

That said, creating a new two-headed regulatory solution is probably the only way this proposal ever really works. That's not to say it won't pass and create just one oversight group, but If FINRA were to become the new regulatory body and have power over both sides in this debate, it could simply cram regulation on investment-advisers in ways that favor broker-dealers.

Veres noted that he's not the only person to think that "FINRA regulation of RIAs would sound a death knell for fiduciary RIA advice."

That would be an enormous step backwards.

This shouldn't be so hard. Both models can co-exist, but so can a fiduciary standard. As much as people hate commissions and transaction fees, there definitely are times when having those conflicts of interest laid out, clear and in focus can lead to financial advice that is in the best interest of the customer.

It raises the standard that everyone must operate under, which improves how individuals feel about their advisory relationships.

Sadly, that's not likely to be the outcome here. The only real question is whether the politicians will let the fiduciary-responsibility issue die from inactivity, or whether they will actively kill it off because that would please some deep-pocketed supporters.