Dear Mary Schapiro:
From what I've been reading, as SEC chairwoman you're busy working on the rules that will set in motion the new Wall Street overhaul law. That is why I'm writing to you today. I know that one of the rules you're considering would require stock and insurance brokers to put their customers' interests before their own.
Most of the consumer advocates and other experts I've spoken with in recent weeks have said that they're pretty confident you will go ahead and write the new rule (even though the financial overhaul law stops short of requiring it). But many of them are concerned that the new rule won't go far enough. Quite frankly, so am I.
By my count, you've already received more than 100 letters from various stakeholders — some were thoughtful, some outright absurd — on this issue, which from here on out I'll just call fiduciary duty. So please consider this an official comment letter, written on behalf of the average investor, many of whom are relying on their brokers' advice to achieve some semblance of financial security in retirement.
Many of these consumers don't even realize that their brokers — who often call themselves financial advisers — aren't held to the same standards as investment advisers, who are required to put their customers' interests first. Sure, brokers must recommend "suitable" investments, but we all know that it's a much weaker standard and leaves too much room for potential abuse — one that can line the pockets of the broker at the expense of the investor.
It's hard to argue against a new rule, though the insurance industry will probably continue to try. Surprisingly, Wall Street had, at least outwardly, been more receptive to the notion of a uniform fiduciary duty for both brokers and investment advisers. So I was quite confused after I read the study commissioned by the Securities Industry and Financial Markets Association, the trade group for the big banks and brokers, which came to the bizarre conclusion that putting customers first was, in fact, bad for customers. Were you just as perplexed?
I called the association for clarification. Apparently, I had gotten it wrong. It wasn't going to "hurt" investors, an executive told me, it was just going to cost those investors more money. What was even more curious, however, were some of the issues that the association chose to study. As Barbara Roper, an advocate at the Consumer Federation of America, put it, "They chose to analyze a mythical situation that will never occur."
Take commissions, for instance. The study seems to assume brokers will no longer be able to charge commissions under a new rule, which couldn't be further from the truth. Didn't the association read the Dodd-Frank Act? It specifically says receiving commissions "shall not" be considered a violation of a fiduciary standard. Yet the association chose to calculate how much customers would be forced to pay in fees, if the brokers had to shift from a commission-based pay structure to a fee-based one. The study estimated it would cost $460 more a year for someone with $200,000 in assets. But that's a nonissue.
What they should have studied was how they might eliminate the conflicts inherent in charging commissions. A former Wall Street broker told me the reason they are often so pushy is because, absent the sale of a product, they don't get paid. Why not study ways to manage this issue? Or contemplate other ways to charge for advice?
The study also claims that adopting a broad fiduciary standard could limit the number of products that brokers can offer to a client. Right now, when the brokerage firm sells you a security, like a stock from its own account, or a municipal or corporate bond that it had a hand in underwriting, it stands to profit from the transaction. That's a conflict of interest, which means the broker needs consent from the client to move ahead.
But this is a weak argument against the new rule. As Mercer Bullard, who serves on the Securities and Exchange Commission Investor Advisory Committee, pointed out to me, there are thousands of brokers who already act as fiduciaries because they have discretionary control over their customers' accounts. So how do they manage the issue? "It's a blatant attempt to mislead commentators on the issues instead of grappling with the real issue," he said. "And there is a real issue."
As you know, there are plenty of ways that brokers can manage this conflict — the SEC just needs to clarify exactly when this type of activity is okay. For instance, perhaps brokers should obtain consent from a client at the beginning of a relationship, which grants permission to trade in liquid securities, but to check before, say, selling the customer illiquid securities with very subjective values. And naturally, requiring brokers who are giving advice to ensure the transaction is in the client's best interest.
When I asked Ira Hammerman, the association's general counsel, about all of this, he said that the industry didn't want a watered-down rule. "It's all nonsense," he said. "If the new law of the land will result in a fiduciary standard, that is fine. We support that. We just want the SEC to define it, and provide guidance as to how a multifaceted financial institution can comply."
He offered a hypothetical. What if, for instance, a customer who also happens to be an employee of Apple doesn't want to sell a concentrated position in that company's shares, even if the broker advises the client to do so? Financial advisers who serve as fiduciaries deal with this all the time, especially with new clients. It can easily be solved with a plain-English disclosure, no?
Of course, we don't want to simply paper over the many conflicts with these disclosures — disclosing a conflict is not the same as trying to eliminate it. Even Sallie Krawcheck, who oversees Merrill Lynch's brokers as president of Bank of America global wealth and investment management, said that the industry needed to do a better job of transforming its "telephone book" disclosures into something more digestible. "That is going to be a challenge," she added, noting that she, too, was for the fiduciary standard so that "clients can make decisions about their advisers without having a Ph.D. in regulatory science."
But for that to happen, the rule really does need to be as strong as the one that financial advisers already adhere to (and the law does say it should). Or else we're right back to where we started, and that raises the question of whether a broker's fiduciary duty will always be slightly less pure than a financial planner operating outside the brokerage ecosystem.
(I haven't even gotten to some of the arguments put forth by the insurance industry. Did you see the comment letter from the Independent Insurance Agents and Brokers of America? It said that identifying the "ideal product among many different alternatives is not as simplistic, straightforward and clear-cut as some mistakenly believe." You can't blame them for saying that. I mean, have you tried to read a variable annuity contract lately?)
It's impossible for the new rule to resolve all the conflicts, but it needs to attack them head on.
Even though the political climate has shifted, this should not be a partisan issue. Don't give in to the argument that the additional regulation will stifle capital formation, or that the costs will be so high that the small investors may be pushed aside. There are plenty of financial planners who would be happy to take their business.
Sure, it's going to cost brokerage firms hundreds of millions of dollars and untold hours to put this new standard into effect. But they should look at those costs as a marketing expense. After all, a fiduciary standard is going to provide brokers with a whole new sales pitch.
That's why it's so important that the SEC ensures there's something substantial behind that inevitable pitch. Consumers shouldn't be left to wonder whose interests come first.