Compensation: SEC mandate called too broad

Financial advisers are troubled by an administration proposal that would allow the Securities and Exchange Commission to ban commissions and take other sweeping actions regarding their fees.

Even fee-only advisers have reservations about the plan, put forward in draft investor-protection legislation the Department of the Treasury sent to Capitol Hill July 10. The bill would give the SEC broad powers to rule on sales practices and compensation by brokers and advisers.

“The question is how would they make those broad-based decisions,” said Diahann Lassus, chairman of the National Association of Personal Financial Advisors of Arlington Heights, Ill., which represents fee-only financial planners.

“We’re not clear what it really means yet and how it would impact the way people do business,” said Ms. Lassus, who is president of Lassus Wherley & Associates PC, a New Providence, N.J., firm that manages about $250 million.

The Obama administration’s draft legislation, which includes the stipulation that brokers acting as advisers abide by fiduciary duties in acting solely in the interests of customers, requires the SEC to examine — and, where appropriate, issue rules prohibiting — questionable sales practices, conflicts of interest and compensation schemes for brokers and investment advisers found to be “contrary to the public interest and the interests of investors.”

“It’s almost like they’re saying it’s wrong to make a profit,” said Richard Salmen, president of the Denver-based Financial Planning Association.

“There can be many, many situations where it serves the investor’s best interest and it’s profitable for the intermediary,” said Mr. Salmen, who is senior vice president of GTrust Financial Partners Co., an Overland Park, Kan., firm that manages $400 million.

Under the investor-protection draft bill, the second in a series of legislative proposals the administration is asking Congress to enact to reform regulation of the financial services industry, the SEC could take a wide range of actions, including banning commissions.

Indeed, the precedent for doing that has already been set. The Financial Services Authority in London, the United Kingdom’s financial service regulatory agency, issued a rule June 25 that prohibits financial advisers in that country from accepting commissions to sell investment products as of 2012, FSA spokesman Robin Gordon-Walker said.

The Financial Services Institute Inc. of Atlanta, which represents independent-contractor broker-dealers, fears that a ban on commissions could become a reality if the Obama legislation is passed in its proposed form.

That would be bad for investors who do not have large sums to invest, said David Bellaire, the organization’s general counsel and director of government affairs. “Unless we want small investors to take a do-it-yourself approach to their financial decision making, we need to have a viable economic model and commissions provide that,” he said.

The SEC has traditionally required that disclosures be sufficient to give investors enough information to make good choices. Under the proposed legislation, the SEC would become the industry fee czar, banning compensation practices deemed not to be in the best interest of investors.

Fee levels themselves could be set by the SEC, said Richard Marshall, a partner in the investment management and securities litigation group of Ropes & Gray LLP in New York. “If something was outside the industry average, the SEC could say “that’s too much,’” he said.

The language is broad enough that it could lead to the banning of a wide range of compensation practices, including particular types of sales loads or 12(b)-1 fees charged by brokers who sell mutual funds, Mr. Marshall said. Other mutual fund sales proposals that never got off the ground, such as the SEC’s proposed 2004 point-of-sale rule, which would have required brokers to disclose payment methods that could pose a conflict of interest, could be resurrected.

In addition, “payments for shelf space,” made by funds to brokerage firms to get on lists of “preferred” funds that the brokers push, could be abolished, Mr. Marshall said. The payments, while disclosed, are difficult for investors to understand, he added.

Revenue-sharing payments made by mutual fund managers to compensate brokers also could come under the ax, said Soo Yim, a partner in the Washington office of international law firm Wilmer Cutler Pickering Hale and Dorr LLP. “There may be some pressure to take another look at these type of arrangements,” she said.

The Investment Company Institute in Washington is still evaluating the proposal and declined to comment on it, said spokesman Mike McNamee.

“The most likely low-hanging fruit is differential compensation,” said Barbara Roper, the Pueblo, Colo.-based director of investor protection for the Consumer Federation of America in Washington. Paying brokers more for selling a certain investment than they would make selling other investments is “clearly designed to encourage sales based on the financial interest of the broker or adviser, rather than the best interest of the clients,” she said.

“Taken to its logical conclusions, the whole system of compensation in the securities industry is riddled with conflicts of interest,” Ms. Roper said. “No one seeking to design a system to encourage sales practices in the investor’s best interest would come up with the system we have.”

The proposed mandate will give the SEC “the tools it needs to ensure that side payments or sales practices, or conflicts of interest, do not in fact interfere with investor interests,” Michael Barr, the assistant Treasury secretary for financial institutions, said at a July 10 press briefing on the legislative proposal. “That may be cold calling in terms of sales practices or other measures,” he said.

SEC Chairman Mary Schapiro is under pressure to beef up investor protections at the agency after its failure to detect the gigantic Ponzi scheme perpetrated by Bernard L. Madoff and for failing to detect catastrophic weaknesses in mortgage-backed securities. That may lead it to to be more aggressive in pursuing measures that investor advocates have been pushing for in recent years.

That has advisers concerned. “They’re asking to legislate morality from compensation,” said Sean Sebold, president of Sebold Capital Management Inc., a fee-only advisory firm in Naperville, Ill., that manages $60 million. “Are we going to have investment advisers that can’t sell products because of the commission structure even though they can be, in fact, good for the client?”

E-mail Sara Hansard at [email protected].