Where do we go from here?

The following is an edited transcript of the InvestmentNews Regulatory round table, in Washington, Jan. 21. The discussion involved Dan Barry, David Bellaire, Kevin Carroll, Rep. Scott Garrett, R-N.J., Marilyn Mohrman-Gillis, Patricia Struck and David Tittsworth. It was moderated by assistant managing editor Robert Hordt and Washington bureau chief Sara Hansard.

InvestmentNews: Should adviser regulations be harmonized, and if so, how?
Mr. Tittsworth: The right question is whether harmonization is necessary at all. It’s a word that has crept into the lexicon of a number of different people — and not one that I particularly like, for what that’s worth. It seems to be a code word for imposing broker-dealer rules on investment advisers, not the other way around. Maybe I have a misperception about that, but that seems how it is used in most contexts. The right question is: What are the appropriate regulations for any activity? If people are doing similar things, they should be treated the same way under the law and under the applicable regulations.
Mr. Barry: Harmonization is sort of in the eye of the beholder. I think we are all roughly in sync on what David said, in that like services should be regulated in a like manner. I haven’t checked Webster’s dictionary lately, but I think harmonization kind of gets to that. It is not saying it shall be exactly the same down to detail. But it is harmonizing in the sense that it is coordinated and sensible and makes beautiful music to your ear, I suppose. But if you start digging down and asking for the details of what are they going to do to create harmonization, that’s where we all probably go to separate corners and see things a little bit differently.
Mr. Carroll: I think you start with the premise that the brokerage industry and the advisory services industry have converged to some extent and that there are brokers and advisers providing identical services — first-line investment advice — to customers.
If you accept that finding, then it would make sense that a consistent standard should be applied to both when they are doing the same thing for investors.
The Rand [Corp.] study [conducted for the Securities and Exchange Commission] found that investors were confused about what particular role their financial professional was serving in, whether it be an adviser or a broker-dealer, and that the regulatory system might benefit from harmonization in that respect.
Ms. Struck: It is not just that customers are confused. What the Rand study also showed us was that the way [different sets of] investment professionals characterize what they do and what kind of relationship they plan to establish with their investor clients is really the same in many cases.
“Harmonizing regulation” is an appealing-sounding term, but I think it assumes something we really haven’t agreed on. It sounds as if it has to be a lowest common denominator. I think we need to be very careful about that.
When you talk about a standard that applies to the same services, we have to be very careful to make sure that it is a high enough standard to give investors the protection that they think they are getting and are really entitled to.
Mr. Carroll: Not to get ahead of the conversation, but the concept of harmonization, at least from our perspective, is not just that the regulatory regime be a consistent, uniform regulation applied to both sides but that it be enforced and examined in a consistent and uniform manner.
Mr. Bellaire: Whatever standard is finally agreed upon needs to be backed by some rigorous examination and enforcement. And we have real concerns about the various proposals that are out there to do that.
To do anything else, to offer a heightened standard, and not examine and enforce, is really to offer investors a hollow promise. I don’t think any of us want to see a regulatory system that misleads investors by talking about high standards and then not verifying that people are living up to them.
InvestmentNews: What would be the impact of bringing brokers under fiduciary standards? And should fiduciary standards change so that you can have a more common system?
Ms. Mohrman-Gillis: From our perspective, whether harmonization will work depends on the standard that is applied. The fiduciary standard applied to advisers under the [Investment] Advisers Act [of 1940], which is a principles-based facts-and-circumstances standard that has been in existence for almost 70 years, is the standard that we believe should be applied to broker-dealers who are providing investment advice.
InvestmentNews: Congressman Garrett, do you think that the regulations need to be harmonized, and if so, what is the best way to do it?
Mr. Garrett: Can’t you all just get together on this?
You all are familiar with where we are in the process. We have heard quite extensively from the relevant groups during the last six to nine months on the topic. There are arguments going both ways as far as the inability to harmonize them relative to their own individual unique quality and nature, both with regard to services and to compensation and the like.
Where we are now is obviously some degree of compromise on that. Where we eventually end up, I don’t know. I’m curious as to whether that is actually going to be one of the pressing issues that we eventually will resolve in the final legislation.
I would guess it is probably lower down on the agenda today; I don’t think harmonization was in [the Obama administration’s new] proposal.
InvestmentNews: The Senate Banking Committee’s Dodd draft eliminates the broker exemption from the Investment Advisers Act and says that if you are a broker who gives any type of advice, you must register as an investment adviser. That’s not the way the House bill reads, of course. What would be the impact of the Dodd draft? Could brokers live under that standard?
Mr. Tittsworth: State regulators, some consumer groups and financial planning groups and our organization representing investment advisers put out a myths/facts piece a couple weeks ago about the [discussion draft from Sen. Christopher Dodd, D-Conn.]
I think the key point is that while the Dodd discussion draft removes a broker-dealer exclusion under the Investment Advisers Act, it doesn’t mean that every broker-dealer is an investment adviser; it means that if a broker-dealer meets the requirements of what an investment adviser is — that is, a person who is in the business for compensation of rendering advice regarding securities — [he or she is] subject to the same laws and regulations as other investment advisers.
The draft also gives the SEC broad authority to exempt people or activities that it believes are consistent with investor protection and other provisions of the Investment Advisers Act.

DODD DRAFT ‘CLEANER’

So it isn’t like it is just some broad, sweeping, change-the-universe type of an approach. I think it makes a lot of sense, and it is a cleaner way, perhaps, of dealing with these issues than the House bill, which involves various SEC rulemakings and adds some complexities that the Senate approach doesn’t.
Mr. Garrett: Where it all began was more Draconian, trying to figure how we should do this from Congress’ perspective.
Mr. Carroll: The Dodd approach does not work for the brokerage industry. It goes too far.
You have to start with fundamentals. First, does the fiduciary standard, the status quo standard under the Advisers Act, work well? The answer is no, it doesn’t. It is unevenly applied. It is not definitive enough. It is state-by-state. Courts are the ones that decide how or whether it is applied. That’s why SIFMA has called for a federal fiduciary standard [for] when brokers provide personalized investment advice to individual clients, because it would represent a better standard and better protection for investors. It would be codified, regulated and applied by the SEC in a manner that the status quo fiduciary standard for advisers is not.
The fact is the status quo standard is not examined to the extent brokers are examined extensively under SEC and [Financial Service Regulatory Authority Inc.] rules. It is not enforced as evenly.
We need to do better for investors. That’s why we have made the proposal that we have. I think it does represent that better choice.
Mr. Tittsworth: I happen to respectfully disagree with my good friend representing the brokerage industry.
Number one, it is absolutely false to say that the fiduciary standard under the Advisers Act isn’t well-established or definitive. Since 1963, Kevin, there has been a Supreme Court decision, Capital Gains Bureau v. SEC. It definitively said there is a fiduciary standard that goes back to common-law principles. It has been in case law for years. I can cite you the TransAmerica [Corp.] case, other subsequent Supreme Court decisions that refer to the federal fiduciary standard.
It is absolute nonsense to say that the Advisers Act fiduciary duty is not definitive enough. Where there has been uncertainty is on the broker-dealer side as to whether or not a broker-dealer does certain things to go beyond the suitability standard that is the basic facts-and-circumstances standard for brokers and become somehow a fiduciary. And that is a more inconsistent application.
Every investment adviser registered with the SEC or the states has a fiduciary duty. It is absolute nonsense to say that people don’t understand what that fiduciary duty is. It is well-established. And that’s what should be applied.
So the idea that their fiduciary standard is some sort of amorphous term and all the states interpret it differently is absolutely false.
Mr. Bellaire: I would like to respond to that.
InvestmentNews: For the congressman’s benefit: Mr. Bellaire, most of your members are actually dually registered as broker-dealers and investment advisers, right?
Mr. Bellaire: That’s right.
Mr. Garrett: You should be sitting in the middle.
Mr. Bellaire: We definitely have perhaps a unique perspective of operating under both regulatory schemes. So we are keenly aware of the strengths and weaknesses of each. But I disagree with much of what David [Tittsworth] just had to say.
In the piece in which some of the groups at the table tried to point out what they labeled as “myths” about the opposition to the application of the ’40 Act fiduciary duty to all market participants, they characterized the exemption under the ’40 Act as a regulatory loophole. Nothing could be further from the truth. It is part of the ’40 Act, and it has been in place for 70 years.
As a result, it is hard to call something like that a regulatory loophole. It was, in fact, Congress’ intention to allow registered reps and broker-dealers to offer advice that is incidental to the transactions which they are recommending to investors.
The fiduciary duty under the ’40 Act isn’t all it is cracked up to be. We hear over and over again that the fiduciary duty obligates an investment adviser to do what is in the best interest of their clients. That is not true. What the fiduciary duty obligates someone to do is what’s in the best interest of their clients unless they disclose through their contract or their Form ADV that they are going to do something else.
Bearing that language on Page 15 of the Form ADV, which is not a document that is easy to read, is not an effective disclosure.
So what we have is a bumper sticker definition that is used to convince investors that they have significant protections, when, in fact, they do not.
Another aspect of this, under the Finra rules that broker-dealers are held to, we often hear that this is a debate between fiduciary [duty] versus suitability, and that’s not a fair comparison.
Fiduciary is a broad concept that applies in a whole bunch of different areas, not just the recommendation of a product or a service. Suitability is one rule in a large rule book, and it deals with recommendations.
The real fair comparison is fiduciary versus the concept of just and equitable principles of trade, which is the first rule in the Finra rule book. And my argument is that those two concepts are not all that far apart.
Under Finra rules, investors are guaranteed a whole host of things that they don’t get under the ’40 Act. First of all, their financial adviser will have passed qualifying exams that demonstrate their knowledge and experience. An SEC-registered adviser doesn’t have to pass any qualifying exams.
Under Finra rules, you have to participate in ongoing continuing education to demonstrate you know what’s going on with regulatory requirements, changes in products and other things that are relative to your clients. That’s not a requirement of investment advisers.
In addition, if you are affiliated with a broker-dealer, your advertising will be reviewed by the brokerage firm. Some of it will go off to Finra for their review and approval and comment. So there is a check and balance in that advertising, which is a main source, of course, of how clients come in and start to work with folks.
On the adviser side, there is no review like that. The investment adviser —
Mr. Tittsworth: There are plenty of rules on advertising under the Investment Advisers Act.
Mr. Bellaire: Yes, and the person that enforces them is the registered investment adviser.
Mr. Tittsworth: You are right that there is no federal qualification test, but most investment advisers are highly educated. They have all sorts of requirements. Many of them have designations —
Mr. Bellaire: I didn’t interrupt you when you were speaking. If you would let me finish my thought.
Mr. Tittsworth: I understand, but this is a fairly long series of things. I thought it might help to talk about some of them before we get too far along.
Mr. Bellaire: I appreciate that. I would like to finish my short list. Just a few items more.
Mr. Tittsworth: A few more?
Mr. Bellaire: Three, in fact, but I could go on. We have net-capital requirements. We have fidelity bond requirements. We have in certain product types, like variable annuities, a standard which I would say is even higher than what an adviser would be held to.
So if we adopt the Senate approach of simply making what is a simple and elegant little change, what we do is, we abandon a bunch of protections that investors already enjoy when they work with a registered rep of a broker-dealer or a dually registered firm.
So I think it is unfair and inaccurate to describe the fiduciary duty under the ’40 Act as always a higher standard or to describe the fact that broker-dealers have for a long time offered incidental investment advice as a regulatory loophole.
Mr. Barry: I wouldn’t dispute any of the rigors you are talking about for securities regulation. It is there for its own reason, because it is about keeping the markets fair and operating properly, as well as [about] investor protection.
You seemed to suggest, though, in describing the fiduciary duty that if an adviser simply provides a Form ADV, then they don’t have to worry — that they are pretty much protected from a lawsuit [resulting from not] applying fiduciary standards.
I don’t think that’s the case. While I think that is a factor that can be considered in disclosure, it is hardly a blanket protection if you are not acting in your client’s best interest. If that is all it took, I think brokers would be beating down the door to say, “Yes, give us that standard; all we have to do is hand over the ADV.” So I dispute that a bit.
Clearly, there are different regulatory structures and standards. What we’re talking about here is trying to bring them onto the same page for the same services. I think that the brokerage industry’s approach on that makes sense for them and at best solves half the problem.
What we are trying to do here is so-called harmonization, at least on fiduciary duty and getting the same standard. That obviously would be raising the standard that brokers currently operate under.
Over and above what they are currently doing, from a regulatory perspective, they have to act in the best interest as opposed to mere suitability. The industry has come a long way towards accepting a higher standard. And that’s all well and good.

WHAT SERVES INVESTORS?

Ms. Struck: At the state level, [any individual] giving investment advice has to go through a competency exam or has to have some kind of designation which provides the same protection for investors. After all, isn’t that why we are all here? Aren’t we here because of the people that we want to protect — that is, the investors?
If you are a person that characterizes yourself as entering into a trusted relationship with investors, then what you ought to be able to do is to step up to the plate and say, “I am going to undertake always to put your interests ahead of mine, always to do what is in your best interest.”
Mr. Carroll: You actually tied in to what is a core tenet of SIFMA’s position — that we should remove the fiduciary issue from the vagaries of state common law and put it in the hands of the experts who regulate in this area, the SEC. Fiduciary is not regulated by the SEC. It is drawn from the same provisions in the ’40 Act, the anti-fraud provisions that are identical in the [Securities] Exchange Act [of 1934].
A court could look at the Exchange Act provisions and say it is identical to the ’40 Act and say, “Oh, there is a fiduciary provision there.”
Ms. Struck: I don’t think you will ever find a state regulator talking about the vagaries of state common law.
Mr. Carroll: Right. States regulate to avoid that as well.
Ms. Mohrman-Gillis: State common law has been regulating fiduciary duty and the application of the fiduciary duty to professionals across the board, not just in the advisory realm.
Going back to your concept about your three principles, I think at the core, we are talking about a principle-based standard that is applied in facts and circumstances. There is 70 years of application of this in the advisory context. And the notion of creating a new federal statute that would identify new principles, slightly different principles that would then have to have another 70 years of interpretive action after that, one could really argue that that creates more disruption, more confusion in the industry than applying the well-established principles-based standard.

Mr. Carroll: We are not talking about a start-over. If you look across the 50 states, the state of fiduciary law is in disarray. The legal commentators, the folks who have done the research — and I have done it myself — [say] it is a mess.
Let’s take the common law of fiduciary, and let’s codify it and continue its development in the context of SEC enforcement actions, administrative proceedings in court. But let’s put it back with the agency it belongs with, the SEC.

Mr. Tittsworth: Codifying fiduciary duty is like providing a road map for wrongdoers, Kevin. I would be happy to exchange law review articles or get some of our legal experts on both sides together and let them hash it out.
There is a federal fiduciary standard. You have a definitive Supreme Court case.
Just because the word “fiduciary” is not in the statute, you can’t erase this Supreme Court decision that came out in 1963 and has been consistently applied by the state courts, by the SEC, which is our principal regulator, and other federal courts. The Supreme Court has called it a federal fiduciary standard in the TransAmerica case.

REGULATORY STALEMATE

InvestmentNews: Congressman, you indicated earlier that you don’t think this harmonization issue might make it into the final reform legislation.
Mr. Garrett: I’m usually the optimist, but [in the current atmosphere of partisanship] I’m not as optimistic that we will achieve any of what we would see as some sort of reforms that we need in the area.
This issue, because it was not totally fleshed out and we didn’t have all you guys sitting in the room saying, “We are all on the same page,” this can sort of be pushed off, which is a good thing.
It is a good thing from a politician’s point of view, because I know where you all are and that you would like to just say, “Let’s get to that point and get it done.” But we have to deal with you people after it is all done next year too.

[But] by setting up sort of a federal regulatory structure to implement that, you are not addressing half the problem. [When] the customer goes in [and] gets investment advice, they should be able to expect the same standard no matter who is giving them the advice. I think this approach still will result in a dual standard, maybe a higher one for brokers, but you would have a different one for independent investment advisers and brokers.
Mr. Carroll: The brokerage industry has come a long way. What we are suggesting today is an improvement over the existing fiduciary standard.
You can’t say that the fiduciary standard is uniformly applied and evenly applied, because it depends on the state’s common law. The fiduciary standard will be applied differently in a Utah state court than it is in a Maine state court. There are lots of examples of that. We cited that in our testimony in both July and October of this year.
So when you show up to the reg-reform debate with nothing but the status quo in your briefcase, it is hard to accept that you are serious about protecting investors.
The long way that we have come is even further than the fiduciary standard that is currently in place. If you have the SEC rulemaking about it and enforcing it and examining for it, you will have a better regulatory regime than we have today.
InvestmentNews: Congressman, what do you think on this issue? The House bill passed with no Republican support. If there is going to be regulatory reform, won’t Congress have to deal with this harmonization issue? What do you think of the House provision?
Mr. Garrett: I’m not sure this ends up in anything anyway this time around. I guess that’s the major issue. So this is all just good discussion for next time.
To your point, Mr. Bellaire, would you suggest that the potential middle ground is simply a change in disclosure to address that problem?
Mr. Bellaire: In part.
Our idea, which is a little different than what you have heard from Kevin and SIFMA, is that we develop three basic principles that would be provided to all investors — whether they are working with a broker-dealer or an adviser — on a 3-by-5 card that could simply say, “Here are the basic obligations of the [investment] professional.”
Then we let the SEC take those principles and apply them to the unique business relationships [that] exist between broker-dealers and their clients, and [between] advisers and their clients. So in these two different contexts, the principles may be applied and interpreted in somewhat different ways, but the same basic responsibilities exist.
One of the reasons we see that as beneficial is that the history of the advisory business indicates that there are certain account minimums which are required to make it profitable for an adviser to work with a client. And that prices a lot of people out of the market.
The Senate bill, we are afraid, would have that unintended consequence.
We think our approach allows for existing business relations to continue, but on perhaps a new and perhaps somewhat heightened standard.
Mr. Garrett: It wouldn’t necessarily be a heightened standard. Would you agree?
Mr. Bellaire: It is hard to see these standards as monolithic ideas.
Mr. Garrett: You guys all are intimately involved. One of my first meetings was to explain what the actual standard is. I’m a lawyer, but I do slip-and-fall cases.
Ms. Struck: It is kind of the same thing. It is all facts and circumstances.
Mr. Tittsworth: And whether you are talking about fair dealing or fiduciary or suitability, there are a certain amount of facts and circumstances that go into every one of those. Would you agree with that?
Mr. Bellaire: I would.
I note in your paper that you put out about myths and so on, one of the ideas in there which you use to respond to some of the industry concerns is that an adviser can define the scope of their relationship with a client. I think that absolutely happens. That goes to the point that I was raising earlier, that if I can define the scope of my relationship through contract and disclosure and form, then I can also change that standard, and that applies in very important, critical ways that a client isn’t aware of.
Mr. Tittsworth: That is not at all what our paper says. I would be happy to read it to you.
To say that disclosure is always buried is an unfair characterization. It could be buried on a 3-by-5 card as well. It sounds very simplistic to hand some person a 3-by-5 card and somehow all these problems are going to disappear.
Part of fiduciary duty is appropriate full and fair disclosure. So bearing that does not meet that standard. So I respectfully disagree with your repeated characterization [that] advisers are just bearing this.
Going to the business models, we think that the fiduciary duty allows for all types of business models and choices, and investors have a range of services that they can get from various investment advisers.
Financial planners provide different services than I think what you were referring to, David [Bellaire], as kind of the core wealth management model might be the words, not defined under federal law.
Institutional management, as you well know, has some different business aspects to it and maybe the retail setting that has sort of been the primary focus of the Congressional or policy debate that’s going on.
But fiduciary duty, I think part of it is that it is flexible enough, and it doesn’t mean that in all cases, for example, you have to provide discretionary, ongoing portfolio management services.
You can be a fiduciary. Many investment advisers, including members of our organization — I imagine some of yours — provide non-discretionary service, advisory services. Those are two different services.
So non-discretionary is a historically brokerage relationship where I have to call you, my client, to say, “Hey, I want you to buy 100 shares of X, Y, Z,” and unless you say OK, I can’t do it.
Discretionary, which is the typical investment adviser and wealth management model, certainly, that’s usually the agreement upfront, and I have the authority to make investment decisions on your behalf.
I want to make one other point before I forget. [Mr. Bellaire] talked about net-capital requirements and suggested that that somehow makes brokers better for investors. The reason there are net-capital requirements for brokers is because brokers have custody of funds and securities of their customers.
In the vast majority of investment adviser situations, the basic model is that you do not have custody of client funds. That is a big difference, and that’s the reason we don’t have net-capital requirements for investment advisers. It doesn’t make sense to impose that on investment advisers.
There are plenty of other requirements.
You didn’t talk about codes of ethics for brokers, [something that is] required for investment advisers. You didn’t talk about designating a chief compliance officer and having annual reviews, also required of all investment advisers.
You talked about advertising. I jumped in because there are lots of requirements.
I actually think the investment adviser rules for advertising are in need of great reform, but not because it doesn’t protect investors or because it doesn’t have pre-review that the Finra rules provide but because there are 100 no-action letters that are difficult to decipher.
Ms. Struck: I’m afraid we are going to run out of time on this particular question. I wanted to add another thing. It is almost a shame that we don’t have here a laptop so we could project a picture of the Form ADV and what is disclosed on [the Investment Adviser Registration Database]. I think if we had a picture, what you would see is that is about the easiest disclosure. To me, that is the model for the way information should be disclosed.
The way most people today are able to access disclosure is online. And it is very comparable across the board to anybody engaged in that kind of business. To say that it is not clear disclosure is probably not a fair characterization.
I also wanted to mention a couple things that we are not taking into account in terms of qualifications of individuals or people giving investment advice, people who are investment advisers.
Ms. Mohrman-Gillis: Congressman, in terms of the extension of the fiduciary standard of care to those who provide investment advice, my sense is that there actually is more commonality across the various industry groups on the big concept that there should be a fiduciary standard applied.
My understanding is, the brokerage industry has embraced the concept of a fiduciary standard. The dually registered folks have embraced it. Certainly, financial planners, investment advisers, the consumer groups, [SEC Chairman] Mary Schapiro [have done so]. So there is a lot of commonality there.
Mr. Garrett: Is there a “but” coming?
Ms. Mohrman-Gillis: The debate which you heard [here] is: How do you define “fiduciary standard,” and should it be a new SEC-defined federal standard or should it be the principles-based standard that has been applied under the Advisers Act?
I still think that there is general endorsement of that concept that came out of the administration’s proposal initially. The one industry that is saying, “Stop, put the brakes on; let’s study this,” is really the insurance industry. They are isolated on that point. I don’t think that they should be standing in the way of Congress’ embracing the fiduciary standard of care for the delivery of advice.

Mr. Garrett: How do you embrace it without addressing the whole piece at one time?
Mr. Tittsworth: We wouldn’t be talking about any of these issues in a legislative context were it not for the [Bernard] Madoff scandal.
Going back to whether or not there is a need for regulatory reform, and we all have various views on that, but to me, the core issues are trying to address the financial crisis that occurred in 2008 and the subprime mortgages and the securitization of those mortgages and the improper use of leverage.
[Congressman], I’m not wise enough like you to understand what the real solutions to those may be. But I totally agree with you. This is down a pecking order, as much of an interest as I may have or my members may have in this. I don’t think the fiduciary duty and SEC resources are going to be the decisions that are going to decide whether there is going to be a financial services regulatory-reform debate.
While I’m agreeing with the congressman, I also want to agree with my good friends in the brokerage industry. Apart from some of the issues on which we expressed some disagreement, I totally agree that SEC resources should be adequate to inspect investment advisers. And they are not today.
There are a whole range of things, and the House bill actually, in my view, kind of goes overboard on giving the SEC more resources than it would ever need to inspect investment advisers.
But I think we do agree — or at least [Mr. Bellaire] and I agree — that Finra as a self-regulatory organization is not the answer.
Mr. Bellaire: Can I just contradict a little bit? I don’t want my organization’s position to be characterized.
Where we agree is [that] there needs to be more resources directed to adviser compliance. How those are allocated [and] who performs the functions may be areas where we disagree.
Mr. Carroll: I agree that the House version on fiduciary and the Dodd committee print on fiduciary are irreconcilable.
To the extent study would be called for to help figure out how to bridge that gap, it is hard to oppose that.

MORE SEC RESOURCES

Ms. Struck: I just wanted to add a comment on regulatory resources.
NASAA’s view is not so much that the states should take power away from the SEC; actually, NASAA’s position — [one] that we voted on as an organization — was that resources should be increased for the SEC so that, as to those advisers that they regulate, they can do their job more effectively.
As to state regulation, though, we should probably be going up to [a threshold of] $100 million in assets under management. We should have probably rather than the current 60% of all advisers under our jurisdiction probably closer to 70%.
That would be a fairer allocation of the regulatory burden. And as to a self-regulatory organization, Finra or any other, that’s not the appropriate way to regulate the advisory activity.
For what it’s worth, I wanted to mention that Finra has done a fantastic job with helping create a resource, the [Investment Adviser Registration Depository], as well as [the Central Registration Depository], that makes information so available to investors. I think a lot of us have forgotten the days before that resource existed.
If you haven’t gone and looked at what is available on IARD, you should do that. That is really a fantastic resource. But does that make Finra a good regulator for this industry? I think it is apples and oranges.
Mr. Carroll: There is a public version, BrokerCheck, that anyone can go on and check out a broker. Is there an adviser check?
Ms. Struck: Yes, because everything is public on IARD.
Mr. Tittsworth: You go to the website Patty [Struck] is talking about and put in “Carroll Investment” and the Form ADV comes up, your business address, your phone number, the principals in the firm, disciplinary history, assets under management.
Mr. Bellaire: Can I ask you a question, Patty, about state jurisdiction over advisers?
I don’t doubt in any way, shape or form the sincerity of the state regulatory authorities to take on that role. But both the House and the Senate bill have the means to provide more funding for the SEC. Neither of them provides more funding to state securities divisions.
InvestmentNews indicates that under the Senate bill, we would have 4,200 new advisers coming to the states, and the natural result of that would be, more people would become investment advisers under the Senate bill. So the burden you could expect would be 4,200-plus.
How do you envision state securities administrations getting the resources to do that?
Ms. Struck: What you would want to look at first of all is what states are doing now.
One of the things states are doing now is, on an average, doing exams of the investment advisers in their states once every three to five years. Compare that to the SEC record, [and state examination] is infinitely more frequent.
And in addition to doing those frequent exams, we also are in constant communication, because you picture how investment advisers are all located; they are all in states. That seems a simplistic way to depict it.
There is one SEC with a few regional offices. But every investment adviser is located in a state. Almost every state has an exam and regulatory program. Every state has an education and outreach program.
Let me give you an example. In my state, we have something between 250 and 300 advisers. We would have around 400 under the new scenario. We get out and examine once every five years at the least frequent, perhaps a little bit more often.
We would simply build in a little bit more emphasis on the advisory function than on the broker-dealer exam function. In other words, states are prepared to take on that responsibility. As I think anybody who represents brokers or investment advisers knows, we know how to get our fees in the states.
Mr. Bellaire: My understanding [is that] there is something like 15 states that don’t have a routine exam program at this point.
In fact, New York state under the Martin Act doesn’t have the authority to conduct those types of exams. That is particularly relevant when you have Madoff and Cohmad [Securities Corp.] and so on in the state of New York that led to so much trouble.
What efforts is NASAA going to give should you get this newfound authority to address those 15 states, especially New York?
Ms. Struck: I think that 15 might be high. There are some, but I don’t think 15.
You mentioned a really good example, New York. Then you mentioned the Madoff example, and there we are not talking about state advisers in the first place.
Mr. Bellaire: But [Mr. Madoff] operated a broker-dealer for years in the state.
Ms. Struck: Right. We can’t necessarily assume that most states even have exam programs for broker-dealers. I think they have them for investment advisers.
Mr. Bellaire: Do you think investors are aware of that?
Ms. Struck: That’s a really good question. I think investors are becoming a lot more aware of that.
InvestmentNews: Mary Schapiro said in December that “all securities professionals” should be subject to the same standards of conduct, the same licensing and qualification requirements, the same disclosure obligations, the same regulatory and record-keeping standards, and a “robust examination and oversight schedule.”
Should there be just one license for anybody who gives advice?
Ms. Mohrman-Gillis: I was there. What I heard [her say] was as a consumer, if you are walking into a storefront and you happen to run into a registered rep first before you run into an adviser, and you are asking for and getting the same services, it shouldn’t be the registration that distinguishes the type of service you get, number one, or the duty of care that you are owed as a consumer.
That was the principal point that I heard her make — and very strongly — on the notion that the same duty of care should apply to the delivery of similar services, regardless of the registration held by the financial intermediary.
Mr. Barry: When we were talking earlier about harmonization, it was — pretty much to a person — about regulating the delivery of services, like services in a like manner.
That gets to the overarching principle, which is what the consumer can and should be able to expect when they walk in the door, no matter whose door it is. Whether the regulations and licensing should be exactly the same, I’m not sure that matters so much to the consumer if they are getting substantially the same protections, and they are getting a fair marketplace in which to get those services.
I think that’s the bottom line for them, and that should be the overarching principle.
Ms. Struck: As it affects individual investors, I think that is true.
When I think about being the person who gets the complaints first before they get funneled out to investigators and examiners, the typical complaint I get is, an individual investor walked into a broker’s office in, say, Watertown, Wis., and was assured that this person was going to give him investment advice and was going to place the trades for him and was then going to watch the person’s account over an undefined period of years, and that’s what the client expected.
And then when it didn’t work out that way, when he didn’t get that kind of ongoing supervision of his account, he was surprised.
Why was he surprised? Because people make promises, and they don’t keep them. And they will do a lot to get the business in the first place, but perhaps as time goes on, they are not as interested in doing what they promised they would do.
That’s the typical complaint that I get. I think that probably would be relieved by creating that fiduciary standard that would apply to the individual selling the product who also was giving investment advice on the front end — if that person had a fiduciary standard. That would be, I think, what the investor going in there in the first place thought they were signing up for.
Mr. Carroll: I think to the extent that Ms. Schapiro suggests there might be additional opportunities for harmonization beyond fiduciary, there is probably some truth to that.
To the extent she is suggesting that there should be standardization whenever financial professionals are doing the same thing, there is some merit there. But we are concerned that broker-dealer firms have a business model such that providing personalized investment advice could be a very small component of it.
There are large segments of that business model — that don’t involve providing personalized investment advice — that should not fall under an Investment Advisers Act, and need to be kept separate from it.
That’s, I think, one of the big problems we have with the Dodd proposal. It doesn’t seem to recognize that to the extent it needs to.
Mr. Tittsworth: Part of the import here is we have mainly been talking about the legislative debate on Capitol Hill so far, and I think maybe all of us would agree there is a fair amount of uncertainty about how that is going to turn out.
What this speech by Chairman Schapiro tells me is that as chairman of the relevant agency, she certainly has some strongly held feelings about harmonization — for lack of a better term — of broker-dealer and investment adviser regulation.
So it is standard of conduct. And — I don’t want to reopen the fiduciary-duty debate right now — but [it is] the same licensing and qualification requirements you were talking about, the same disclosure obligations, Form ADV, 3-by-5 card, the same regulatory and record-keeping standards, and robust examination and oversight schedule.
That could be read as basically everything. Maybe somebody can elucidate on whether there is a plan, but part of what is going on is that Chairman Schapiro and others at the SEC are watching what is happening on Capitol Hill. But no matter what happens on Capitol Hill, I think there are going to be some regulatory implications, especially for people that we represent, federally regulated investment advisers. So it will be very interesting to see exactly what they come out with.
InvestmentNews: What should be done on 12(b)-1 fees?

Mr. Bellaire: This is a key issue for our membership. We would agree with the fact that the 12(b)-1 name for these fees is hardly transparent and should be improved.
Investors should have at least a chance to be able to figure out what it is. But simply abolishing 12(b)-1s would have wide-ranging and unintended consequences. They are the mechanism by which we attempt to ensure that a financial adviser affiliated with a broker-dealer has an ongoing desire to support and service a client account.
They provide that financial incentive, and that is essential to ensuring that investors get a perceived service. And that’s extremely important.
We have had a great example here over the last few years in that the incidental advice that a financial adviser who is paid through a 12(b)-1 provided was so important to many investors who may have been tempted to sell their mutual fund portfolio at the bottom of the market and then miss the growth we have experienced.
The financial adviser is compensated to service that account and provide the incidental advice that says, “Hey, hold on. The history of these market downturns is that there is sometimes a swift uptick in the economy and in the market, and you don’t want to be on the sidelines for that.”
The 12(b)-1 fees have helped to ensure that many investors got that kind of help and support that helped them avoid huge mistakes that inexperienced investors would make.

401(K) RESTRICTIONS

InvestmentNews: A bill approved by the House Education and Labor Committee in June would set serious restrictions on investment advisers’ giving advice on 401(k) plans and try to limit fees or improve disclosure on fees. Do you think that’s the way to go?
Ms. Struck: Where in the very near future more harmonization is going to be appropriate — necessary — is in the area of the people that give advice to us on our retirement assets.
That’s something that nobody talks about. And I think that in the next five years, that will shape up as one of the top issues for all of us in this room.
Mr. Tittsworth: I suppose that in terms of Capitol Hill, it is one of the anomalies that [issues involving the Employee Retirement Income Security Act] and Department of Labor are [covered] in the [House and Senate committees dealing with education and labor]. You have securities issues in the Senate Banking and House Financial Services Committee.
So I think that only exacerbates the lack of coordination sometimes on some very important issues that you highlighted, Patty.