Financial advisers must have the confidence of investors

Must hardworking Americans become regulatory experts in financial services to feel confident that the person they turn to for financial advice has their best interests in mind and is properly regulated?

Obviously, the answer is no. In practice, however, and for far too long, it has been difficult for the average investor to understand the rules surrounding the person giving them financial advice. That may be changing.

On Sept. 13, an influential House subcommittee will hold a fact-gathering hearing on two important — but often overlooked by the public — components of implementing the Dodd-Frank Act: the Securities and Exchange Commission’s plans to establish a uniform fiduciary standard for all retail investment advisers and the possibility of creating a self-regulatory organization for investment advisers.

The Financial Services Institute Inc. will be a key witness at this hearing, arguing for a properly structured uniform fiduciary standard and in favor of the Financial Industry Regulatory Authority Inc.’s serving as the self-regulatory organization for investment advisers. Financial Services Committee Chairman Spencer Bachus, R-Ala., and Capital Markets Subcommittee Chairman Scott Garrett, R-N.J., should be applauded for leading this important exploration of the issues.

THE PROBLEM

Unlike registered representatives affiliated with broker-dealers, retail investment advisers currently operate under a patchwork of regulation, including disparate legal, examination and enforcement standards, creating regulatory gaps that leave consumers to sort out the distinctions, as if the majority of Americans could actually do so. While registered investment advisers are held to a fiduciary standard of care based upon broad principles of conduct, they may go years with little or no regulatory supervision. Registered representatives are held to a suitability standard of care supported by prescriptive rules and frequent regulatory supervision. Of course, most investors don’t know the difference between a registered representative and a registered investment adviser.

While much has been written about the SEC’s efforts to harmonize the standard of care for the protection of all investors, the regulatory-supervision gap has received far less attention. This leaves Americans at risk and must be remedied soon.

The current system includes variations in the number and frequency of examinations, which depend on an adviser’s regulatory affiliation and corporate structure, not the critical needs of investors. While broker-dealers can expect routine regulatory exams no less than every two years, investment advisers are examined a shocking once in 11 years, on average.

But perhaps most disturbing of all, “approximately one-third of advisers registered with the SEC have never been examined.” That fact came from Carlo di Florio, director of the SEC’s Office of Compliance Inspections and Examinations, in recent testimony.

The current regulatory disparity not only puts investors at great risk, it undermines investor confidence, which in turn jeopardizes not only the investment goals of millions of Americans but also the economy at large.

THE SOLUTION

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the SEC to conduct a study to review the need for enhanced examination and enforcement resources for investment advisers. The law also granted the SEC authority to establish a uniform fiduciary duty for investment advisers and broker-dealers, and the ability to create an SRO for investment advisers.

Together, these changes to the current regulatory structure, once implemented, will ensure that all American investors receive the same protections, regardless of whether they do business with a broker-dealer or an investment adviser.

The FSI believes that a new uniform fiduciary standard must be carefully designed so as not to put any particular business model or segment of the investing public at a disadvantage. Because our members’ relationships with their clients are uniquely personal, and their reputations are key to their success, it is essential that the new standard of care recognizes the differences between our members’ business model and those, for example, of large institutional investment advisory firms.

As a result, we have called on the SEC to ensure that the standard of care they mandate is carefully tailored to work for all business models and client relationships so that investors retain access to the broadest possible range of choices among financial service providers while gaining the protections they deserve.

Dodd-Frank’s objective of improving examination and enforcement, which seeks to correct a significant regulatory gap that exposes retail investors to possible harm, also is laudable. The FSI is concerned about the quality and frequency of examinations of retail investment advisers on the federal level, which is why the creation of an SRO and frequent examinations — already part of broker-dealer regulation — are critical.

Currently, state supervisory programs for registered investment advisers also are inadequate. They vary widely, and even the strongest state investment adviser examination program does not provide the level of oversight that broker-dealers currently receive.

While the SEC or a state securities regulator might examine an investment adviser, it is much more likely that the only oversight of an adviser’s activities comes from an internal compliance officer, who may be the investment adviser himself or herself. FSI believes it is simply unacceptable to allow a huge segment of the financial advice business to engage in self-supervision. As a government, and as an industry, we owe investors better than that.

For all those reasons, we believe that Finra — which has the proper funding and resources to function successfully as the national self-regulator of registered investment advisers — should be given that responsibility.

Now more than ever, with an uncertain economy and 79 million baby boomers starting to retire, all American investors must have confidence in the reliability of the investment advice they receive. A uniform fiduciary standard and an SRO for investment advisers will help provide that confidence for investors and, ultimately, much-needed confidence in our economy.

Dale E. Brown is president & chief executive of the Financial Services Institute Inc., the trade group of 124 independent financial services firms and nearly 28,000 independent financial advisers.