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MAKING CENTS OUT OF THE NEWS
Blog #25
(June 25th, 2009)
FINANCE RULE OVERHAUL: THE PRESIDENT'S PLAN
By Tom McAllister, CFP™
President Obama’s comprehensive plan to reform regulation of the financial markets has been called "sweeping", as indeed it is, potentially making significant changes in the regulation of many aspects of the U.S. economy.
"Federalizing" certain aspects of insurance, an industry traditionally controlled in each of the separate states, is a good idea. In my opinion, many insurance entities are far too large and too far-reaching to be regulated by a patchwork of state insurance commissioners. I suspect insurance companies occasionally choose to do business in states where they can overpower their own regulators.
Stricter regulation and site inspection for hedge funds is another part of the President's proposal I favor, in view of the widespread abuses recently uncovered in this area.
As a registered investment advisor and principal of a securities broker/dealer, I support the proposal to apply a fiduciary standard of client care. Putting "teeth" into the requirement of putting clients' best interests ahead of those of advisory firms is a measure long overdue. We Certified Financial Planner practitioners are required by our Code of Ethics to do this. In fact, I have operated as a fiduciary for more than three decades, ever since registering as an investment advisor with the SEC.
By way of clarifying the term "fiduciary standard", I will compare that to the lesser standard of "suitability" used by the large national broker dealers firms, such as Morgan Stanley Smith Barney and Merrill Lynch. By this suitability standard, investment recommendations have to be “suitable” given the current circumstances of the client.
In fact there has been a long-simmering debate between large stock brokerage firms and Registered Investment Advisors, over the fiduciary requirement versus the suitability standard. My view is that when selling or buying an individual security for a client's account, the suitability standard is sufficient to protect the client's interest. However, when a firm or an individual adviser is given the discretion to purchase and sell securities within clients’ accounts, that calls for a fiduciary role by the investment manager and any broker involved in the account. It appears the Obama administration agrees.
In the process of changing the rules, some ambiguity persists. Securities and Exchange Commission Chairman Mary Shapiro suggested that brokers be required to disclose any departures from the fiduciary framework should they engage in such departures. Implicit in that comment was the idea that it would be impractical to hold brokers to a fiduciary standard 100% of the time.
Knowing the mechanics of investment transactions as I do, I can envision instances in which exceptions might be made, but in which disclosure would nonetheless be needed.
If a firm is underwriting or making a market in a security, that security might well be a very appropriate holding for certain investors' managed accounts. However, the brokerage firm would be making a second profit on the transaction (one profit on the underwriting or market making, one on the management fee). Building a “Chinese Wall” between the investment managers and the underwriters and market makers could be an answer to this conflict, but in the absence of such a division, the conflict should be disclosed at the time of the transaction.
While I consider myself a believer in the free market, I have come to believe that a heavier government hand in the financial arena might turn out to be a good thing.
With all the rapid changes in our economy and in the investment markets, there are many investors who would benefit from more consistent guidance. We are currently accepting new financial planning and investment clients, and would appreciate your referrals.
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