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Compliance Reflectors

One thing you may not know as an investor: Almost everything your financial advisor says or does is guided by the ever-evolving regulatory environment in which we operate. And, as you may have gleaned from the media, there’s a lot of introspection going on in that area at the moment. The Great Recession officially ended almost exactly two years ago, but nobody wants to see it recur anytime soon. To that end, enter the regulators.

Having served as a Chief Compliance Officer (CCO) for a number of years, I am a strong proponent of financial regulation — both what it has been and, with some measure of optimism, what it appears to be evolving into. To give you the bird’s eye view, under existing regulations, there have been two broad types of financial intermediaries – fiduciary advisors (such as I am) and broker/dealers.

Fiduciary advisors’ business is to dispense investment advice. As such, we are subject to fiduciary duty, and must act with the utmost good faith in our clients’ best interests. For example, if I were helping a client choose between two mutual funds and the only substantive difference was the cost, I would be legally obligated to advise that client to select the lower-cost fund. Fiduciary advisors are currently regulated by the SEC or by the state(s) in which they do business

Broker/dealers’ business is to place trades – to buy/sell products on investors’ behalf. Any investment advice they dispense is considered secondary to this core function. Because their advice is considered incidental, it need only be “suitable.” This means they can recommend the higher-priced fund in the above illustration (and if it earns them a higher commission, they just might), as long as it is suitable for an individual investor’s portfolio. Broker/dealers are regulated by FINRA.

To quote Walter Cronkite, that’s the way it was. Today, as the industry assesses how to improve itself, almost all bets are off. Up for discussion are a number of variations on the theme of The Way We Were, such as:

  • Should everyone dispensing any investment advice, whether primary or incidental, be subject to the same fiduciary standards?
  • If so, will those standards be “relaxed” to allow transaction-based financial professionals to continue earning sufficient commissions for their labors?
  • Who should regulate whom, and under what circumstances? What are the best roles for the SEC, FINRA, state regulators, self-regulating organizations (SROs), and any new bodies that may be formed?

In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act tasked the SEC with studying our current standards of care and reporting their proposed rulings for reform to Congress. Those reports were submitted earlier this year, with the SEC recommending universal application of fiduciary standards and continued consideration regarding appropriate regulatory agencies.

In short, the tale is not yet told on the specific details of reforms to come from the Dodd-Frank Act and the SEC’s rulings. But from what I’ve seen so far, I’m hopeful about what the future holds. In my opinion, while the functional realities don’t always march in lock step to our industry’s best intentions, proposed reforms are see-sawing ever more closely toward achieving what I see as their key function: to ensure that you, the investor, are best positioned to make objective, well-informed decisions about your wealth.

That’s NOT to say that financial regulations are meant to guarantee that you’ll get rich, or that you’ll even break even. Rather, they help ensure that, if you do lose money in the markets, it will be with your full understanding and informed acceptance of the risks you’re accepting and the prices you’re paying to participate.

Recently, I read a trade journal article assessing the overall winners and losers in these ongoing discussions. I found the article’s identified losers as heartening news: “Those whose business models are based on selling overpriced and/or proprietary products have the most to lose. In a fiduciary world, a proprietary product is – presto — an instant conflict of interest that must be disclosed. Overpriced proprietary products will put sellers into an even worse position.”

If these are the losers, then I’m hopeful that will make the winner exactly the right person: the investor.

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