Due Diligence

Fiduciary Versus Suitability: A Concrete Example

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bad advice In Slate magazine, Timothy Noah writes that brokers should be held to a fiduciary standard, citing the following example offered by securities attorney Stuart Meissner:
Meissner's clients, Claire and Alex Moskvin of West New York, N.J., sold their house in 2006 for $975,000. They told their broker at Wachovia (since purchased by Wells Fargo) that they wanted to invest the money for a year or two and then retrieve it to buy a new house. The Moskvins suggested treasury or municipal bonds, where the principal would be insured. Instead the Wachovia broker steered them into mutual funds. When the market crashed and the Moskvins lost $227,000, they sued. "The defense," Meissner told me, "was basically that [Wachovia] didn't have a fiduciary duty." The case went to arbitration, and the Moskvins won about $90,000, but Meissner believes they would have won much more had Wachovia been statutorily bound to the stricter standard to which the Moskvins assumed, in their ignorance, it already adhered.

Noah laments that there aren't concrete examples like this in the SEC's study of whether to extend a fiduciary standard to brokers, and he's right to. The practical implications of the differences between the fiduciary and suitability standards can be very hard to describe in plain terms. That's partly why there is so much confusion in the market in the first place.

But here's where Noah's column gets it wrong. At the end of his column, he says everything will be ok because SIFMA, the broker trade assocation:

is cautiously supportive of the uniform standard. Maybe that's because it would be too embarrassing for the brokers to say out loud that they don't feel like putting clients' financial interests ahead of their own.

SIFMA has been cautiously supportive of the standard because it is expecting that the SEC will leave room for brokers to continue to operate under their current business models when the agency writes new rules. The group wants a business-model neutral standard, for obvious reasons. The way the SEC report is written now, it's very difficult to predict exactly what if anything the SEC Commissioners will do with the SEC staff recommendations in that report--will they require b/ds to eliminate conflicts or just disclose them, and which conflicts, and what kind of disclosures. And these issues will have a huge impact on the broker/dealer business model--in particular things like principal trading, differential compensation, proprietary products and conflicts of interest.

Of course, investment advisers and fiduciaries aren't perfect either, and will likely face quite more regulation under the reccommendations of the SEC fiduciary report. And that will be the subject of my next post.

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