FINRA Chairman and CEO Richard Ketchum thinks broker/dealer firms need to bulk up on disclosure regardless of whatever rulemaking comes out of Congress on the fiduciary issue. In remarks today at a SIFMA compliance and legal division conference, Ketchum said the industry must move forward to improve the quality and kinds of disclosures firms provide to clients, particularly disclosures about the services that b/ds provide.
The call is consistent with the group's lobbying efforts to become the SRO for investment advisors, says consumer advocate and Fund Democracy Mercer Bullard. “Part of their lobbying effort is to show that they are committed to raising standards for brokers to something closer to the fiduciary standard for advisors,” says Bullard. “The argument he’s been making to members is that either we do it or the SEC will do it to us. That is an argument that has found some audience in the broker community.”
Though he didn't specify, Ketchum was likely advocating greater disclosure on b/d services like principal trading, investment banking, IPOs, etc., the biggest sticking point in the debate over the fiduciary standard for b/ds because they account for such a huge part of Wall Street wirehouse business. Today, broker/dealers that also act as investment advisers under the Adviser's Act of 1940 can engage in principal transactions only in non-discretionary accounts, under temporary rule 206(3)-3T, and never if the securities involved have been issued or underwritten by the advisor or an affiliated broker/dealer—except for investment-grade bonds. Even then they must get client consent. That temporary rule sunsets at the end of this year.
“In a brokerage environment, product manufacturing is still very important. It goes all the way from investment banking products to SMA products,” said Alois Pirker, Aite Group analyst, estimating that most wirehouses get 50 percent or more of their revenues from product manufacturing—for some a lot more. “Brokerages have moved to open architecture over the past decade, but they are still product shops in large part. RIAs get away with being fiduciaries because they’re not product shops. They’re advice and investment management shops. It’s a different proposition.”
Under current rules, wirehouse advisors can only collect asset-based fees as opposed to commissions on client accounts if they either 1) act as fiduciaries or 2) let the corporate RIA manage the account, says Pirker. Financial planning is also split. If an advisor provides a client with a certain level of financial planning advice close enough to straight investment planning, the advisor need not be a fiduciary. But once he starts offering more complex services like tax planning, estate planning or succession planning, then he must be a fiduciary, Pirker says. The lines are muddy, however.
Ketchum said plain English disclosures about the services that a broker/dealer offers, and any conflicts of interest that exist as a result, should probably be made when a client opens a new account.
“At this moment it remains unclear whether Congress will adopt a fiduciary standard for broker/dealers, or whether it will require that the SEC study the issue,” Ketchum told attendees during the keynote address at the conference, held in Washington D.C. “FINRA supports a fiduciary standard for broker/dealers that provide personalized advice. But even if Congress does not immediately impose such a standard, I do not believe that FINRA and the industry can stand back as if we have learned nothing from recent history. Regardless of where one stands on the fiduciary question, we all can agree that we must consider other ways to improve broker/dealer regulation. It is time for us to improve the quality of disclosures about products that broker/dealers offer to their customers. Even more important, we must begin to develop disclosures about brokerage services, and the conflicts of interest that a broker/dealer faces when it offers these services,” he said.
FINRA supports a “business-model neutral” fiduciary standard for broker/dealers that provide personalized advice, which sounds a little different from the standard that governs financial advisors under the Investment Advisers’ Act of 1940. In an April 29 speech, Ketchum told his audience at the Insured Retirement Institute Government & Regulatory Affairs Conference that FINRA supports a fiduciary standard that would cover securities, insurance products, banking products, futures and the like and would, at a minimum, “ensure that… every person who provides financial advice and sells financial product [be] tested, qualified, and licensed.” He continued, “Every such person should be subject to a balanced, business-model neutral fiduciary duty, and regular and rigorous examinations by a regulatory authority. All advertising for financial products and services should be fair, balanced and not misleading. Every financial product and service should be appropriate for the investor to whom it's recommended and every customer should receive timely disclosure for the product and services being recommended. This disclosure should address in plain English the risk, disadvantages and other features of the product or services.”
Ketchum also said in his speech that there need to be shock absorbers in the market for the kinds of drops that occurred in trading Thursday. “We need to step back and ask what that means. Whether it involves taking a brief break after a 15 to 20 percent drop in an extraordinarily short time or otherwise,” he told attendees. “We can’t be in this position of redesigning what happens in trades and making decisions in what trades should be broken with respect to markets that go close to zero. That isn’t an acceptable place.”
Ketchum emphasized that he thinks it is the exchanges and the industry who should decide what supports and controls should be put into place. He also said that there must be ways to eliminate abuses of high-frequency trading. “The tools available to high frequency traders that allow them to instantaneously enter and cancel large numbers of orders create risks of inter-market manipulations and other trading abuses to which we must be able to respond,” he said. “In today’s markets, manipulative scenarios are not constrained to one market.” He continued, “The risks of missing instances of manipulation, wash sales, abusive short selling and other improper ‘gaming strategies’ is unacceptably large.”
