A decision on whether all financial advisors should be legally required to act in the best interest of their clients-as mandated by the Investment Advisers Act of 1940-has been postponed. The decision about how to regulate registered investment advisors has been put on hold.
But don't let the quiet fool you.
Decisions on these two issues will redefine the competitive landscape of the financial advice industry. In fact, the looming battles are the biggest things to happen to the independent financial advice industry since it emerged from infancy 35 years ago.
At stake is whether registered investment advisors will come under the scrutiny of Finra. Also, the decades-long struggle between fee-only advisors and commission-compensated registered reps will come to a head. At the core of the debate, the issue of whether financial planning is a true profession, is also going to be influenced-if not decided-by the outcome of the coming battle. And the future of the Financial Planning Association will also be decided.
Here, in a question-and-answer format, is what's happening.
Why is this coming to a head? Because the financial crisis and a slew of headline-grabbing frauds-including the granddaddy of all investment scams, the Madoff scandal-led to enactment in July 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The act mandated the U.S. Securities and Exchange Commission to rewrite 65 rules and conduct a dozen research studies about a wide range of regulatory issues as part of sweeping reform to the regulation of the nation's financial system. The act ironically saddled the SEC and other federal agencies with more work, in the form of research studies that must be completed in order to implement the reforms mandated.
Does Dodd-Frank require financial advisors to do what's in the best interest of their clients? No. But a key part of the Dodd-Frank law that affects financial planners, investment advisors and brokers mandates that the SEC impose regulations requiring a "fiduciary duty" by broker-dealers and investment advisors to their customers. "Although the act does not create such a duty immediately, it authorizes the SEC to establish such a standard and requires that the SEC study the standards of care which broker-dealers and investment advisors apply to their customers and report to Congress on the results within six months," according to Wikipedia.
Why is a fiduciary standard of care such a big deal? Because under current regulations, registered representatives affiliated with brokerages don't adhere to a fiduciary standard of care, which requires that an advisor always do what's in the best interest of a client. Registered reps must adhere to a less onerous standard of care, which says an advisor must give advice to a client that is suitable but not necessarily in his best interests. Imposing a legal obligation on advisors to always give clients advice that is in their best interest would impose greater liability on brokerages and hamper sales of financial products that generate profits but are not always in the best interest of clients.
What's all this talk about the Financial Industry Regulatory Authority being named to oversee Registered Investment Advisors? Section 914 of the Dodd-Frank Act mandated that the SEC conduct a study to review and analyze the need for enhanced examination and enforcement resources for investment advisors. Currently, RIAs are regulated under the Investment Advisers Act of 1940. The SEC regulates RIAs with $100 million or more under management; states regulate RIAs with less than $100 million. However, the Madoff Ponzi scheme and subsequent scandals highlighted the fact that regulators are examining RIAs about once every decade. Section 914 required the SEC to review:
the number and frequency of its examinations of investment advisors,
whether Congress should authorize the SEC to designate one or more self-regulatory organizations (SRO) to augment the commission's efforts in overseeing investment advisors, and
approaches to examining the activities of RIAs that are affiliated with a broker-dealer.