Does the current system of legalized bribery through campaign contributions matter?
Consider the case of a provision in the financial products regulation bill that would impose on stockbrokers the same sort of fiduciary duty lawyers have: to act in the interests of their clients when that conflicts with their own interests. It’s not a hard question, it seems to me, though I’d be willing to settle for a system where each brokerage house had to choose whether to be subject to such a standard or not, and disclose its choice to its clients.
The provision was in the original Obama Administration proposal and in Sen. Dodd’s version of the bill, but Tim Johnson of South Dakota wants to replace it with a “study,” and may get his way.
Campaign contributions aside, a fight over the fiduciary standard is a huge political winner for the Democrats. This is exactly the kind of issue we want to take into November. Go ahead, Goopers: explain why it’s “big government” and “the nanny state” and “socialism” to ask brokers not to cheat their clients. Good luck with that.
Here’s hoping some Senator offers the original proposal as an amendment to whatever bill comes out of committee.
I wonder if most "full-service" houses would even survive such a change. Their compensation structures are mostly wedded to commissions for trading volume and kickbacks for selling featured products.
Of course most of them haven't survived very well by cheating their clients either.
It really is not a bad plan at all. Investment advisors have a fiduciary duty to clients. It would make sense if they just required a ratio of investment advisors to brokers to phase in a new system. As paul suggests, this would be a radical change.
It may be the case that Tim Johnson wants to simply kill the idea. Having said that, however, it's not at all clear to me that it makes sense for the same set of fiduciary obligations to be imposed on (1) brokers with discretionary trading authority over their client's account, (2) investment advisers who get paid for providing investment advice, (3) brokers who provide tailored investment advice without separate charge incidentally to their main function of executing trades ordered by the client, (4) brokers that provide generic investment research to all clients without separate charge, and (5) brokers that simply execute trades without providing investment research or advice. The higher one goes on the last list the more likely it is that the investor will place his trust and confidence in the advice being given and the more severe the broker's conflict of interest becomes. Why shouldn't the scope of their duties therefore vary, as well? After all, free advice is worth what you pay for it.
I think I would be fine with the Bainbridge notion with a few stipulations. E.g., any non-fiduciary broker found to have stated or implied that a client could trust their advice (either to be factual or in their best interests) would be barred from the securities industry for life; any non-fiduciary-brokerage firm whose advertisements, brochures, public statements etc were found to lead more than 10% of a random sample of potential customers to believe that its advice could be trusted to be either factual or in a client's best interest would be offered the choice of converting to fiduciary status or disbanding.
The problem is that, other than 5) in the list above, pretty much every other class of broker contains individuals and firms that have fairly apparently preyed on the trust they attempt to instill in clients.
Mark,
I'm a big fan of you and this blog, but sometimes you are distressingly out to lunch. Reread, please, with a colder eye, this sentence that you wrote: "Campaign contributions aside, a fight over the fiduciary standard is a huge political winner for the Democrats."
In what universe is "a fight over the fiduciary standard" going to be, in a general election decided by the American electorate we know and love, "a huge political winner" for anyone at all? I'm going to go out on a risky limb and say that a 'fight over the fiduciary standard' is not going to make the tiniest iota of difference in any election in my lifetime. You really need to read more Matt Yglesias and Ilya Somin at Volokh and various others on the ignorance of the median American voter. Certain bloggers in recent days have been making the good and accurate point that the Dems should not fear blowback from using reconciliation to pass health care amendments because low-information voters do not have the slightest idea what reconciliation is. That's right, but the general point cuts both way – those voters are never, in a thousand years, going to learn what the 'fiduciary standard' is either. And no, it won't make any difference if you describe it with somewhat less technical language.
Taking Bainbridge's list, I'd say the following:
1. Should have to justify every single trade. Whatever one thinks of the EMH in principle, from the point of view of an individual investor there is little reason, given an adequately diversified portfolio, to trade other than to rebalance the mix of investments. A competent broker should know this, so representations to the contrary should be regarded with extreme suspicion.
2. There is a clear fiduciary responsibility. Not even close.
3. Sounds like a combination of (1) and (2). I'm not sure what "tailored investment advice" is.
4. Depends on the nature of the generic advice. If it's access to research done by various outside firms then probably OK, but one can still imagine a conflict arising wrt choice of research made available. Would have to be egregious, I think, to be troubling.
5. No problem.
BTW, I suspect that a more useful reform might be eliminating the mandatory arbitration clauses in broker agreements. Clients don't do too well in these arbitrations.
I don't get it — this standard already exists.
It is well established in law that a broker owes a fiduciary duty to a securities investor. See Gochnauer v. A.G. Edwards & Sons, Inc., 810 F.2d 1042, 1049 (11th Cir. 1987); Ward v. Atlantic Security, 777 So.2d 1144 (Fla. 3d DCA 2001); State ex. rel. Painewebber v. Voorhees, 891 S.W.2d 126 (Mo. 1995); Glisson v. Freeman, 532 S.E.2d 442 (Ga. App. 2000); Beckstrom v. Parnell, 730 So.2d 942 (La. App. 1st Cir. 1998)[claris law].
In addition the underlying NYSE Rule 405 of "know thy client" along with the NASD's requirement to brokers for suitable investments demands that brokers hold out their customers first in any transaction. This is true even where the investor suggests- or even demands- a product that would be unsuitable for their purposes. (The only time a broker could sell an "unsuitable" product might exist when an investor makes an initial suggestion for an investment and where the broker subsequently informed the investor both verbally and IN WRITING PRIOR to the sale that the investment did NOT fit the suitability standards for the particular investor. (After which the broker may still refuse to conduct the transaction.))
Investors "trust" brokers based upon a real or perceived level of honesty, good faith, judgment and responsibility in looking after the money entrusted to him/her. The broker, in accepting this money, assumes and accepts a responsibility to serve the best interests of the investor. The broker MUST determine if an investment fits within the customers risk profile, income, age, objectives (assuming correct), etc. and is also within the guidelines for proper diversification.
The Rules of Fair Practice set down by the NASD state that a broker has definitely breached his/her duty if a broker
1. recommends speculative securities without finding the customer's financial situation and being assured that the customer can bear the risk
2. does excessive trading (churning) in a customer's account (whether the account is discretionary or not)
3. does short term trading (and switching) of mutual funds
4. set up fictitious accounts to transact business that would otherwise be prohibited
5. makes unauthorized transactions or use of funds
6. recommends purchases that are inconsistent with the customer's ability to pay.
7. makes unauthorized transactions or use of funds
8. commits fraudulent acts (such as forgery and the omission or misstatement of material facts including any conflict of interest).
This obligation for fair dealing is not removed through the simple completion of a one page new account form required by brokerage firms. (Minimum information includes full name, address, phone number, employer, social security number, citizenship, acknowledgment that customer is of legal age, spouse's name and employer (if any) and investment objective.
Other information varies as to firm but might include bank and personal references, previous brokerage accounts, and if the account was solicited, referred, walk in, etc.)
Nor is the liability removed by sending the completed form to the client since clients do not and cannot be expected to know how a particular investment fits within individual and specific investment guidelines. It does however relieve the broker of mistakes entered on the form by either party that would be apparent to- and should have been corrected by- the client. [efmoody]
There is no such waiver for a broker that just conducts transactions as Professor Bainbridge suggests — or any of his other 4 points. One cannot claim, for example, to be an investment adviser or simply make trades but not give advise without being subject to the regulations, even if they don't conduct transactions or only conduct transactions.
They are all covered. Even Etrade and the like review all orders (most likely automatically with a manual secondary review if issues arise) to see if the order meets certain requirements including but not limited to your stated assets/income/risk selection (the form you filled out when you started the account).
Brokers are also required to report and receive approval for any outside activities whether paid or volunteer including but not limited to serving on the board of charities, corporations, moonlighting employment, outside income, family trusts/businesses, substantial gifts received, etc. (minimum standard exists some firms are more stringent in their requirements to ensure they meet the standards for a fiduciary) and are required to provide documentation including tax returns as verification if asked.
So not only are they required to inform their client their Principal is required to verify transactions are within regulations and free of conflicts of interest. Brokers are also restricted from insider trading and IPO's and are required to inform any company they have a personal account with that they are a registered broker.
Contrary to popular belief the securities industries are highly regulated (Madoof was a Federal enforcement issue and changing the law isn't going to change that).
It sometimes seems current regulations boarder on being onerous for average brokers, forcing many honest ones from starting or into leaving the business early in their careers, leaving behind either the best and slickest "cheats" or those large and committed enough to survive (did you know that every letter you receive from your broker is pre-approved by the legal/marketing department, including the birthday card you received and any notations outside the approved texts is subject to regulatory actions — at least annually files are audited for adherence to all regulations by most firms). Yet these facts are unknown to the general public and, it appears, to our lawmakers.
Full disclosure – I am a broker and I have seen the explosion of regulations paperwork over the past 30 years. Most for the better, some just CYA.
(Cross posted at Professor Bainbridge's blog)