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News January 16, 2012 Issue

Fiduciary Standard for Broker-Dealers Still Appears a Ways Off

Congress came calling and the SEC has responded.

Last month, chairman of the House Financial Services Capital Markets Subcommittee Scott Garrett (R-NJ) asked SEC Chairman Mary Schapiro for a progress report on her pledged economic analysis of the impact of imposing a fiduciary standard on broker-dealers.

Garrett specifically wanted to know the number of SEC staffers devoted to the analysis and how many hours they were spending on it. He asked for an estimated timeline for completion of the analysis, and whether the final product would be subject to public review and comment. Garrett also requested a timeline for any proposed rulemaking, "if justified through rigorous cost-benefit analysis."

Last week, Schapiro addressed Garrettís request, and it looks like any fiduciary standard for brokers is still very much a work in progress.

Three economists in the SECís Division of Risk, Strategy and Financial Innovation are currently working on the economic analysis, said Schapiro. Two of them participated in the working group that developed the Section 913 study and recommendation. The three economists do not devote their time exclusively to this project, but are supported in the analysis by the efforts of staff in both the Divisions of Investment Management and Trading and Markets.

So far, theyíve analyzed publicly available data on such metrics as the economics of the financial advice industry, the quality of financial services, areas of conflicts-of-interest, consumer disclosure and retail investor behavior, she said. The economists have also digested and summarized the available literature, consisting of approximately 150 different articles.

Still, Schapiro anticipates that the SEC will require additional relevant data and empirical analysis from the public to complete the task.

"As such, SEC staff, including Risk Fin economists, are drafting a public request for information to obtain data specific to the provision of retail financial advice and the regulatory alternatives," she said. Through the request, the SEC hopes commenters will provide information that would otherwise be privately held and unavailable, but that will allow continued analysis of the market for retail financial advice.

Sources have indicated that the SECís request for information may be released as early as next month.

A year ago and along party lines, the SEC recommended that a fiduciary standard of conduct should apply to broker-dealers when providing investment advice to retail customers.

The recommendation came in a study mandated by Section 913 of the Dodd-Frank Act (DFA). At the time the study was released, the two Republican commissioners, Kathleen Casey and Troy Paredes, said they could not support the studyís recommendation. The six-month time-frame for producing the study that was imposed by the DFA was too short to gather the necessary empirical data, they said. The studyís "pervasive shortcoming" was that it failed to justify its recommendation to fundamentally change the broker-dealer regulatory regime. The study had not adequately articulated or substantiated the problems that would purportedly be addressed via that regulation. The study also did not adequately recognize the risk that its recommendations could adversely impact investors, and failed to provide an appropriate cost-benefit analysis.

"A stronger analytical and empirical foundation than provided by the study is required before regulatory steps are taken that would revamp how broker-dealers and investment advisers are regulated," said Casey and Paredes.

The study should be viewed as a starting point for further research and consideration, rather than as forming the primary basis for rulemaking. Before the Commission proposes rules in this area, more rigorous analysis - rooted in economics and data - is needed to avoid unintended consequences.

In our view, the collection and analysis of empirical data - particularly data relevant to evaluating the impact of regulation - is essential for the Commission not only to determine whether rulemaking is appropriate but also to develop appropriate rules should the Commission choose to go forward.

Garrett and his fellow Republican subcommittee members have made it known to Schapiro and the SEC that they agree wholeheartedly, and are "disappointed" with the SECís recommendation to impose a fiduciary standard on broker-dealers.