CONGRESSIONAL HEARING REPORT
DATE OF HEARING: September 13, 2011
SUBJECT: “Ensuring Appropriate Regulatory Oversight of Broker-Dealers and Legislative Proposals to Improve Investment Advisor Oversight”
COMMITTEE: House Financial ServicesSubcommittee on Capital Markets and Government Sponsored Enterprises
REPORT BY: NASAA Corporate Office,
Office of Government Relations
Members Present
Republicans: Chairman Scott Garrett (NJ); Full Committee Chairman Spencer Bachus (AL); David Schweikert (AZ); Edward Royce (CA); Judy Biggert (IL); Steve Stivers (OH); Robert Dold (IL); Michael Grimm (NY); Bill Posey (FL); Robert Hurt (VA); Steve Pearce (NM); Michelle Bachmann (MN); Randy Neugebauer (TX)
Democrats: Ranking Member Maxine Waters (CA); Carolyn Maloney (NY); Stephen Lynch (MA); Andre Carson (IN); Gary Peters (MI); Ed Perlmutter (CO); Brad Sherman (CA); Ruben Hinojosa (TX); Al Green (TX); Carolyn McCarthy (NY); Brad Miller (NC); Joe Donnelly (IN); Keith Ellison (MN); Jim Himes (CT)
Witness
William E. Dwyer III, Chairman, Financial Services Institute
Ken Ehinger, President and Chief Executive Officer, M Holdings Securities, Inc., on behalf of the Association for Advanced Life Underwriting
Terry Headley, President, National Association of Insurance and Financial Advisors
Steven D. Irwin, Commissioner, Pennsylvania Securities Commission, on behalf of the North American Securities Administrators Association
Richard G. Ketchum, Chairman and Chief Executive Officer, Financial Industry Regulatory Authority
Barbara Roper, Director of Investor Protection, Consumer Federation of America
John G. Taft, Chief Executive Officer, RBC Wealth Management, on behalf of the Securities Industry and Financial Markets Association
David Tittsworth, Executive Director/Executive Vice President, Investment Adviser Association
Overview
On September 13, 2011, the House Financial ServicesSubcommittee on Capital Markets and Government Sponsored Enterprises held a hearing titled “Ensuring Appropriate Regulatory Oversight of Broker-Dealers and Legislative Proposals to Improve Investment Advisor Oversight.” Among the eight panelists called to testify was Pennsylvania Securities Commissioner Steven D. Irwin, who appeared on behalf of the North American Administrators Association (NASAA). The purpose of the hearing was to examine the two studies mandated by Sections 913 and 914 of Dodd-Frank. The main topics of discussion were the possible extension of the fiduciary standard of care to broker dealers and the possibility of creating a self-regulatory organization (SRO) for investment advisors. Additionally, on Thursday, September 8th, Full Committee Chairman Spencer Bachus shared draft legislation with all witnesses invited to participate in the proceeding. The draft legislation, entitled the “Investment Advisor Oversight Act of 2011,” would establish an SRO for Investment Advisers, and during the hearing it was discussed at length.
Background
Harmonization of the Duty of Care (“Fiduciary Duty”)
Although the services provided by broker-dealers and investment advisers are becoming increasingly similar, broker-dealers and investment advisers have been held to different standards of care in their dealings with retail customers. Broker-dealers—regulated primarily by FINRA—are held to a suitability standard, which requires that when a broker-dealer recommends the purchase, sale, or exchange of any security, the broker-dealer must have reasonable grounds for believing that the investment is “suitable” for the customer given the customer’s financial status and investment objectives. By contrast, registered investment advisers—regulated by the Securities and Exchange Commission (SEC)—are held to a fiduciary duty standard, which imposes upon investment advisers the affirmative duty of “utmost good faith, and full and fair disclosure of all material facts,” as well as an obligation “to employ reasonable care to avoid misleading” their customers.
A 2008 SEC study found that many retail customers do not understand the differences between broker-dealers and investment advisers, since some of the services provided by broker-dealers and investment advisers are often indistinguishable. In fact, the biggest difference between broker-dealers and investment advisers may be the manner in which they are compensated. While broker-dealers and investment advisers often offer the same services, broker-dealers typically charge commissions on the trades they execute for retail customers; by contrast, investment advisers typically charge an annual fee that is calculated as a percentage of the assets that they manage.
As the activities of broker-dealers and investment advisers have grown increasingly similar, one of the goals of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-203) was to rationalize the regulation of broker-dealers and investment advisers and to harmonize the separate regulatory schemes for each. Title IX seeks to harmonize the regulation of broker-dealers and investment advisers in the following ways:
• Requiring the SEC to mandate increased disclosure from broker-dealers and investment advisers to their customers about the standards that govern the terms of their relationship;
• Authorizing the SEC to require broker-dealers to disclose to their customers information about costs, risks, and compensation;
• Authorizing the SEC to issue rules for broker-dealers and investment advisers regarding sales practices, conflicts of interest, and compensation schemes;
• Restricting the ability of broker-dealers and investment advisers to require that disputes with their customers be resolved through arbitration; and
• Mandating that the SEC apply the same enforcement standards against broker-dealers and investment advisers.
The Dodd-Frank Act and the Oversight of Broker-Dealers and Investment Advisers
Section 913 of the Dodd-Frank Act required the SEC to report to the House Financial Services and Senate Banking Committees on the standards of care applicable to broker-dealers and investment advisers when providing personalized investment advice to retail customers. Section 913 permits—but does not require—the SEC to issue rules that address the standards of care for brokers, dealers, and investment advisers that provide personalized investment advice about securities to their retail customers.
Section 913 also allows the SEC to exercise its enforcement authority under either the Securities Exchange Act of 1934 (Exchange Act) or the Investment Advisers Act of 1940 (Advisers Act) for (i) violations of the Exchange Act related to the standard of care applicable to broker-dealers who give personalized investment advice to retail customers, and (ii) violations of the Advisers Act related to the standard of care applicable to investment advisers. Section 913 also requires the SEC to prosecute violations of the standards of care applicable to broker-dealers and investment advisers “to the same extent” under the Exchange Act and the Advisers Act.
Section 914 of the Dodd-Frank Act required the SEC to study “the need for enhanced examination and enforcement resources for investment advisers” and report its findings to the House Financial Services and Senate Banking Committees. Specifically, Section 914 required the SEC to examine the number and frequency of investment adviser examinations by the SEC for the five years preceding the enactment of the Dodd-Frank Act; the extent to which authorizing one or more self-regulatory organizations (SROs) to augment the SEC’s oversight of investment advisers would improve the frequency of examinations; and alternative approaches to examining the investment advisory activities of dually registered broker-dealers and investment advisers or affiliated broker-dealers and investment advisers. Section 914 also directed the SEC to use its findings in the study “to revise its rules and regulations, as necessary.”
Finally, Section 410 of the Dodd-Frank Act transferred oversight of mid-sized investment advisers that manage between $25 and $100 million in assets from the SEC to the states. This provision will require approximately 3,350 advisers currently registered with the SEC to withdraw their SEC registrations and register with state securities authorities. Investment advisers who operate in more than 15 states would be permitted to register with the SEC.
The “Investment Adviser Oversight Act of 2011.”
Drafted by Chairman Bachus, this legislative proposal adopts the second alternative from the Section 914 study—authorizing SROs for registered investment advisers, funded by membership fees, to supplement the SEC’s oversight of investment advisers. The legislative proposal would amend the Investment Advisers Act of 1940 to provide for the creation of national investment adviser associations (NIAAs), registered with and overseen by the SEC. Investment advisers that conduct business with retail customers would have to become members of a registered NIAA. The SEC would have the authority to approve the registration of any NIAA. The legislation permits the SEC to suspend or revoke an NIAA’s registration, or censure or impose limits on an NIAA’s activities and operations, if the SEC finds that the NIAA has violated the Advisers Act, SEC rules, or its own rules, or without reasonable justification or excuse has failed to enforce compliance with any such provision by an NIAA member firm or associated person.
The legislative proposal requires the SEC to determine whether an NIAA has the capacity to carry out the purposes of the Advisers Act and to enforce compliance by its members and their employees with the Advisers Act, the SEC’s rules under the Act, and the NIAA’s rules before the investment advisers association can register as an NIAA. The SEC also must determine that the NIAA’s rules meet the following criteria:
• Assure a fair representation of the public interest and the investment-adviser industry in its selection of directors and administration of its affairs, and provide that a majority of its directors do not come from the securities industry;
• Are designed to prevent fraud and protect investors;
• Are consistent with the Advisers Act and fiduciary duties under the Act and state law;
• Do not impose any burden on advisers that is not in the public interest or for investor protection;
• Provide for periodic examinations of members and their related persons, and for coordination of those examinations with the SEC and state securities authorities; and
• Provide for equitable allocation of dues and fees; and establish appropriate disciplinary procedures for members and their associated persons that violate the Advisers Act, SEC rules, or NIAA rules.
Members Statements
Chairman Scott Garrett (R-NJ) stated that the SEC currently has too much on its plate. He argued that this has resulted in important things not getting done. For example, he stated that investment advisors are presently only examined approximately once a decade. He cited the Bernie Madoff scandal as a product of this lack of oversight. He stated that Dodd-Frank has resulted in an “unprecedented avalanche of new rulemaking.” He noted that these new responsibilities being granted to the SEC adds an even greater burden on the already strained agency. He questioned why the SEC would be focusing on discretionary rulemaking such as extending the fiduciary standard to broker-dealers when it has yet to issue so many rules mandated by Dodd-Frank. He also noted that the SEC has a history of having its rule-making overturned by the courts which has resulting in costly legal fees. He added that the SEC has wasted millions of dollars by neglecting to conduct proper risk-benefit analysis. With all this in mind, he stated that he is unsure why fiduciary rulemaking is under consideration by the SEC at this time.
Ranking Member Maxine Waters (D-CA) stated that most consumers don’t know the difference between investment advisors and broker-dealers. She noted that the line between the two has become blurred in recent years. She applauded the SEC for recommending that the fiduciary standard be extended to broker-dealers. She cautioned against the creation of an SRO for investment advisors and expressed her strong belief that regulation should come from properly funded government agencies.
Full Committee Chairman Spencer Bachus (R-AL) stated that the SEC has not shown the necessity of a broker-dealer fiduciary standard. He argued that this rulemaking would come at the expense of other mandatory rulemakings. He noted that currently only 9% of investment advisors are examined each year. He stated that while this must change, user-fees are an unworkable solution. He argued that an SRO for investment advisors would provide the most comprehensive solution. He stressed that this is necessary to augment and supplement SEC examinations.
Representative Carolyn Maloney (D-NY) stated that although few consumers can tell the difference between the two, investment advisors and broker-dealers are subject to different standards of care. She noted that while investment advisors must adhere to a fiduciary standard, which requires them to put the best interests of their client’s first, broker-dealers must only adhere to a suitability standard. She stated that both investment advisors and broker-dealers must be adequately examined and supervised. She stated that a lack of oversight allowed the Bernie Madoff scheme to go undetected for far too long. She noted that an SEC staff study mandated by Dodd-Frank has recommended that the fiduciary standard be extended to broker-dealers. She stated that something needs to change and that the status quo is unacceptable.
Representative David Schweikert (R-AZ) stated that he is concerned about the unintended consequences of SEC rulemaking. He expressed concern that extending the fiduciary standard to broker-dealers would take away consumer choices in regard to both advice and products. He stated that he is concerned that this would damage the financial future of our country.
Representative Stephen Lynch (D-MA) stated that it is important to foster an environment in which investment advisors and broker-dealers continue to help consumers invest their money wisely. He stated that it is incumbent upon Congress to ensure that when small businesses and individuals place their trust with investment professionals that trust is not misplaced. He stressed regulators must be given the resources necessary to protect investors.
Representative Edward Royce (R-CA) expressed concern that extending the fiduciary standard to broker-dealers may result in less choice, higher fees, and access to fewer products. He stated that he worries that this standard would restrict access. He stressed that rules cannot be issued without a full understanding of their implications.
Representative Andre Carson (D-IN) stressed that funding for the SEC must be increased. He noted that the SEC would need additional funds to carry out the new responsibilities it has been granted under Dodd-Frank. He stated that Wall Street already greatly outnumbers and outspends the SEC.
Representative Judy Biggert (R-IL) expressed concern over the DOL’s fiduciary standard. She stated that this is an example of the duplicative and overreaching regulation that this administration has been imposing and that this is the worst possible time for this.
Representative Gary Peters (D-MI)noted that he himself is a former investment advisor and broker dealer. He stressed that consumers do not understand the difference between the two. He stated that regulators must be given the resources to do their job.
Representative Steve Stivers (R-OH) stated that he is “a fan” of Chairman Bachus’ proposal but he is interested to hear what the witnessed have to say in regard to an SRO for investment advisors.