Dodd-Frank

Congress takes a closer look at how money men work with you.

By Amanda Millward

[Editor's Note: This article has been updated since it ran in the April 2011 issue.]

After the demise of the financial sector—stock market crash, Enron and Worldcom scandals, housing market collapse, Madoff Ponzi Scheme, ETC.—it’s no wonder that the public is skeptical about entrusting their money to industry representatives. Many don’t understand the different roles financial professionals can play, or the amount of education they should have. It’s important for consumers to know as much as possible about their financial planners and how they work. And while the average person does a bit of homework, congress is working to ensure anyone who dubs him/herself as a financial pro is putting the consumers’ best interests first.

 

They were watched, but were they watched close enough?
One can surmise the fear that ripped through the minds of many during the fall of 2008 closely mirrored the pandemic anxiety people had during fall of 1929 when the stock market crashed, throwing the United States into the worst financial depression in the nation’s history. And, today, while the nation continues to struggle through the infancy stages of recession recovery, those who played a large part in the economic downfall are just learning of the transformation their industry may soon undergo.

From the Great Depression came a structure of financial regulations that are still in play today—the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940. The 1934 Act created the Securities and Exchange Commission (SEC) as the governing body of the financial sector, as well as Self Regulatory Organizations (SROs), to oversee and regulate financial broker-dealers and brokers—requiring them to follow a suitability standard of care. The 1940 Act set the standard for investment advisers to follow the fiduciary standard of care.

For the longest time, brokers and investment advisers followed two different codes of services: fiduciary and suitability, with the fiduciary standard of care being the highest level of care a financial planner can give to the consumer. Both standards mandate the planner disclose information to the consumer, with fiduciary standards requiring planners to disclose any conflicts of interests; mention if there is a product that would suit the consumer better than that which the consumer already has (even if the planner does not offer that product); and identify any risk that is involved with the product. The suitability standard states that the planner, usually brokers, do NOT have to disclose everything to the consumer, only offer the consumer enough suitable information—leaving room for conflict of interest.

There are, however, a few key differences in the way investment advisers and brokers do business. Investment advisers do just what their title says they do: They give advice on clients’ investments; while brokers generally sell a product. Investment advisers typically get paid by the advice they give, and brokers by the products they sell—whether it’s by the product, the number of which the broker sold, or the size of the product.

Unfortunately, the 1934 and 1940 Acts did not adjust as the financial world transformed, and different careers, such as financial planners, emerged as did different ways for financial professionals to do business. And in the late 1990s and early 2000s, the market saw credit default swaps and the use of synthetic derivatives.

As Bryan Beatty, financial planner and partner of Egan, Berger & Weiner, LLC, in Vienna, says, “They haven’t done any real work on the regulations to sort of control any behavior to [the] client adviser since the 1940 Act. [The Dodd-Frank Wall Street Reform and Consumer Protection Act] is going to change the industry.”

While the SEC and individual states regulate investment advisers, broker-dealers and brokers, The Financial Industry Regulatory Authority (FINRA) helps by regulating brokers-dealers and brokers. Yet, with all of these regulators it is no surprise there is confusion. And it is no wonder that schemes as big as those of Enron and WorldCom went unnoticed for years. With the nation in another financial crisis, closely following the Great Depression, it is no wonder that Congress had to move quickly on the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, and get the financial industry up to 21st-century standards.

So what is the Dodd-Frank Act, and how will it change the financial industry?
There are several causes for the drafting and passing of the Dodd-Frank Act. However, Bernie Madoff’s Ponzi Scheme was considered an extreme case of regulation oversight. Madoff allegedly had his own auditor instead of having a third party audit his books. Madoff was not examined, and he may have had a lot of power in the SROs. Barry Glassman, President of Glassman Wealth Services, LLC, in McLean, remarks, “Madoff didn’t just con illiterate investors; he conned everybody. The normal safeguard just didn’t accomplish what it was supposed to.”

Within the Dodd-Frank Act, studies were commissioned to try and get a better understanding of the financial world as a whole. In particular, two major studies were conducted in order to understand the business practices: Section 913, dealt with the SEC’s study of whether to extend the fiduciary standard of care to broker-dealers who provide retail investment advice; and Section 914, a dealt with enhancing investment advisor examinations of investment advisers, broker-dealers.

What the studies found was that having the two different standards of care were confusing to the consumer that all financial planners should follow the highest standard which is the fiduciary standard of care.
Many financial planners are in favor of the recommendations, and most planners believe brokers and investment advisers should follow a fiduciary standard of care and should be examined more regularly. “There’s too much muddled confusion over [whom] the adviser represents and what the risks are,” opines Glassman. He adds, “As a fiduciary, it is easier for me to explain to clients who I represent.”

While most financial planners are agreeable to the switch to a fiduciary standard of care, the Section 913 study also made the recommendation that there should be one uniform SRO to regulate investment advisers, brokers and broker-dealers. (It is rumored that FINRA has asked to be the SRO; however, a representative of FINRA was unable to comment at press time.)

Most investment advisers do not want to be regulated under FINRA. They believe that FINRA is too powerful governing brokers and broker-dealers, and adding their control to investment advisers would make FINRA the overall regulator of the financial sector. Most investment advisers want to stay under the control of the SEC.

Similarly, there are financial planners who do not want the new recommendations to take effect, period. They think that the system that they have been working under is just fine and that the recommendations would have some negative effects on both brokers and consumers.

David Wexler, founding partner of Greenberg, Wexler & Eig, LLC, in Bethesda, Md., says, “From the people who are in the business of helping people to identify risks and securing insurance products to mitigate that risk I don’t think [they] necessarily need more regulations and need to be held to a fiduciary compliance standard when I think the broker-dealer standard is high enough and it seems to work.”

Beatty, who is for uniform fiduciary, explains that many financial professionals have a lot to lose if the system is changed. He says, “There are a lot of people making a lot of money with the way the system currently is. They don’t want that changed.”

These planners believe that there won’t be as many products as there are now for consumers to choose from, that consumers will have to pay more for advice and product selection, and that it will affect the way brokers sell. The financial planners that believe the system is fine the way it is claim that with any type of work there will always be a few bad apples trying to cut corners to increase revenue, but that the system works to stop these crooked people. “From my little piece of the world we’re regulated enough and the people who really do create transgressions are fairly easily caught and are fairly easily dealt with,” says Wexler.

However, there are financial planners on both sides of the spectrum that believe, based on the 913 and 914 studies along with the other hundreds of studies the Dodd-Frank Act commissioned, that the financial world has a long wait ahead before a decision will be made about a uniform standard of care or uniform SRO. SEC commissioners have released a statement calling for more studies before the SEC can make a decision, and that the conclusions of the studies are nothing but recommendations.

Beatty warns, “That change is coming voluntarily or involuntarily. I prefer voluntarily because involuntarily comes with consequences with getting involved in a way that hurts the public. I hope 2008 is a great lesson. I hope we can learn from 2008.”

Why You, the Consumer, Should Care
Unfortunately, it is hard to recognize fraud, but there are a few key things to keep in mind. First, do not write a check directly to your financial planner. Instead, make sure it goes to a public custodian, i.e. Fidelity. Always make sure you are receiving financial statements from your planner and the custodian, and always compare the two statements. Kevin Keller, CEO of the Certified Financial Planner Board of Standards Inc. (CFP Board), advises the public, when looking for a financial professional, to look for the CFP Board certification and seal. “Our mission is to benefit the public, and we do that by granting our CFP certification and upholding the recognized symbol of excellence.” The CFP Board of Standards, Inc. is a 501(c)(3) organization that upholds the standard of conduct for financial planners. Any financial professional that is registered with the CFP Board must follow the CFP certification process of education, must practice for a minimum of three years, are required to take exanimations, and all certificants must commit to the highest standard of care when working with consumers. It is one of the highest certifications a financial professional can hold.

The CFP Board has produced two documents, “10 Questions to Ask When Choosing a Financial Planner” and “CFP Board’s Consumer Guide to Financial Self-Defense,” to help consumers understand and protect their assets when it comes to investing money.

Consumers have the toughest job of all. It is very important for the general public and consumers to be aware of the studies that have come out of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 because these studies have the potential to change how investment advisers, brokers and broker-dealers handle accounts. The study on investment advisers and broker-dealers (as required by Section 913 of the Dodd-Frank Act) recommends that both should follow the fiduciary standard of care and put the client’s best interest before the firm’s best interest. This is a very important step toward giving consumers the best services possible.

When it comes to choosing either an investment adviser or broker to handle financial needs, it depends on what the consumer seeks. The best advice is to do some research on the companies, ask questions about the companies’ services and make the best choice for your needs. Kenneth Robinson, senior planner for the Monitor Group Inc., in McLean, suggests that consumers know how their advisers are getting paid. He says, “It’s critical to understand how a financial adviser is compensated. What is their business model? How do they make money? Understand that there a number of different ways that financial advisers are compensated and that can present conflicts of interest.”

Glassman advises, “I would suggest to people to look for advisers who are like them. Personality, relationship, is really important. It is critical that the investor feel they can bring up concerns in good times and bad.”

This financial world is very difficult to understand, and the recent recommendations do not make it any easier to understand. The studies of the Dodd-Frank Act did not set any new regulations, only recommendations. The SEC and Congress still have a lot to discuss, and the consumer should not be taking this lightly. “[Consumers should] stay on top of it and read as much as they can on the topic and what is happening with what the proposed rules coming out of the Dodd-Frank studies,” suggests Robinson. “Consumers should be worried if nothing comes from the studies and no real action is taken.”

In a study that was commissioned by CFP Board, Consumer Federation of America, AARP and other consumer groups, most Americans are confused about which financial professionals must follow a fiduciary standard of care. It also states that about 91 percent believe that financial professionals follow the same standard of care. It is imperative that the consumer understand what is going on with Study 913 and Study 914, understand how their financial planner is getting paid, and understand the mandates placed on financial professionals through fiduciary and suitability standards of care.

For consumers, it is important that they can trust the financial planner with their assets. The CFP Board offers a listing on their website at www.cfp.net—also see the top financial planners within this issue—and all CFP members have adopted a fiduciary standard of care.

“People in our industry should be held to the high and consistent standard; and if we could do that, the general public will benefit from that,” says Robinson.

 

Red Flags:
WE’VE KNOWN HIM FOREVER.
Always do your homework. Do research on the investor and always ask questions.

JUST SIGN HERE. I’LL TAKE CARE OF THE REST.
Never leave any blanks. Read the document and complete all necessary paperwork. Always ask for copies of the paperwork.

THIS IS JUST FOR MY SPECIAL CLIENTS.
There are no special deals. Ask for it in writing or if they carry professional liability insurance.

I’LL SEND YOU ALL OF THE INVESTMENT REPORTS.
Make sure you receive statements from an independent third-party source., i.e. Charles Schwab, etc.

MAKE THE CHECK PAYABLE TO ME.
Never make a check payable to the adviser and never leave the payee line blank.

I KNOW IT’S A DIFFICULT TIME, BUT YOU NEED ME TO DECIDE.
Be suspicious of pressure tactics during a major life change. Find someone you trust to help you.

THIS ONE’S A NO-BRAINER. YOU CAN’T LOSE.
There is no such thing as a free lunch. If your advisor tells you otherwise, take your business elsewhere.

THIS OFFER IS GOOD FOR TODAY ONLY.
Do not be pressured with persuasion tactics. Give yourself time to consider the investment before deciding.

I CAN REPLACE THAT WITH SOMETHING BETTER.
Ask yourself “better for whom?” or what your planner is getting out of the deal.

IT’S VERY COMPLICATED. NO NEED TO BOTHER YOU WITH ALL THE DETAILS.
Ask lots of questions. Do not let your planner off the hook. Ask for second opinions.

Source: Certified Financial Planner Board of Standards, Inc.

 

(April 2011)