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Big Changes May Be In Store For The Securities Industry

The end of mandatory securities industry arbitration and broker fiduciary duty may be closer that you think.  In recent weeks, the House Financial Services Committee passed the Investor Protection Act of 2009, which contains these and other significant reforms.  And a bill contemplating similar reform is making its way through the Senate.  With health care reform stealing center stage over the past few months, the IPA has managed to quietly gain traction and, if ratified in its current form, promises to be one of the most dramatic and sweeping changes in securities legislation in years. 

No more mandatory customer arbitration.  For more than a decade, investors have generally been required to arbitrate disputes with their brokerage firms and brokers before the National Association of Securities Dealers (NASD), the New York Stock Exchange (NYSE) or their successor merged entity, the Financial Industry Regulatory Authority (FINRA) - quasi governmental or self-regulatory organizations charged by the SEC with maintaining member rules of conduct and policing firms and registered representatives.  Over the years, customers, member firms and individuals have extolled the pros and cons of the forum, which undeniably provides a convenient and relatively speedy process for resolution of claims.   If the IPA is passed, however, it will give the SEC the power to prohibit or limit the use of mandatory arbitration if it determines such action is in the best interests of the public and would protect investors.  But how the SEC will determine which actions protect investors and which actions do not are details that simply have not yet been worked out.  While it remains unclear what impact this provision will have on the current arbitration systems, the potential exists that the SEC could prevent arbitration of disputes altogether if it determines that customers would be better served through traditional lawsuit channels.   

Fiduciary what?  Sometimes referred to as the "F" word in professional circles, fiduciary duty refers to a heightened duty of responsibility a person owes to his or her client in certain circumstances.   When someone is a fiduciary to you they owe their highest level of loyalty and must disclose, among other things, information such as their compensation and if their interest in a transaction conflicts with yours.  To state the obvious, a natural tension exists anytime someone is sold something whether it be a stock or anything else.  When a person sells a product or service they receive a commission or some other form of compensation and, like most things, can receive higher commissions for selling certain types of products instead of others.  Currently, brokers are not held to the fiduciary standard unless they exercise control over their client's account either expressly or impliedly.  Investment Advisors (IA), on the other hand, who dispense "investment advice," are considered fiduciaries and held to the higher standard.  If you are asking yourself what is the difference between IAs and brokers, check out Kara McGuire's article in the November 22, 2009 issue of the Minneapolis Star Tribune (Section D) titled "Financial advisors don't all follow the same rules."  The article provides an excellent overview, in layman's terms, of some of the key differences between brokers, IAs, and what it means to be a fiduciary.  While the idea of creating a uniform system of conduct for brokers and investment advisors is, on its face, appealing, if not for the simple reason of having one standard of conduct, the proposed standard - that brokers be held to a fiduciary standard for dispensing investment advice - poses potential conflicts for brokers selling proprietary firm products.  

While the IPA is still a ways off from being ready for House approval, it may be a sign of things to come.  Investors and the securities industry would be well served by paying close attention to this and other proposed securities reform regulations in both the House and Senate as sweeping changes are being fast-tracked for approval.  Stay tuned....

Full post as published by OverRegd - Securities Regulation and Litigation Blog on November 25, 2009 (boomark / email).