Fiduciary Responsibility: Likely the New Standard for Brokers

In my some thirty years as a securities arbitration attorney, never in my wildest dreams did I imagine that one day the political winds might blow in favor of individual investors.  But the Obama Administration, to its credit, has advanced a proposal that would dramatically curtail the ability of Wall Street firms to rip off their clients.

The little noticed proposal in President Obama’s regulatory overhaul would require that brokers be held to a “fiduciary” standard when peddling products rather than the “suitability” standard that is currently in place.  The proposed change isn’t mere semantics: It means that brokers will have to put their clients’ interests ahead of their own - and if they don’t, they will be more easily held legally accountable.  Being held to a suitability standard has long been Wall Street’s worst fear, and you can safely bet your battered retirement savings their TARP-financed lobbyists will do everything they can to block the proposal.

Although Wall Street brokers like to fashion themselves as “financial advisers,” most of them are in fact just salesmen looking to push products that will generate the highest  fees and commissions for themselves and their firms, rather than serve the best interests of their clients.  Typically, the products generating the highest commissions are those manufactured in-house and the brokers are under considerable pressure to sell these often dubious products. Case in point: when Merrill Lynch was having trouble getting customers to buy the firm’s highly questionable auction rate securities, Frances Constable, a managing director responsible for overseeing Merrill’s auction rate securities desk, sent out an email admonishing brokers, “The gloves are off and we are not concerned about issuer perception of [Merrill Lynch's] abilities and the competition. Gotta Move these microwave ovens!!”  At the end the day, Wall Street pushes its products much the same way as Sears does its kitchen appliances.

Under the suitability standard, a Wall Street broker can sell a client a costly and powerful microwave oven regardless of whether there is a cheaper one available and without consideration of a client’s needs.  The suitability standard only requires that broker’s sell microwave ovens to clients who have a legitimate need for them; they aren’t required to sell the best-priced microwave ovens or ones with BTUs best suited for their clients.  That’s why most arbitration rulings are in favor of brokers; the suitability bar is set so low they barely have to lift a leg to step over it.

But under a “fiduciary” standard, brokers would have to not only sell their clients the best availably priced financial microwave oven, they would be required to ensure the microwave oven was of a proper size and power for their client’s financial pantries.  This requirement would make it considerably easier for individual investors who were snookered by their brokers into buying financial products, that ultimately were not in their best interests, to seek legal redress.

The SEC could adopt the Obama Administration proposed rule change on its own, or Congress on its own could pass legislation if the agency once again fails to fulfill its obligation to protect investors.   It’s heartening that newly appointed SEC chairwoman Mary Schapiro has publicly endorsed the Obama administration’s proposals and has gone so far as to say they are “not a panacea to deter all fraud against individual investors.”  That suggests to me that Ms. Schapiro might be in favor of imposing additional regulation to protect individual investors.

Still, the jury is not yet out on whether Ms. Schapiro and Congress can resist the formidable pressures that Wall Street will place on them to quash the Obama administration’s suitability proposal.  If they can, some good will finally result from Wall Street’s widespread wrongdoings that brought America to the brink of collapse.  Indeed, if the fiduciary standard proposal survives intact, it will be the most significant development on Wall Street since the passage of the Glass-Steagall Act of 1933.