FINRA’s know-your-customer (KYC) and suitability rules
(effective date was extended to July 9, 2012) have caught the attention of the broker-dealers the most. (The other two rulemaking decisions mentioned in the survey are OTC derivatives regulation and the so-called Paul Volcker Rule – ban on proprietary trading.) The Ernst & Young survey
, which included responses from 42 broker-dealers from March 20-May 3, found that 71.5 percent of respondents the FINRA rules would result in a high impact on their compliance and control processes while 64.3 percent believed the uniform fiduciary standard, although there is no planned specific rulemaking scheduled, would have a high impact.
One of the more intriguing aspects of the uniform fiduciary standard is the Dodd-Frank Act doesn’t actually call for writing rules, but instead just asking the SEC to issue a study looking at the need for such a standard. The SEC did issue that study in January, in which it recommended there be such a standard of conduct for broker-dealers and investment advisers. The key sticking point for many on this issue is the confusion by retail investors over the roles played by the broker-dealers and investment advisers.
“The question is what would the standard look like,” said Nancy Reich, executive director in the financial services risk management practice of Ernst & Young. “You would have to take into account the different business models of investment advisers and broker-dealers.
“If that standard was applicable to broker-dealers, there would have to be a lot of work done, such as getting additional disclosures and additional information from clients. It would not be a simple task for firms to become compliant.”
As for the standard itself, the SEC’s report
calls for the following:
- Consistent with Congress’s grant of authority in Section 913, the Staff recommends the consideration of rulemakings that would apply expressly and uniformly to both broker-dealers and investment advisers, when providing personalized investment advice about securities to retail customers, a fiduciary standard no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2).
- In particular, the Staff recommends that the Commission exercise its rulemaking authority under Dodd-Frank Act Section 913(g), which permits the Commission to promulgate rules to provide that: the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.
In my conversation with Reich last week, she reiterated what the SEC study found: “many retail investors do not understand and are confused by the roles played by investment advisers and broker-dealers.” The study went on to say that many investors are confused by how the standards of care apply to investment advisers and broker-dealers when providing personalized investment advice about securities.
Reich also pointed out how broker-dealers would have to modify their compliance and supervisory programs.
“If the rule was adopted, [broker-dealer] firms would have to assess where there is a conflict of interest,” she said. “They would have to know where the conflicts exist and how to mitigate those. They would have to do an assessment of those programs, which would include additional disclosures and additional information from clients. They may have to change the supervisory and compliance processes. Compliance [department] should modify its routines to align with the business.”
Not surprisingly, the activity that E&Y survey respondents thought posed the greatest challenge to a broker-dealer was “modifying broker-dealer compliance and supervisory programs” (76.2 percent). The second most challenging activity was “identifying all material conflicts of interest in accounts, services and processes” (71.4 percent).
One of the more ironic findings in the survey was the answer to the question: Does your compliance function anticipate any of the following in 2011? The answer was “hiring additional compliance staff” (50 percent). The irony lies in the fact that the current economic conditions make it problematic for broker-dealers to hire more people while new regulations basically dictate that they make those hires.
“There’s a tension when there’s a lot of new regulations,” Reich said. “Dodd-Frank has created a lot of new regulations for banks, [broker-dealers] and others. Some of the new rules require new competency structures.
“In some cases, the [banks and broker-dealers] have to cut staff in one area, but have to meet the regulatory responsibility in another.”
When it was suggested if the broker-dealers should use third party companies, Reich responded that it was an alternative. However, there is a caveat.
“The latest FINRA rules state that companies have due diligence rules that say third parties meet the obligation of the law as if the work was being done in-house,” Reich said.
While the new Dodd-Frank Wall Street Reform and Consumer Protection Act and Financial Industry Regulatory Authority (FINRA) rules that would affect broker-dealers have either not been written or implemented yet, many of those who would be affected expect there to be a huge impact, according to a new study released by Ernst & Young.
Of the four major rulemaking decisions being mulled by the SEC, FINRA and the FDIC, the uniform fiduciary standard and