Regulatory "Reform" Bill Shafts Individual Investors

05/12/2010 05:12 am ET | Updated May 25, 2011

I should have known it was too good to be true. A few months ago I was enthusiastically optimistic that the regulatory reform bill Congress was looking to pass would include an important investor protection measure known as the "fiduciary duty" standard, which would require brokers to put their clients' financial interests ahead of their own. Senator Christopher Dodd (D-CT) said he supported the measure, as did SIFMA, Wall Street's lobbying arm. Indeed, John Taft, head of the SIFMA committee on regulatory reform, even acknowledged, "It's a big deal for our industry to do this." The SEC and FINRA also indicated support for adopting the standard.

Despite all the declared "public" support, it's near certain that the regulatory reform bill Congress is expected to pass next week won't require holding brokers to a fiduciary standard. The provision has been quietly dropped from the proposed legislation currently being circulated. The omission should be of major concern to investors who buy stocks, bonds, and other financial products from Wall Street brokers.

Wall Street brokers currently must adhere to what's known as the "suitability" standard, which Wall Street maintains means that they are only required to sell financial products suitable for clients at the time of sale and they don't have to disclose commissions. On a practical level, for example, if a broker puts a client into a certain stock, Wall Street maintains that the broker isn't responsible for monitoring the performance of that stock after the sale is completed. The stock only has to be "suitable" at the time of sale. Under the "fiduciary duty" standard, the broker could be required to monitor a client's entire portfolio and ensure that it remains consistent with the stated investment objectives. The broker also could be required to sell financial products at the lowest available cost.

Put simply, the fiduciary duty standard would dramatically raise the standard of client conduct brokers would be legally required to maintain.

There is a compelling argument for requiring brokers to adhere to a fiduciary standard. They typically market themselves as financial "advisers" and a $875,000 study the SEC commissioned in 2008 found that's how most investors regard them. As the saying goes, "It it quacks like a duck..."

It's not yet clear to me how the fiduciary standard provision from the latest draft bill proposal disappeared, but there is evidence that Wall Street was possibly head-faking support while quietly moving to kill the measure. A Morgan Stanley memo recently uncovered by Bloomberg advocated that the SEC "should be given the responsibility to thoughtfully review brokerage services and regulations, and promulgate new, specifically tailored rules for the brokerage business." Translation: Let's refer the matter to the SEC and let their staffers study and bury the matter. Morgan Stanley, the firm with the biggest broker network, has good reason to fear the adoption of a fiduciary standard: the standard could ultimately cost the firm up to seven percent of its earnings, according to an analyst.

Given that Wall Street brought the nation to near ruin, one might have expected that Congress would finally have had the will to stand up to the industry's powerful lobbyists. But once again Wall Street has trumped the system. And the SEC and FINRA, which unilaterally could implement the fiduciary standard, have opted to remain on the sidelines.

Individual investors should take note how there is no one in Washington moving to protect their interests.