Thursday, January 26, 2012

Two Standards

The Dodd-Frank Act (Wall Street Reform and Consumers Protection Act) was passed in the summer of 2010 in the aftermath of the global financial crisis. The bill required the Securities and Exchange Commission (SEC) to conduct a study of the standards under which investment advisors and broker-dealers provide investment advice.

The problem is that broker-dealers and investment advisors operate under different regulatory regimes and are subject to different legal standards. In its executive summary, the SEC notes that "retail investors are generally not aware of these differences or their legal implications." http://www.sec.gov/news/studies/2011/913studyfinal.pdf

Here's the issue:

Investment advisors are held to a fiduciary standard of care. They must, by law, serve the best interests of their clients. If a conflict arises between their interests and those of their clients, they must subordinate their interests to those of their clients.

Broker-dealers are held to a suitability standard of care. This standard requires broker-dealers to make recommendations that are consistent with the interests of their customers. Notice that this standard does not require broker-dealers to serve the best of their clients.

This week The Wall Street Journal provided an update on the battle over these standards: http://online.wsj.com/article/SB10001424052970204301404577171112474127468.html

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