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Dodd Bill Requires Year-Long Study of Fiduciary Issue, SRO Idea, Gives SEC Muscle

Banking reform legislation introduced Monday by Senate banking committee chairman Christopher Dodd would give the SEC greater enforcement muscle over RIAs, and would require it to conduct a study examining the effectiveness of extending the fiduciary standard to brokers.

Banking reform legislation introduced Monday by Senate banking committee chairman Christopher Dodd would give the SEC greater enforcement muscle over RIAs, and would require it to conduct a study examining the effectiveness of extending the fiduciary standard to brokers. The study would also look at the value of having one or more SROs oversee investment advisers in conjunction with the SEC.

Among other things, the bill would also codify the Investment Advisory Committee, an investor advocacy group at the SEC that was created last summer by Chairman Mary Shapiro and has already met twice. And it would give the SEC authority to restrict mandatory arbitration.

In a press conference Monday, Dodd emphasized the bipartisan effort that has gone into creating the current bill, and his commitment to passing banking reform legislation before the end of this year. “Every day we delay is a day we are unprepared for what is around the corner,” he told reporters.

But getting this bill passed will be a battle. Dodd announced the new bill without Republican support. It still needs to go to a vote in the Senate Banking Committee, something Dodd says he hopes will happen next week. Dodd predicts the bill will end up on the Senate floor in late April.

The four major components of the bill include an end to too-big-to-fail bailouts, a strong, independent consumer watchdog, an early warning system for the next crisis, and transparency and accountability for exotic instruments like hedge funds and derivatives.

On the issue of investment adviser regulation, the bill would require that the SEC conduct a study to determine whether a fiduciary standard should be extended to stockbrokers, rather than adopting the fiduciary standard for all financial advisors outright, as Dodd originally proposed. That study would be conducted over a period of a year, rather than 18 months suggested by Senator Tim Johnson (D-South Dakota).

“A lot of the provisions are designed to get as much support as possible, from Democrats and Republicans,” says David Tittsworth, executive director of the Investment Adviser Association. “The study provision was strongly supported by Johnson, a Democrat, but also strongly supported by [Senator Mike] Crapo, from Idaho, a Republican. I assume that part of the calculation was that this bipartisan support might help the overall bill’s chances.”

Among other things, this one-year study would look at the effectiveness of existing regulatory standards of care for investment advisers and brokers (fiduciary versus suitability), regulatory gaps in the current regulatory structure and the effectiveness of investment adviser versus broker regulation. It would also examine whether applying a fiduciary duty to all financial advisors would limit product choice or raise costs for smaller investors, and the potential impact of creating one or more SROs to oversee investment advisers, alongside the SEC. There are clearly opposing opinions in the industry about whether an SRO would good or bad, and what group might play that role--FINRA or a new group dedicated only to financial planners.

"They have abandoned their commitment to a fiduciary duty which is disappointing," said Mercer Bullard, president and founder of consumer advocacy group Fund Democracy. There is still a possibility that the application of fiduciary duty to brokers will make it into a final bill, however, he says. "The House bill clearly mandates a fiduciary duty, not to mention that we have a week to fix that problem," he says.

Two other key provisions in the bill would make it easier for the SEC to police the investment advisory industry. The bill would increase the asset threshold for those investment advisers (RIAs) regulated by the SEC to $100 million from $25 million, reducing the number of RIAs overseen by the SEC by about 40 percent. “That means the SEC would have the ability to come around and inspect you much more frequently,” says Tittsworth. Of course, on the other hand, it would increase the number of RIAs overseen by the states by about 28 percent. Though these RIAs with $25 million to $100 million would be spread out among a number of states, it might mean that smaller RIAs would ultimately be subject to less oversight.

The bill would also require that the SEC be self-funded, likely keeping the money it collects from securities transactions, about $1.5 billion a year, rather than sending it to the Treasury as it currently does. Today, the SEC typically gets about $1 billion in appropriations.

The bill also amends the Investment Advisory Act of 1940 to give the SEC rulemaking authority to restrict mandatory predispute arbitration. And it creates incentives and protections for whistleblowers, creating rewards of up to 30 percent of funds recovered for information provided. Finally, it codifies the Investment Advisory Committee, and creates an office of the investor advocate, within the SEC.

The introduction of today's bill is just a first step. “The politics of this thing are extremely difficult,” says Tittsworth. “If the Democrats jam through reconciliation on healthcare like they’re talking about [doing this weekend] that could really poison the water,” he says. "Dodd faces uphill battle, but he is a skilled negotiator.”

Tim Ryan, CEO and president of broker/dealer advocacy group SIFMA, issued a statement Monday in support of Dodd’s legislation. “We hope today’s announcement by Senator Dodd brings us another step closer to enacting the reforms that are vital to strengthening our financial system, this year,” said Ryan. “We remain committed to supporting responsible reform that balances stronger regulatory transparency and oversight with the industry’s ability to finance America's economic recovery and job creation.

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