Investor Protection: Brokers and Insurance Companies Hope to Weaken Gains

The game's afoot. The financial industry is beginning its stealth attack on financial reform. First up: The single speck of potential investor protection that sneaked into the new law.

If activated, the change could push brokers, planners and insurance agents toward selling their clients better investments than they might be recommending now. That happy outcome, however, depends on how the Securities and Exchange Commission writes the rules -- and brokers and agents are swarming it. They have a trump card: their owned-and-operated members of Congress, who can threaten the SEC with budget cuts if it doesn't play along. Unless investors find some effective champions of their own, the result could be even less protection than you have now.

The issue is fiduciary duty -- two words that most investors don't understand, yet that shape the financial products you're sold and your relationship with your financial adviser.

The only people who can legally call themselves "investment advisers" have a specific duty to their clients. They're required to put your interests ahead of their own. A product or strategy they recommend should not fatten their pocketbooks at your expense.

Years ago, however, the SEC carved out an exception from this rule for the benefit of brokers as well as planners and insurance agents who sell variable annuities. They're allowed to give you self-interested advice -- for example, by selling you the class of mutual-fund shares that pays the highest commissions instead of lower-cost shares in the same fund.

By law, brokers and agents can't put "investment adviser" on their business cards because they don't follow the fiduciary rules. That's no hindrance to their business. Instead, they promote themselves as "financial advisers" or "financial consultants," which sounds like the same thing. Their clients expect and get advice and don't fully realize how skewed their adviser's incentives can be. "Brokers say that what's good for them is good for you," says Tamar Frankel, professor of law at Boston University. "Sometimes that's true but probably not."

There are other distinctions. True investment advisers have to disclose their fees upfront, in brochures and in copies of the background material they file with the SEC. They also have to disclose any conflicts of interest. Brokers and insurance agents don't.

During the struggle over the Wall Street Reform act, consumer groups and state securities regulators pressed Congress to extend the fiduciary rule to everyone who gives investment advice.

The insurance industry's lobbyists fought it with roadside bombs. "They make the lobbyists for the brokerage industry look like pushovers," says Mercer Bullard, head of Fund Democracy, which advocates for investors. The last thing insurance companies want is for agents selling variable annuities to be hobbled by cost disclosure and the rule that they have to think of the client first.

In the end, Congress punted. It ordered the SEC to study the fiduciary standard for six months and then propose a rule. Public comments on how to run the study (which will influence the outcome) closed last Monday. SEC chair Mary Schapiro has spoken on the pro-investor side. The industry hopes to slant the findings in its direction.

Assuming that the SEC will impose at least some change, the securities industry has a version of its own. "We'll accept a limited fiduciary standard," it says, "but only if the SEC writes specific rules for how advisers should behave."

That's the trap that could weaken the investor protections that you have now.

The fiduciary standard is a general principle of law. The duty of care for clients is broad and covers new abuses as they come up. For example, a court of appeals recently ruled against Citibank for cutting the internal costs of its mutual funds and pocketing all the savings. Investors were charged as if the costs had stayed the same. That's a clear example of failing to put the clients' interests first. (Citi has appealed the decision to the Supreme Court.)

The brokers and agents want any fiduciary duty to clients codified into a list of do's and don't, which they'd be happy to help write. That amounts to creating a roadmap to ways of evading the standard, Bullard says -- not just for brokers but for investment advisers, too. It wouldn't cover new situations like the Citibank case. You'd wind up with less protection than you have today.

What differences would you see if the SEC ruled that your financial adviser had to put your interests first?

Brokers and agents scream that investment products would cost you more. Firms would have to spend extra time training and supervising their salespeople, teaching them what it means to put clients' interests first, and hiring lawyers to make sure that all costs are properly disclosed.

Boo hoo. All that client-focused effort sounds like a plus to me. As for costs, a more likely result is that disclosure and competition will drive them down. Expensive variable annuities should be harder to sell. You might become aware of your broker's conflicts of interest and opt for simpler, cheaper, and better products.

Already, brokers are often held to a fiduciary standard in arbitrations and in courts. The reason they fight a formal application of the duty is that "they don't want to disclose upfront information about their fees," Frankel says.

Beyond disclosure, "the biggest impact could be in requiring advisers to take costs into account when they make recommendations," says Barbara Roper, director of investor protection for the Consumer Federation of America. It's against your best interest to sell you a high-cost product when low-cost ones could better serve your ends.

That discovery is what the Great Wall Street Sales Machine fears the most.

More on MoneyWatch:
Financial Reform Bill: Investor Protection Gets Knocked Out
Financial Reform: A Big Win for Consumers, a Big Loss for Investors
Will Brokers Have to Put Your Interests First?