Like a snowball rolling down a hill, the idea of applying a fiduciary duty standard to broker-dealers is gaining momentum.
The House financial services reform bill, passed last year, included a provision that requires a fiduciary duty when a broker-dealer provides personalized investment advice to a retail customer.
The Senate’s version of the bill, as reported out of the Banking Committee, required a study of the benefits and feasibility of imposing a uniform fiduciary duty on financial intermediaries who provide similar investment advisory services.
But things took a quantum leap forward, certainly for municipal bond market participants, with the derivatives proposal by Sen. Blanche Lincoln, D-Ark., who has wants to legislate that a swap dealer that either provides advice about a swap or enters into a swap with a state or local government, a pension plan, an endowment or a retirement plan, have a fiduciary duty.
That proposal was followed quickly by one from Sen. Arlen Specter, D-Pa., that would broaden Lincoln’s measure to cover any security or swap advice or transactions entered into with anyone, while also criminalizing any breach of the fiduciary duty with up to 25 years in prison.
Sen. Barbara Boxer, D-Calif., has a proposal that, while not criminalizing a breach, would impose a fiduciary duty on any advice, not just advice regarding swaps, given to a government, a pension plan or an employee benefit plan — including advice given in the context of a negotiated offering.
And Securities and Exchange Commission chairman Mary Shapiro has advocated yet another version — a uniform fiduciary standard for all financial services professionals providing investment advice about securities to investors.
With all these proposals out there, we need to step back and thoughtfully consider the alternatives. The concept of fiduciary obligation has been around for centuries. It arose out of the situation where one person had control over another person’s property, like a guardian’s control over the property of a minor. Clearly in that situation, the guardian should not take advantage of the situation and enrich him or herself at the expense of his or her ward.
The concept has been broadened to other situations where there is a relationship of trust and one person relies on another’s expertise or representations. At bottom, it is an obligation to put another person’s interest ahead of your own. When the obligation applies, it is strict, and if you violate it, any gain you receive as a result has to be given back.
Investment advisers have had a fiduciary obligation to those to whom they give advice for more than 60 years. But exactly what fiduciary duties are remains vague. In fact, SEC commissioner Luis Aguilar said recently that “it is not necessary or even necessarily desirable to define those duties explicitly.”
Because these are strict but vague duties, based on a relationship of trust and reliance, Congress should be careful about imposing them and certainly should not do so without careful consideration. Requiring any financial professional who gives advice, not just investment advisers, to have a fiduciary obligation is conceptually sound. But the devil is in the details, and being able to separate out when a broker-dealer is giving investment advice may prove difficult to determine.
But clearly, imposing fiduciary duties on a party with whom you are negotiating an arm’s length transaction — as senators Lincoln, Boxer and Specter would do — is wrong and flies in the face of what a fiduciary relationship is all about.
Obviously, parties should deal fairly and can be required to disclose relevant and material facts. In fact, the Municipal Securities Rulemaking Board’s Rule G-17 already requires dealers to deal fairly, which in an arm’s length transaction is the appropriate standard. Misrepresentation and fraud cannot be tolerated.
But a fiduciary relationship goes far beyond that. It requires putting the other party’s interests above your own, and that is a standard that undermines the very nature of a market transaction between two parties.
The idea of imposing fiduciary duties on dealers has been around for a while. In January 1995, then-Federal Reserve Board chairman Alan Greenspan testified before Congress that if dealers are required to ensure that an end-user’s use of a product is appropriate, such requirements might serve as a means for end-users to shift a transaction’s risk back to the dealer through legal actions.
If such legal risks are exacerbated, dealers may begin charging a premium to cover uncertain future legal claims. In other cases some dealers could move their activities overseas or completely withdraw from the market. Greenspan noted that such an outcome would present considerable costs to the economy.
Rather than taking the approach of senators Lincoln and Specter, a better approach would be to require that a municipality have a true fiduciary — a regulated swap adviser who is independent of the counterparty. The counterparty should also disclose risks and costs and other information as required by a regulator. The counterparty should have to provide the regulator with documentation that these requirements were met and the regulator should make that information publicly available.
That would be a workable solution.
Mike Nicholas is chief executive officer of the Regional Bond Dealers Association.