Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Monday, July 13, 2009

Some Key Provisions of Proposed Investor Protection Legislation

I posted over the weekend the text of the proposed Investor Protection Act of 2009(Download InvestorProtectionAct2009) released by Treasury.  In this blog, I discuss some of its key provisions:

Investment Advisory Committee.  The role of this Committee (already organized by Mary Schapiro) is to advise and consult with the SEC on regulatory priorities, initiatives to protect "investor interest," and initiatives to promote investor confidence; the SEC is not required to follow any of its recommendations.  Its members are supposed to represent the interests of both individual and institutional investors and "use a wide range of investment and approaches."  The members are supposed to meet a minimum of two times a year. (sec. 911)

Establishment of a Fiduciary Duty for Brokers, Dealers, and Investment Advisers, and Harmonization of the Regulation of Brokers, Dealers and Investment Advisers.  As drafted, this proposal offers the promise of a complete rethinking of the duties of broker-dealers.  The key provision, however, is drafted as permissive language, so it may be illusory.  Specifically, the proposal states:

 The Commission may promulgate rules to provide, in substance, that the standards of conduct for all brokers, dealers, and investment advisers, in providing investment advice about securities to retail investors or clients (and such other customers or clients as the Commission may be rule provide), shall be to act solely in the interest of the customer or client without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice. (section 912(a))

If this legislation were enacted as a mandate to the SEC to adopt such standards of conduct, it would make a long overdue transformation of the broker-dealers' responsibilities.  Keep in mind that under federal securities law broker-dealers are only liable for fraudulent advice; there is no federal remedy for brokers who negligently provide customers with advice.  Moreover, under the prevailing interpretation of the FINRA/NASD suitability obligation, brokers owe customers duties only when they make recommendations to customers; the obligation does not extend to advice to hold securities.  Moreover, state law generally does not require brokers to provide updated advice to customers even when they initially recommended the securities. 

In contrast to the permissive language about the standards of conduct, the proposed statute provides that the SEC shall (1) take steps to facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with investment professionals, and (2) examine and, where appropriate, promulgate rules prohibiting sales practices, conflicts of interests, and compensation for financial intermediaries that it deems contrary to the public interest and the interests of investors. (sec. 912(b))

Currently, the problem of conflicts of interest are generally "managed" by disclosure of the possibility of a conflict in confusing, boilerplate language; thus, securities laws generally treats broker-dealers as sales persons who can recommend proprietary products or services that provide a substantial financial benefit to the broker or his firm, even though there are better alternative products and services available, notwithstanding the fact that brokers customarily advertise themselves as financial "advisers" or "consultants" who look out for their customers' best interests.  If adopted, this legislation would require clearer and more informative disclosure, at a minimum, and, in addition, (hopefully) prohibition of the more egregious conflicts of interest. 

If the SEC enacted standards of conflict as proposed in the legislation, the federal law would finally move closer to recognizing that broker-dealers owe fiduciary duties to their customers.  Could this happen?  Let's wait and see.

The proposed legislation also states that the SEC has the authority to prohibit or impose conditions on the use of pre-dispute arbitration agreements in customers' agreements if it finds that such prohibition or limitation is in the public interest and for the protection of investors. (sec. 921)  Since the SEC already has this authority implicitly under its authority to approve or disapprove of SRO rules, I do not see what this provision adds to the current law. 

The proposed legislation also has some interesting provisions on whistleblower incentives and protections and the establishment of an Investor Protection Fund, which I will discuss in a later post.

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As a broker (registred rep) what the hell does this mean?? Geez this is crazy, it essentially kills all functions of a broker calling anyone about anything...
The issue is faulty products, too many mutual funds, etc...this would wipe out all but say 50000 or so reg reps...mainly they would field unsolicited orders...

Posted by: Steve Smith | Aug 12, 2009 12:41:01 PM

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