House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises Hearing
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"Legislative Proposals to Relieve the Red Tape Burden on Investors and Job Creators," including discussion of H.R.1135, the "Burdensome Data Collection Relief Act"; H.R.1105, the "Small Business Capital Access and Job Preservation Act"; H.R.1564, the "Audit Integrity and Job Protection Act"; and a proposal to amend Section 913 of the Dodd-Frank Act dealing with the fiduciary duty for broker-dealers.
Testimony by
Chairman Garrett, Ranking Member Maloney, and Members of the Subcommittee, I am
I have spent more than three decades in the securities and insurance business. I was honored to share my experience with this Subcommittee when I testified more than a year and a half ago. As I said then, a standard of care for financial professionals that sounds good in theory may fail in practice if it is vague and amorphous and provides no guideposts for compliance. And, a fiduciary duty offers little protection if regulators do not have the tools and resources to effectively oversee the financial professionals who are subject to it. I reiterate those statements today.
During consideration of Dodd-Frank, the then-Chair of the
The study produced in 2011 by the
The
I have great respect for the
Representative Wagner's bill would address these issues very directly. If the criteria in her discussion draft before you today had been in place from the outset, precious time and resources would have been saved by the
It is well recognized that the regulatory and oversight regime for broker-dealers is more rigorous than the regulation of investment advisers. n6 If any changes are to be made to enhance investor protection, priority should be given to bringing adviser regulation up to the level for broker-dealers. This is critical, since, annually only 8% of the 11,000 registered investment advisors are examined by the
Potential Impact of a
As a practical matter, let me discuss how the
All of our members are licensed insurance professionals; many are licensed in multiple states. Many of our members own their own insurance agencies, in some cases with multiple offices, and some of these agencies own or are affiliated with registered broker-dealers or investment advisers. Many AALU members are registered representatives of
Many life insurance producers offer variable life insurance and variable annuities, in addition to what may be viewed as more traditional life insurance products. These bundled products offer consumers investment choices for their accumulating cash values - the variable element of the product - with separate guarantees from the issuer such as a guaranteed death benefit and lifetime income guarantees, which are important options for customers seeking to address their life insurance protection and retirement needs and which have been recognized as even more important in recent years of market volatility. It is the sale of these products that triggers broker-dealer registration and
AALU's submission to the
We believe consideration of the multiple layers of regulation and oversight of these variable insurance products, together with their product-specific disclosure and due diligence requirements, should have led the
In addition, without any empirical evidence or data, the
The regulatory regime applicable to broker-dealers is more rigorous than that applicable to investment advisers, including: the level of regulatory oversight and examinations; the legal requirements for internal supervision programs; the specific liability of supervisors, which is designed to assure that they vigorously supervise the activities of those subject to their supervision; the qualification requirements for salespersons/advisers and supervisors; requirements for training and continuing education; and the nature and totality of the regulatory requirements in furthering effective programs of supervision and oversight to protect retail customers.
If the goal of imposing upon financial intermediaries any legal duty - fiduciary or otherwise - is anything other than to create liability for the intermediary, it should be to protect investors through assuring appropriate broker and adviser conduct. Regulation should provide appropriate and effective guideposts. In other words, regulation should provide clear rules of conduct, from which a financial services organization can develop training for its employees, supervision of their conduct, procedures to achieve compliance, and measures by which they can audit their conduct. Regulators then can examine and measure financial services professionals against these rules and assess for compliance. Thus, the regulations should be (1) clear and understandable to the financial professionals to whom they apply; (2) capable of being measured and monitored by supervisory personnel who are held accountable for compliance (and which are, in fact, monitored by supervisory personnel); and (3) capable of being audited and enforced by regulators. This is the model FINRA follows. It is not the Advisers Act model, where the broad, amorphous fiduciary standard of conduct has evolved essentially from case law and
Investor Confusion Can, and Should Be, Addressed More Effectively
AALU members believe our customers fully understand the role in which our members operate. Indeed, if there is any concern about the current level of disclosures, we believe many customers feel buried under the weight of required disclosure and account-related documents.
Nonetheless, we support efforts, such as FINRA's Notice 10-54, to develop better and clearer disclosure for customers of broker-dealers. n11 Indeed, we believe the FINRA process offers the potential to give thoughtful consideration to the types of disclosures that investors would find most useful in making investment decisions and to simplify the information most relevant to consumers. In AALU's comment letter to FINRA, we advocated for a simple document provided at the beginning of a customer relationship, with information about the roles, conflicts and services provided by a broker-dealer.
On this issue, the
Studies that (1) reflect investor confusion over legal duties that apply to financial professionals but also (2) show investor satisfaction about their own financial services provider point clearly to the need for more effective disclosures and investor education, not the need for wholesale changes in the legal standards.
Need to Address the Investment Adviser Inspection Gap
As we have testified previously, we believe the
Moreover, if investor confusion is to be the basis for new regulation, we submit that few investors understand that if their financial services professional is a registered broker-dealer, it is supervised by the
No standard of care is effective without a mechanism to monitor and enforce its application. The Commission and other regulators and self-regulatory organizations already devote the clear majority of their oversight and inspection resources to broker-dealers. An investment adviser who is compensated based on assets under management or fees for services and time can be just as likely to make an inappropriate recommendation to garner more assets as any commission-based broker. Devoting limited Commission resources to imposing a uniform standard of conduct for brokers, dealers and investment advisers should be considered only if and when the oversight, inspection, and supervision gap between broker-dealers and investment advisers is sufficiently addressed.
Imposing a broad, vague fiduciary duty on broker-dealers would provide no increase in investor protection
While under certain circumstances (such as when a broker has discretionary authority over a customer's account) a broker may be held to the legal standard of a "fiduciary," we believe Advisers Act regulation or a broad fiduciary duty standard has not provided superior investor protection for customers of investment advisers and would not provide a measurable increase in investor protection for retail customers of broker-dealers. In contrast, a regime for advisers that more closely resembles that for brokers and dealers would likely benefit retail customers, in view of the specificity of the rules and the strong examination program resulting from FINRA oversight.
For variable life insurance products sold by licensed insurance agents in particular, which are among the most highly-regulated products sold by the most highly-regulated financial services professionals, nothing under the Advisers Act regulatory scheme compares to the comprehensive and robust customer protections already in place: comprehensive due diligence with respect to the customer's needs and financial capacity; suitability assessment relating to both annuity and investment products; disclosures to customers about the investment product; transaction-by-transaction review and approval by the carrier/issuer; immediate and transaction-by-transaction review of each transaction by a broker-dealers' securities principal; and meaningful and effective oversight by as many as four different levels of regulators (and often involving multiple regulators at the state level). While we do not believe AALU members' clients are confused about the insurance producer's role and any potential conflicts, the
Even beyond highly regulated variable products, as discussed above, the Commission/FINRA regulatory and oversight regime for brokers and dealers - which is highly specific, proactive, capable of being monitored by supervisors (and is, in fact, monitored) and capable of being audited by regulators (and is, in fact, regularly audited by regulators) is rigorous. In fact, we believe investors, if fairly surveyed, would choose a regime which provides specific rules of conduct to guide financial professionals, imposes liability upon supervisors for failing to meet robust supervisory requirements, and provides for periodic and robust regulatory oversight, over a regime in which a financial professional may have a legal "fiduciary" obligation but operates under the assumption that a regulator may audit its activities only once every 10 years. The comparative benefits of the broker-dealer regulatory and oversight regime over the current regime for investment advisers have been amply demonstrated.
Imposing an Advisers Act fiduciary duty standard or "best interest" standard could harm investors by reducing customer choice and access to financial services
The concept of "fiduciary duty" addresses the age-old agent monitoring problem (the lack of a principal's control over, and inability to continuously monitor, its agent) by imposing various duties and obligations enforced through the courts. The elements of the duty are principles-based, not rules based, and the duty is, by its very nature, after-the-fact liability creating. n14
Many of our members operate under the Adviser's Act implied fiduciary duty and under certain specific rules adopted by the Commission under the Advisers Act. But a general fiduciary standard is inappropriate as applied broadly to sales of securities products where the broker does not hold himself/herself out as an investment adviser and does not exercise discretionary authority. It is particularly inappropriate for bundled, self-contained products like variable life and variable annuities, which come pre-assembled with several investment choices and separate contractual guarantees from the issuer such as guaranteed death benefits and lifetime income guarantees. The range and features of these products makes it difficult to determine which product is "best" and, under a "best interest" standard, almost certainly would lead to increased litigation. Our members have a long history of being able to determine suitability - and we operate under FINRA and state insurance regulators' enhanced suitability standards for these products. However, determining what is "best" would be a highly subjective determination, opening a producer to second-guessing and liability, often years after the sale of a product.
. Is the best product in a rising market the one that is most aggressively allocated to equities? Some would argue that is the case.
. But, could the best product for the client that dies three years into the contract be the one with the highest death benefit?
. In a prolonged depressed equity market, is the product with the best income guarantee the most favorable to the client?
. Which is the best product for clients when there are tradeoffs, such as one product with fewer investment choices and lower costs and another with higher charges but a wider range of investment choices?
The 2011
Thus, we believe the imposition of a broad new "best interest" or fiduciary duty standard inevitably will lead to uncertainty and litigation. In our view, this will influence many life insurance producers to withdraw from the sale of these products and reduce investor access to them.
Conclusion
AALU believes the current legal and regulatory standards of care for brokers and advisers are fundamentally sound and recognize the importance of delivering a range of choices to customers based on needs and costs. Well-publicized abuses and failures that led to the recent financial reform effort have not been related to the standards of care for brokers, dealers and advisers. Indeed, where there have been abuses and scandals, they in large part have been due to the failure of vigorous regulatory oversight and enforcement of existing standards, and not any identifiable weaknesses in the standards themselves. This problem will remain regardless of any changes to the standard. As a result, the focus should be on the process of ensuring that the standard appropriate to a defined customer relationship is met.
We also believe the issue of investor confusion is somewhat misdirected. There exist many choices and options in accessing financial services that may be "confusing" to customers without their becoming educated beyond their desire. Yet, these differences in product choices, costs and services are fundamental to a delivery system that allows people across all wealth and income levels to access the benefits of financial services in some form. The solution is not to eliminate potential confusion through homogenization, but to ensure understanding of the standard selected to meet their needs and the role in which a financial professional is serving them.
Let me close by saying that life insurance enables individuals and families from all economic brackets to maintain independence in the face of potential financial catastrophe. The life insurance industry, through permanent life insurance and annuities, provides 20% of Americans' long-term savings. Two out of three American families - that's 75 million families - count on the important financial security that life insurance products provide. Therefore, any proposed change in regulation that could limit consumer choices and access to these critical protection and savings vehicles should meet a high burden with respect to the need for the changes.
I have spent most of my professional career working in businesses that are regulated by the
Thank you for the opportunity to testify in this important hearing. AALU looks forward to continuing to work with you on these critical issues.
n1 As President and CEO of
n2
n3
n4 Duties of Brokers, Dealers, and Investment Advisers, 78 Fed. Reg. 45, (
n5 Note that the need for rigorous economic analysis is critical, in view of the
n6 See, e.g., Study on Enhancing Investment Adviser Examinations (
n7
n8
n9 See SEC Staff Study, supra n. 2 at 161-162, simply citing
n10 See SEC v.
n11 See FINRA Notice 10-54, Disclosure of Services, Conflicts and Duties (
n12
n13 See U.S. Securities and Exchange Commission FY 2014 Congressional Budget Justification, available at http://www.sec.gov/about/reports/secfy14congbudgjust.pdf.
n14 At a
Read this original document at: http://financialservices.house.gov/UploadedFiles/HHRG-113-BA16-WState-KEhinger-20130523.pdf
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