[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

ENSURING APPROPRIATE REGULATORY
OVERSIGHT OF BROKER-DEALERS
AND LEGISLATIVE PROPOSALS TO IMPROVE
INVESTMENT ADVISER OVERSIGHT

=======================================================================

HEARING

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

----------

SEPTEMBER 13, 2011

----------

Printed for the use of the Committee on Financial Services

Serial No. 112-58

ENSURING APPROPRIATE REGULATORY OVERSIGHT OF BROKER-DEALERS AND
LEGISLATIVE PROPOSALS TO IMPROVE INVESTMENT ADVISER OVERSIGHT

ENSURING APPROPRIATE REGULATORY
OVERSIGHT OF BROKER-DEALERS
AND LEGISLATIVE PROPOSALS TO IMPROVE
INVESTMENT ADVISER OVERSIGHT

=======================================================================

HEARING

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS AND

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

__________

SEPTEMBER 13, 2011

__________

Printed for the use of the Committee on Financial Services

Serial No. 112-58

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72-599 WASHINGTON : 2012
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HOUSE COMMITTEE ON FINANCIAL SERVICES

SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

Larry C. Lavender, Chief of Staff
Subcommittee on Capital Markets and Government Sponsored Enterprises

SCOTT GARRETT, New Jersey, Chairman

DAVID SCHWEIKERT, Arizona, Vice MAXINE WATERS, California, Ranking
Chairman Member
PETER T. KING, New York GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois BRAD MILLER, North Carolina
JEB HENSARLING, Texas CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas GWEN MOORE, Wisconsin
JOHN CAMPBELL, California ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan JOE DONNELLY, Indiana
KEVIN McCARTHY, California ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico JAMES A. HIMES, Connecticut
BILL POSEY, Florida GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK, AL GREEN, Texas
Pennsylvania KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois

C O N T E N T S

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Page
Hearing held on:
September 13, 2011........................................... 1
Appendix:
September 13, 2011........................................... 47

WITNESSES
Tuesday, September 13, 2011

Dwyer, William E. III, Chairman, Financial Services Institute
(FSI).......................................................... 10
Ehinger, Ken, President and Chief Executive Officer, M Holdings
Securities, Inc., on behalf of the Association for Advanced
Life Underwriting (AALU)....................................... 12
Headley, Terry, President, National Association of Insurance and
Financial Advisors (NAIFA)..................................... 13
Irwin, Steven D., Pennsylvania Securities Commissioner, on behalf
of the North American Securities Administrators Association,
Inc. (NASAA)................................................... 15
Ketchum, Richard G., Chairman and Chief Executive Officer,
Financial Industry Regulatory Authority (FINRA)................ 17
Roper, Barbara, Director of Investor Protection, Consumer
Federation of America (CFA).................................... 19
Taft, John, Chairman, the Securities Industry and Financial
Markets Association (SIFMA).................................... 21
Tittsworth, David G., Executive Director and Executive Vice
President, Investment Adviser Association (IAA)................ 23

APPENDIX

Prepared statements:
Hinojosa, Hon. Ruben......................................... 48
Luetkemeyer, Hon. Blaine..................................... 49
Dwyer, William E. III........................................ 51
Ehinger, Ken................................................. 67
Headley, Terry............................................... 80
Irwin, Steven D.............................................. 89
Ketchum, Richard G........................................... 101
Roper, Barbara............................................... 109
Taft, John................................................... 139
Tittsworth, David G.......................................... 229

Additional Material Submitted for the Record

Garrett, Hon. Scott:
Written statement of The American College.................... 265
Written statement of the American Council of Life Insurers... 268
Written statement of the Association of Institutional
INVESTORS.................................................. 297
Written statement of The Bond Dealers of America............. 306
Written statement of The Financial Services Roundtable....... 312
Written statement of the Independent Insurance Agents &
Brokers of America......................................... 321
Written statement of the Investment Company Institute........ 324
Written statement of the Managed Funds Association........... 333
Written statement of the National Association of Independent
Broker/Dealers............................................. 344
Hensarling, Hon. Jeb:
Written responses to questions submitted to Ken Ehinger...... 346
Written responses to questions submitted to Terry Headley.... 350
Written responses to questions submitted to Steven D. Irwin.. 355
Written responses to questions submitted to Richard G.
Ketchum.................................................... 356
Written responses to questions submitted to Barbara Roper.... 359
Written responses to questions submitted to John Taft........ 361
Written responses to questions submitted to David G.
Tittsworth................................................. 363
Written statement of the Association of Institutional
INVESTORS.................................................. 364
Hinojosa, Hon. Ruben:
Written statement of the Financial Planning Coalition........ 373
Schweikert, Hon. David:
Written responses to questions submitted to Barbara Roper.... 492
Waters, Hon. Maxine:
Written statement of Mercer Bullard, AARP Public Policy
Institute.................................................. 494
Written statement of the Financial Planning Coalition........ 531
Letter to Representative Carolyn McCarthy from the North
American Securities Administrators Association, Inc........ 546
Letter to Labor Secretary Hilda Solis, CFTC Chairman Gary
Gensler, and SEC Chairman Mary L. Schapiro from the New
Democrat Coalition......................................... 555
Written statement of the Project on Government Oversight..... 559

ENSURING APPROPRIATE REGULATORY
OVERSIGHT OF BROKER-DEALERS
AND LEGISLATIVE PROPOSALS TO IMPROVE
INVESTMENT ADVISER OVERSIGHT

----------

Tuesday, September 13, 2011

U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:03 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Schweikert,
Royce, Biggert, Neugebauer, Campbell, Pearce, Posey,
Fitzpatrick, Hayworth, Hurt, Grimm, Stivers, Dold; Waters,
Sherman, Hinojosa, Lynch, Miller of North Carolina, Maloney,
Perlmutter, Donnelly, Carson, Himes, Peters, Green, and
Ellison.
Ex officio present: Representative Bachus.
Also present: Representative McCarthy of New York.
Chairman Garrett. Good morning. The Subcommittee on Capital
Markets and Government Sponsored Enterprises is called to
order.
I would like to seek unanimous consent for the gentlelady
from New York, who is not on this subcommittee, to be able to
participate in today's hearing. Seeing no objections, we
welcome the gentlelady with us to the subcommittee.
We have a fairly large panel. We managed to do it somehow
without the extra kiddie table at the end, so you are all
squeezed in there. Sorry about that. But welcome to all of you.
We are going to begin the process. I understand the ranking
member is on her way, but we will begin with opening statements
and then proceed from there to the panel. With that, I yield
myself 3 minutes for an opening statement.
The SEC, I think most people here will agree, has a lot on
its plate to deal with. Some would argue that it has too much
on its plate. This is one of the reasons we see a legislative
proposal such as the one from Chairman Bachus, who is with us
here today, which would shift oversight of retail investment
advisers from the SEC to an SRO.
With too much on the plate over at the SEC, some of the
basics arguably are not getting done. For instance, the SEC in
recent history has been examining investment advisers
approximately once every decade. Because of this, we know that
there have been crooks out there such as Bernie Madoff and
others who have had a greater chance to defraud the innocent
investors. The frequency of examinations, of course, is not the
only consideration. There are other things we can go into here.
FINRA, for instance, also examined Madoff's broker-dealer unit
more frequently than the SEC did, but unfortunately still
missed the fraud that was there.
Nevertheless, I look forward to a robust discussion this
morning on Chairman Bachus' bill and what are the--it is in
draft form, which means that today is a good opportunity to
discuss the merits of it and any changes that might be
necessary.
Another concept the Commission should be mindful of,
especially with its crowded agenda, is the appropriate use of
their resources, which you often hear that they need more of.
The Dodd-Frank Act requires an unprecedented avalanche of new
rulemakings by the SEC. People can agree, or people can
disagree with how many of them are needed or addressing actual
problems, you have heard that discussion in the past, but they
are required in Dodd-Frank and will require a large amount of
the Commission's resources to get them all done and to get them
all done right.
Furthermore, the SEC has a history of having rulemakings,
unfortunately, overturned in the courts. Just recently, for
instance, the SEC had its proxy access rule basically vacated.
Unfortunately, the rule was vacated after the SEC spent a lot
of its resources, over 23,000 staff hours, on the rulemaking
and subsequent litigation at a cost of around $2 million or
$2.5 million. When a potential rulemaking on a uniform
fiduciary standard is considered, the Commission, we believe,
needs to thoughtfully and thoroughly consider the most prudent
course of action that it should be taking.
First, this would be undertaking a discretionary rulemaking
at a time when the SEC is required to do so many other tasks.
And remember, this is at the same time that they are only
examining investment advisers, as I said, once about every 10
years, every decade. Many would argue that more attention needs
to be paid to get this done and other core tasks than
additional discretionary tasks that they have been doing.
Second, no one needs to be reminded here about the Federal
Government's serious spending problems that fortunately, the
Congress is now finally beginning to address. Additional
resources for an agency that has tripled its budget in recent
years basically is not an option.
Finally, the SEC has already wasted, we would say, millions
of dollars pursuing rules without doing the proper economic and
cost-benefit analysis before the rules go out.
So, until the SEC comes forward with a reason backed by
credible and real data that a uniform fiduciary standard is
necessary to address an actual problem, which is not produced
in the study required by Dodd-Frank Section 913, I am not sure
why such a rulemaking would be under consideration now or at
any point.
I thank the panel for coming today before this committee,
and I look forward to what should be an interesting discussion
and diverse opinion from this panel.
With that, I yield to Mrs. Maloney for 3 minutes.
Mrs. Maloney. Thank you, Mr. Chairman, and welcome to all
eight witnesses today. I don't think we have ever had such a
large panel, and it speaks to the importance of the oversight
of investment advisers and broker-dealers. It is a very
important part of this committee's work, and I am pleased that
we are exploring this today.
The committee has looked at scams or schemes in the past,
especially in the wake of Madoff, and today we are looking at
two specific issues that have emerged. The first issue is
whether broker-dealers should be held to a higher standard of
care than they currently are held to, and whether that standard
should be harmonized with what investment advisers are held to.
As it stands now, broker-dealers are required to suggest
products that are suitable to their clients. Investment
advisers, on the other hand, are required to suggest products
that are in the best interests of their clients. The question
is whether consumers will be better served if the standard for
broker-dealers is elevated.
The second issue is whether broker-dealers and investment
advisers are adequately examined and supervised. We are all
wondering on this committee how it is that Bernie Madoff was
able to operate fraudulently for so long without anyone
realizing it, with so many whistleblowers reporting it. Will
more rigorous oversight and examination either on the part of
the SEC, a new SRO or another entity prevent another Bernie
Madoff? Who should be conducting these examinations, and how
often should they be done? These are some of the questions that
we are hoping to obtain answers to today.
Last year's Dodd-Frank bill authorized studies on these
important issues to be conducted by the SEC, both of which were
completed in January, and the study recommended that the
standard for broker-dealers be elevated to something akin to
the standard for investment advisers, and the SEC has indicated
that it will go forward with such a rule. While I do not oppose
the SEC moving forward, I do want to make sure that sufficient
economic impact analysis is done to ensure that consumers will
benefit in the end, and I hope we will explore that today.
The study also suggested three ways that Congress may move
forward to address the issue of examinations: first, imposing
user fees on SEC-registered investment advisers; second,
authorizing one or more self-regulatory organizations, or SROs,
to examine; and third, authorizing FINRA to examine dual
registrants for compliance with the Advisers Act.
Chairman Bachus, I understand, has put forward legislation
that would codify the second of these three suggestions and
would authorize an SRO to supplement the SEC's oversight of
investment advisers.
I think we can all agree that something needs to change,
and that the status quo is not acceptable. So I hope the
witnesses today will be able to comment on the various
proposals and shed light on whether they think it is preferable
to the other suggestions and the suggestions that the SEC made
in their study.
We have a lot of ground to cover today, Mr. Chairman, and
thank you for calling this hearing. I yield back.
Chairman Garrett. I thank the gentlelady.
The chairman of the full Financial Services Committee, the
gentleman from Alabama, is recognized for 4 minutes.
Chairman Bachus. Thank you, Chairman Garrett, for convening
this important hearing to examine Sections 913 and 914 of the
Dodd-Frank Act. Section 913 of the Act gave authority to, but
did not require, the SEC to create a new standard of care for
broker-dealers. Even though the SEC has yet to provide Congress
with any empirical data or economic analysis to justify a
rulemaking on the standard of care for broker-dealers, the
SEC's apparent plan is to push forward with rulemaking by
recalling examiners and reassigning them to write these
optional rules.
It is questionable whether the SEC should undertake
rulemaking for a new standard of care for broker-dealers at the
expense of other statutory mandated rulemaking. If the SEC
decides, however, to issue a proposal to implement Section 913,
it must carefully act and comprehensively act to avoid
disrupting an investor's relationship with his or her chosen
investment professional. Furthermore, the Administration must
coordinate disparate and potentially conflicting rulemaking
efforts regarding the standard of care for investment
professionals.
The Labor Department's proposed rule to modify the existing
definition of fiduciary status under ERISA appears to be moving
forward even though it creates conflicting standards between
advisers for investment accounts and advisers for retirement
accounts and would make it illegal for swap dealers to enter
into swaps with retirement plans. The SEC, the CFTC, and the
Department of Labor must coordinate their efforts to minimize
harm to investors. The last thing our economy needs is
additional disruption or elimination of financial products and
services currently available to American investors.
Investment advisers and broker-dealers often provide
indistinguishable services to retail customers, yet only 9
percent of investment advisers are examined by the SEC or were
examined by the SEC in 2010, compared to 44 percent of broker-
dealers. The Dodd-Frank Act did not fix this serious
examination disparity. Rather, Section 914 merely requires the
SEC to study how to improve investment adviser oversight.
The SEC staff proposed three options to address oversight.
One option, imposing user fees, is unworkable and essentially
amounts to an expansion of the SEC, which is in desperate need
of fundamental reform, not increased responsibility.
A second alternative, allowing FINRA to examine duly
registered entities, would be a partial solution, however,
stand-alone retail investment advisers' examination rates would
not improve.
In my view, the SEC staff's third option, authorizing one
or more self-regulatory organizations or SROs to examine SEC-
registered investment advisers would provide the most
comprehensive and streamlined approach to increase investment
adviser examination rates. Therefore, I have prepared draft
legislation that would authorize the creation of national
investment adviser associations to register, examine, and
discipline investment advisers to retail customers. The
chairman of the subcommittee provided industry groups and other
special interest groups and consumer groups with a draft last
week.
Regardless of the standard of care, bad actors will
naturally flow to a regime where they are least likely to be
examined, therefore, it is essential that we augment and
supplement the SEC's oversight to dramatically increase the
examination rate for investment advisers with retail customers.
In conclusion, customers may not understand the different
titles that investment professionals use, but they do believe
that someone is looking out for them and their investments. For
broker-dealers, that is true. For investment advisers, it all
too often is not true, as was the case with the Bernie Madoff
Ponzi scheme. That must change. I hope my colleagues will
support this legislation and that all interested parties will
join the committee's efforts to improve investor adviser
oversight and enhance investor protection to avoid another
Bernie Madoff experience.
Thank you, Chairman Garrett. I yield back.
Chairman Garrett. I thank the gentleman for yielding back.
And I also thank the gentleman for the work he has done on
the draft legislation that we are considering today.
The gentleman from Massachusetts is recognized for 3
minutes. Mr. Lynch?
Mr. Lynch. Thank you, Mr. Chairman.
I would like to welcome all the witnesses gathered here
today and thank them for their time and effort in helping this
committee with its work, especially Bill Dwyer, who is here
today as the chairman of the Financial Services Institute, but
he is also a resident of Massachusetts. He runs a company
called LPL Financial in Massachusetts. He is a graduate of
Boston College, which at least puts him in good stead with this
Congressman.
Investment advisers and broker-dealers are important
stewards of the wealth of American families, whether by helping
middle-class families with their retirement savings or advising
small businesses on raising capital. Businesses that give
financial advice provide much needed growth in job creation,
and they are a vital part of the economy not only in my
district, but across the country.
It is important that we foster an environment in which
investment advisers and broker-dealers can continue to help
investors grow their money wisely. It is also incumbent upon
this Congress and this committee to ensure that American
families and small businesses that entrust their savings to
financial advisers can be confident that trust is not
misplaced. That is why we must also remain vigilant to ensure
that regulators, whomever they may be, have the resources they
need to keep investors well-informed and their money safe.
I am very interested in hearing the witnesses' testimony
today about the proposals contained in the SEC studies required
under Dodd-Frank as well as any constructive ideas to improve
investor confidence in financial advisers. I hope that we can
have a productive discussion here today about improving this
important industry, and I yield back.
Chairman Garrett. Thank you.
The gentleman yields back.
The gentleman from Arizona is recognized for 1 minute.
Mr. Schweikert. Thank you, Mr. Chairman.
Mr. Chairman, looking up and seeing the new cracks on the
walls, I hope those aren't a message from above.
Mr. Chairman, with so many panelists here today, for
someone like myself, what I am looking for is your insight into
the law of unintended consequences. With the way the regulatory
environment is moving, the promulgation of future rules that
are maybe being drafted, are we heading towards that unintended
consequence of making it harder, making it more difficult,
taking away choices both on advice and in product; and by doing
so, do we ultimately damage through that unintended consequence
the financial futures of our citizens?
Thank you, Mr. Chairman.
Chairman Garrett. The ranking member is recognized for 2
minutes.
Ms. Waters. Thank you very much, Mr. Chairman. Thank you
for holding this hearing today.
Improving the regulation of brokers, investment advisers,
and other financial professionals was a central goal of Dodd-
Frank and is crucial to ensuring that families are protected as
they save for retirement and their children's education or to
buy a home. Research indicates that the average unsophisticated
retail investor often does not understand the differences
between investment advisers and broker-dealers. In fact,
investors, unsurprisingly, expect their financial advisers to
act in their best interests, regardless of the technical legal
standard they may be held to. As the lines between broker-
dealers and investment advisers have blurred in recent decades,
improving consumer protection has become increasingly
important.
For this reason, I applaud the SEC for recommending in
their Section 913 study that broker-dealers and investment
advisers should both be subject to a fiduciary duty standard
when they render investment advice to retail customers, and I
am pleased that many of the industry witnesses here today agree
with me, the SEC, and the investor advocates that this is the
appropriate approach.
Given the widespread agreement on this point, I think that
differences in approaches can be worked out during the
rulemaking process, and there is no need to stop rulemaking in
its tracks, as some of my colleagues have suggested.
Finally, I would caution against delegating more
responsibilities to a self-regulatory organization when it
comes to investment advisers. I would agree with today's
witness from the Consumer Federation of America saying that, as
a general principle, I believe in funding government agencies
to do their jobs rather than farming out those responsibilities
to private entities. It is essential that we provide the SEC,
our cop on the beat for Wall Street, with the funding it needs
to do its job, but with that said, I am interested to hear the
witnesses' comments on Chairman Bachus' bill and how an
investment adviser SRO might work.
I yield back the balance of my time.
Chairman Garrett. The gentlelady yields back.
Mr. Royce is recognized for 1\1/2\ minutes.
Mr. Royce. Thank you, Mr. Chairman.
I would urge the Members to take a look at the arguments
made by two of the SEC Commissioners, Kathleen Casey and Troy
Paredes, as they go forward here. I think that when you look at
their arguments about the study, they say that at the end of
the day, investors may have fewer broker-dealers and investment
advisers to choose from, they may have access to fewer products
and services, they may have to pay more for the services and
advice they do receive. Any such results are not in the best
interests of investors, nor do they serve to protect them.
The argument they are making is that this is a flawed
study, and they are suggesting that this aspect be studied.
They say regulation based on poorly supported recommendations
runs the risk of restricting retail investors' access to
affordable, personalized investment advice and the range of
products and services that they currently enjoy. They are
arguing that without consideration of that, this is a step
back. They say that there is a need for that particular
research and analysis going into this report, and frankly,
grasping potential costs and implications has escaped the SEC
in the past.
That is one of our concerns here, with the corporate
culture at the SEC and other regulatory agencies, and that is a
concerning trend. I think it should be. I think it should be,
for us, a reason to ask that the advice of these two
Commissioners be deployed here in this study. Given the sorry
state of our economy and the continued slide in the
competitiveness of this country and of the competitiveness of
our capital markets, I don't think now is the time to issue
rules without fully understanding the ramifications, and when
two Commissioners say, let us put that into the analysis, I
think it is time to do it. That is the recommendation that I
would certainly have, Mr. Chairman. Thank you.
Chairman Garrett. I thank the gentleman.
Mr. Carson is recognized for 1\1/2\ minutes.
Mr. Carson. Thank you, Mr. Chairman.
Mr. Chairman, as we discuss another study the SEC was
mandated to do through Dodd-Frank, I would like to use this
opportunity to again voice my support to increase funding at
the SEC. My friends, my good friends on the other side of the
aisle have not hidden their desire to slow down or undo parts
of the Dodd-Frank Act by suffocating funds to agencies charged
with enforcing the new law. The Dodd-Frank Act requires the SEC
to implement over 100 new regulations, create 5 new offices,
and undertake about 20 studies. This is a significant
undertaking that needs our support. The SEC needs funds to
carry out new powers to police large hedge funds, derivatives
dealers, and credit raters that it was tasked with by the Dodd-
Frank law. Government watchdogs on Wall Street have long been
outnumbered and outspent by the companies that are opposed to
policing. With the current funding recommendation, Republican
leaders look to continue this imbalance and limit protections.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Garrett. The gentleman yields back.
Mrs. Biggert is recognized for 2 minutes.
Mrs. Biggert. I thank the chairman, and good morning to all
of you and thank you for being here.
As you are all well aware, Section 13 of the Dodd-Frank Act
required the SEC to report to the House Financial Services
Committee and the Senate Banking Committee on the standard of
care applicable to broker-dealers and investment advisers. This
section permits, but does not require, the SEC to issue rules
to address inadequacies in the standard of care. Also, under
Dodd-Frank, Section 914 has a mandate which specifically
requires the SEC to study the authorization of one or more
self-regulatory organizations to supplement the oversight and
investigation of investment advisers.
Despite the congressional mandate for the SEC to
extensively study the fiduciary standard, the Department of
Labor unilaterally decided to preempt the SEC and propose a
rule to overhaul the standard without allowing the SEC to
finish its study. Unfortunately, this is another example of the
Administration imposing duplicative, overreaching, and
burdensome regulations on the wrong folks at the wrong time.
I am deeply concerned that just as Americans are worried
about how much is left in their 401(k)s, the DOL proposal could
reduce the number of options that the middle class rely on for
retirement. Now that the SEC has concluded its study and the
DOL has released its proposal, I am interested to hear from all
of you particularly your opinions on whether the SEC has the
resources to examine all investment advisers and how self-
regulatory organizations could help. Most importantly, I would
like to hear how we can ensure the industry is efficiently
regulated without disseminating the investment options so vital
to millions of Americans.
Thank you all for being here today, and I look forward to
your testimony. I yield back.
Chairman Garrett. The gentlelady yields back.
Mr. Peters is recognized for 1 minute.
Mr. Peters. Thank you, Mr. Chairman, and thanks to the
witnesses for being here today in support of the hearing.
As a former investment adviser who is also a registered
broker-dealer, I understand how important the issues we are
discussing today are to industry professionals and consumers. I
think we can all agree that what is most important is making
sure that consumers are getting good advice. Consumers don't
understand the difference between a broker-dealer and an
investment adviser, and quite frankly, they shouldn't have to,
but when they are given personalized investment advice, they
have the right to expect that advice is in their best
interests.
That said, consumers are not being served if they have
diminished access to quality advice or the full range of
products and services. I will be interested in hearing from the
witnesses how these two very important goals can be
accommodated.
I would also be interested in hearing more about the
Department of Labor's proposed business conduct standards,
which I believe run the risk of severely limiting small
individual investors' access to quality advice.
Consumers also have the right to expect that investment
advisers they rely on are being properly policed. As a former
investment adviser, I know firsthand that the best regulator is
an informed and educated consumer, but unfortunately we have
seen instances where even savvy investors have been taken
advantage of.
Whatever entity is going to regulate investment advisers in
the future, it is critical they are given the resources they
need to do their job. I firmly believe that consumers and
industry both benefit from the investor confidence that comes
from a strong regulator that has the capacity to keep bad
actors out of the system, but that kind of regulator requires
resources which the Republican leadership seems unwilling to
provide.
I look forward to your testimony.
Chairman Garrett. And the gentleman yields back.
We were looking for Mr. Grimm. Unless he is not right
there, then Mr. Stivers is recognized for 1 minute.
Mr. Stivers. Thank you, Mr. Chairman.
I appreciate the witnesses being here today, and with
regard to the three issues we are going to talk about today, I
wanted to sort of have you focus your comments to help us on a
few things.
With regard to the uniform fiduciary standard for broker-
dealers and investment advisers, I have really four questions:
one, what are the substantial problems that this regulation
attempts to address; two, what kind of cost-benefit analysis
has occurred; three, what does the cost-benefit analysis tell
us; and four, what is the impact on consumers?
With regard to the Department of Labor regulation, their
fiduciary rule through ERISA, I am curious what the impact will
be on IRA holders, what the costs will be, and what it will
mean to their options of investments.
And, finally, with regard to examinations, I am a fan of
Chairman Bachus' approach, but I am curious to hear from the
witnesses what they think of Chairman Bachus' approach with
SROs.
I am looking forward to hearing the witnesses' testimony
today. I want to thank you for being with us today.
Mr. Chairman, thank you for allowing me some time. I yield
back.
Chairman Garrett. I thank you for your comments.
Mr. Perlmutter is recognized for 2 minutes.
Mr. Perlmutter. Thank you, Mr. Chairman, and I look forward
to the testimony this morning. I think this is an important
subject, whether regulation should be extended to various
individuals for various products or not. All of this came
from--in my opinion--the frauds that we saw conducted by Bernie
Madoff as well as Stanford and some others. Whether these
regulations really resolve those kinds of frauds or not is
something I would like to hear about.
But as to my friends in the Republican Majority, when the
chairman says maybe the SEC has too much on its plate, when you
take the plate and you shrink it from what you have for the
main course and you make it a dessert plate, yes, there
probably is too much on that plate. But whether or not we need
that regulation, I think is what is important.
Between Madoff and Stanford, about $50 billion to $60
billion was stolen, and the question is, do you want to take
the cops off the beat? Whether these regulations that are being
discussed today are appropriate or warranted, that is one
question, but to take the cops off the beat to allow investor
confidence to erode as it did in the fall of 2008, I think is
just the wrong way to go. We need to be focusing on more
investor confidence, not less, and we need to be focusing on
jobs, and I would ask the Republican Majority to turn their
attention to those things.
I yield back.
Mr. Schweikert. [presiding]. Thank you.
Mr. Schweikert. Mr. Dold, for 1 minute.
Mr. Dold. Thank you, Mr. Chairman.
I certainly want to thank the witnesses for being here
today.
As you all know, approximately 11,000 SEC-registered
investment advisers manage over $38 trillion for more than 14
million customers, and over 5,000 broker-dealers manage over
100 million accounts. With so many millions of Americans
trusting so much wealth to investment advisers and broker-
dealers, it is critical that we create a strong, modern,
rational, and balanced regulatory framework that provides
meaningful investor protections, while avoiding unnecessarily
high costs that investors will ultimately pay.
For this hearing, I am particularly interested in four
specific areas: first, have bifurcated duty standards created
undue investor risk, and would a uniform fiduciary duty
standard effectively enhance investor protection; second, what
are the likely costs, benefits, and risks of a uniform
fiduciary duty standard for broker-dealers and investment
advisers, and how likely and quantifiable are those costs,
benefits, and risks; third, what is the best way to finance
necessary investment adviser examinations, and who can most
cost-effectively conduct those necessary examinations; and
fourth, will the Labor Department's ERISA fiduciary rulemaking
proposal lead to inconsistency and affirmative conflicts with
other statutes and regulations?
And again, I thank the witnesses for being here. I look
forward to your testimony.
Thank you, Mr. Chairman.
Mr. Schweikert. Thank you, Mr. Dold.
Mr. Dwyer, you are our first witness. Thank you for joining
us.
Mr. Dwyer. Thank you, Mr. Chairman.

STATEMENT OF WILLIAM E. DWYER III, CHAIRMAN, FINANCIAL SERVICES
INSTITUTE (FSI)

Mr. Dwyer. My name is Bill Dwyer, and I am president of
national sales and marketing for LPL Financial. By way of
background, LPL is the Nation's 4th largest broker-dealer, with
12,600 FINRA-registered advisers, approximately 95 percent of
whom are also registered under our RIA, making LPL one of the
largest registered investment advisers in the Nation. I am
pleased to testify today on behalf of the Financial Services
Institute, which represents firms supporting over 200,000
independent financial advisers.
As dual registrants that work almost exclusively with
retail investors, FSI members live under both broker-dealer and
investment adviser oversight. This gives us the flexibility to
support clients across the spectrum of wealth, whether they are
small-town investors opening their first IRA or affluent
clients with more complex wealth management needs. We bring a
unique perspective on the issues being considered here today.
Congress should take two critical steps to improve
regulation for hard-working Americans who rely on investment
advice. First, Congress should vigorously oversee the SEC's
work on a new uniform fiduciary standard of care for broker-
dealers. Second, Congress should quickly pass legislation
proposed by Chairman Bachus authorizing the SEC to approve an
SRO for retail investment advisers.
The SEC study found that a uniform fiduciary standard of
care would be in the best interests of the client. We agree.
This new standard should preserve investor access to
personalized investment advice from a broad range of service
providers. The SEC should create core principles of fiduciary
conduct. These will serve as the basis for regulatory
requirements specific to RIAs and broker-dealers. This will
enhance investor protection while preserving investor choice.
Congress should aggressively oversee the SEC's efforts to
develop and implement this new uniform fiduciary standard. In
addition, Congress should insist that the Department of Labor
withdraw and repropose its flawed fiduciary duty rule, which is
in blatant conflict with Congress' stated intent under 913. As
drafted, the DOL rule would limit access to affordable advice
for those who need it most. Also, adoption of the DOL rule is
likely to result in confusing and conflicting fiduciary
standards.
These measures must be paired with effective regulatory
supervision to truly improve investor protection. That is why
we strongly support closing a significant regulatory gap by
increasing examinations of investment advisers. The simple fact
is the SEC does not have sufficient resources to examine
investment advisers. State examination programs are also
inadequate.
To close this gap, Congress should authorize the SEC to
approve an SRO for investment advisers. We believe that FINRA
is in the best position to serve as this SRO. FSI's endorsement
of FINRA is based upon practicality. FINRA has the flexibility
to set user fees and hire staff as needed. FINRA already has
more than 1,000 examiners on its staff. Its private funding
structure is a model for increasing RIA examinations at no
additional cost to the taxpayer. FSI's support of FINRA as the
SRO is also based on precedent. The SEC has more than 70 years
of experience with the SRO model that can be adapted to ensure
a transparent and publicly accountable regulatory structure
over both RIAs and broker-dealers.
In conclusion, this approach to the fiduciary standard and
advisory examination will provide a consistent level of
protections to all investors, level the playing field for
industry participants and boost investor confidence.
Mr. Chairman, Main Street Americans deserve a smarter
system that ensures true investor protection coupled with
access to the best independent financial advice possible. We
deeply appreciate the leadership Chairman Bachus has provided
on these critical issues.
Thank you for your time this morning, and I would be happy
to answer any questions.
[The prepared statement of Mr. Dwyer can be found on page
51 of the appendix.]
Mr. Schweikert. Thank you.
Next, Mr. Ken Ehinger, president and chief executive
officer of M Holdings Securities.

STATEMENT OF KEN EHINGER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, M HOLDINGS SECURITIES, INC., ON BEHALF OF THE
ASSOCIATION FOR ADVANCED LIFE UNDERWRITING (AALU)

Mr. Ehinger. Thank you, Mr. Chairman. Mr. Chairman, Ranking
Member Waters, and members of the subcommittee, I am Ken
Ehinger, president and chief executive officer of M Holdings
Securities. I am testifying today on behalf of the Association
for Advanced Life Underwriting. AALU appreciates the
opportunity you have given us to testify on the important
issues raised by the Dodd-Frank 913 and 914 studies.
Based upon my experience and more than 3 decades in the
securities and insurance business, I can tell you that 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.
AALU does not support the SEC staff recommendation in the
913 study that broker-dealers be subject to the legal standard
of care under the Investment Advisers Act. We believe SEC
Commissioners Casey and Paredes got it right when they said
that the study provided no empirical evidence or data that such
a change would improve investor protection. We also agree with
their conclusion that the study failed to assess the costs and
impact of a change as required by Dodd-Frank, including the
risk that such a change would reduce investor access to
products and services and increase costs.
The need for empirical basis and rigorous cost-benefit
analysis in SEC rulemaking is critical, particularly in view of
the SEC's recent experiences with rulemaking challenges in the
D.C. Court of Appeals. It is in the interests of all of us who
are regulated by the Commission to have a strong and respected
regulator to police our markets and to instill and enhance
investor confidence. The full committee will be holding a
hearing on these broader issues 2 days from now. We want to add
our voice to those who are saying that the Commission, with its
limited resources, simply has to focus on the most critical
issues at hand.
With respect to the SEC's priorities, let me say that
Chairman Bachus, Chairman Garrett, and members of this
committee are performing an important service for investors in
focusing on the need to substantially increase SEC inspections
of investment advisers potentially through a self-regulatory
organization such as FINRA.
AALU members are licensed life insurance professionals.
Many are licensed in multiple States. Most AALU members are
registered representatives of SEC- and FINRA-registered broker-
dealers and/or investment adviser representatives of SEC-
registered advisers. Our members are subject to multiple layers
of Federal and State regulation.
The variable insurance products our members sell give
customers investment choices and an insurance guarantee, which
has been recognized as even more important in recent years of
volatility. It is the sale of these products that triggers
broker-dealer registration and SEC, FINRA, and State securities
regulation and oversight for insurance producers. In fact, the
regulatory requirements for variable insurance products are far
more detailed and rigorous than anything that exists in the
regulation of investment advisers.
Although AALU's submission to the SEC on the 913 study
explained the regulation of variable insurance products in
great detail, the SEC staff did not acknowledge this anywhere
in its study. This concerns us because the range and features
of products such as variable life and variable annuities make
it difficult to determine which product is best, and a best
interest standard almost certainly would lead to increased
litigation. Determining what is best would be highly
subjective, opening up producers to second-guessing, often
years after the sale of a product.
The SEC staff's recommendation for a uniform fiduciary duty
rests almost entirely on a 2008 RAND Report finding investor
confusion over the legal duties that apply to financial
professionals. That same report also found that investors were
satisfied with their own financial service providers. This
points to the need for more effective disclosures and investor
education, not the need for wholesale changes in the legal
standards.
The regulatory and oversight regime for broker-dealers is
superior to the regulation of investment advisers. 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.
Let me close by saying that life insurance enables
individuals and families from all economic brackets to maintain
independence in the face of financial catastrophe. The life
insurance industry, through permanent life insurance and
annuities, provides 20 percent of America's long-term savings.
Two out of three families, that is 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.
Thank you for the opportunity to testify in this important
hearing. AALU looks forward to continuing to work with you on
these critical issues.
[The prepared statement of Mr. Ehinger can be found on page
67 of the appendix.]
Mr. Schweikert. Thank you.
Terry Headley, president of National Association of
Financial and Insurance Advisors.

STATEMENT OF TERRY HEADLEY, PRESIDENT, NATIONAL ASSOCIATION OF
INSURANCE AND FINANCIAL ADVISORS (NAIFA)

Mr. Headley. Thank you, and good morning, Mr. Chairman,
Ranking Member Waters, and members of the subcommittee. My name
is Terry Headley, and I am the president of the National
Association of Insurance and Financial Advisors. For 38 years,
I have been an insurance licensed agent, financial adviser,
registered representative, and an investment adviser
representative. I greatly appreciate the opportunity to share
with you NAIFA's views on the regulation and oversight of
broker-dealers and investment advisers.
I will focus on two issues. First, the imposition of a
fiduciary standard of care on broker-dealers, and secondly, the
creation of an SRO for investment advisers.
Like most of my NAIFA colleagues, I have spent my career
helping Main Street investors achieve their financial goals by
providing affordable financial services for middle-class
investors. Virtually all NAIFA members sell life insurance.
Two-thirds of us are also broker-dealer registered
representatives, selling primarily mutual funds and annuities,
and, like me, about 40 percent of the registered
representatives are also investment adviser representatives.
Many of us provide retirement planning services as well. NAIFA
members are largely small business owners serving the middle
class. The majority of our clients have household incomes under
$100,000, and a sizable percentage have less than $50,000
invested in the financial markets.
The SEC has said they will oppose a single uniform
fiduciary standard of care on broker-dealers and investment
advisers. At the same time, the Department of Labor is
promulgating its own rule, expanding the fiduciary standard.
The DOL's rule, however, is different from the approach
required under Dodd-Frank. As a result, we can see two
different agencies with two different fiduciary standards
serving two different purposes.
We are deeply concerned about the impact these rules could
have on our ability to serve middle-market clients. If, as the
SEC study concludes, consumers are indeed confused, I can
guarantee you that the confusion will only multiply if the
rules are not properly constructed. NAIFA supports
clarification to address client confusion, to ensure that
clients understand the different rules and business models of
investment advisers and broker-dealers, but simply applying the
1940 Investment Advisers Act standard to broker-dealers in a
one-size-fits-all manner would negatively impact product
access, product choice, and affordability of services for
consumers who need them the most.
NAIFA has collected industry data over the past year
showing that if compliance costs and liabilities increase, many
NAIFA members would be forced to discontinue providing services
to middle-class clients. Middle-class investors must be able to
obtain personalized financial advice so they can plan
adequately for their futures.
The SEC study unduly discounts the risk that additional
regulatory burdens could result in middle-class investors
having fewer financial advisers from which to choose.
If the Commission imposes a uniform fiduciary duty, it
must: one, incorporate the Dodd-Frank exceptions providing that
broker-dealer commission compensation and the sale of
proprietary products would not inherently violate a possible
uniform standard; two, account for the unique attributes of the
broker-dealer business model; three, provide new guidance
documents for the industry; and four, be sufficiently clear and
comprehensible so broker-dealers can adjust their business
practices with minimal disruption.
Finally, I would like to mention our belief and official
policy decision that FINRA should serve as the self-regulatory
organization to conduct periodic examinations of SEC-registered
investment advisers. It is clear to us that would be the most
efficient and cost-effective approach to regulating the
examination of investment advisers.
Although we have not had time to fully analyze the bill, we
believe that the draft legislation that would establish an
application and registration process for national investment
adviser associations moves in the right direction and provides
a useful basis for further discussion and consideration. We
look forward to working with the subcommittee on this important
matter.
In conclusion, thank you for the opportunity to share our
views with you today that we deem critical to ensuring all
investors are both protected and have access to competent
financial advice and services. We welcome the opportunity to
assist you in any way that we can. Thank you.
[The prepared statement of Mr. Headley can be found on page
80 of the appendix.]
Mr. Schweikert. Thank you.
Steven D. Irwin, commissioner, Pennsylvania Securities
Commission, on behalf of the North American Securities
Administrators Association.

STATEMENT OF STEVEN D. IRWIN, PENNSYLVANIA SECURITIES
COMMISSIONER, ON BEHALF OF THE NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC. (NASAA)

Mr. Irwin. Congressman Schweikert, Ranking Member Waters,
and members of the subcommittee, I am Steve Irwin, chairman of
the Federal Legislative Committee of the North American
Securities Administrators Association, or NASAA.
At this moment, securities regulators from nearly all 50
States are in Kansas celebrating the 100th anniversary of our
Nation's first Blue Sky Law. For a century, State securities
regulators have combated fraud against mainstream investors,
especially those less able to protect their own interests. In
2010 alone, State securities regulators conducted more than
7,000 investigations, leading to nearly 3,500 enforcement
actions, including 1,100 criminal actions. Last year, 3,200
licenses of brokers and investment advisers were withdrawn,
denied, revoked, suspended or conditioned by the States. Since
2004, State regulators have secured convictions with prison
sentences of nearly 6,000 years.
Traditionally, State securities regulators have pursued
perpetrators trying to defraud mom-and-pop investors locally,
but this does not mean that States do not also play a vital
role in shutting down many more complex schemes involving
national markets. State investigation of violations on a
national level have forced, for example, Wall Street to correct
rampant conflicts of interest among stock analysts, illegal
late trading, and market timing in mutual funds. Most recently,
State regulators returned to investors $61 billion stuck in
illiquid auction rate securities.
Today's hearing is intended to review the Dodd-Frank
Section 914 study and consider steps to improve the oversight
of SEC-registered investment advisers. Mr. Chairman, it is
important to note that the Section 914 study considered only
the question of federally regulated investment advisers. The
study did not consider or make any recommendations regarding
State-regulated IAs. Currently, the States are the sole
regulators of investment advisers with less than $25 million in
assets under management. In mid-2012, this will increase to
$200 million. NASAA would vigorously oppose the creation of any
self-regulatory organization for these State-regulated
investment advisers and their associated persons.
Oversight of investment advisers should remain a government
responsibility. Investment adviser regulations should continue
to reside with State and Federal Governments, which must
zealously carry out their mandates. Government regulators bring
to the table decades of unmatched experience. We see little
benefit in constructing a new layer of bureaucracy with its
incumbent expense. If the goal is strengthening investor
protection through improved oversight of SEC regulated
investment advisers, then the fastest route is to ensure that
Federal regulators have the resources that they need.
Numerous issues must be resolved before establishing an SRO
for SEC-registered investment advisers. The discussion draft
would require small and midsized firms to register with a new
investment adviser SRO. Such advisers usually operate in a
single State. Shifting such regulation to a central office
would subject these small businesses to redundant regulation
and add unnecessary costs to support the new organization. As
the local cops on the beat, the States are best positioned to
be the primary regulator for small and midsized firms. When it
restored State authority over these firms last year, Congress
recognized we are more likely to visit their offices across
America than the SEC or an organization headquartered in New
York or Washington.
The current securities industry SRO model is replete with
conflicts of interest. Industry representatives serve on the
SRO's board and occupy other positions of prominence within the
organization. Premised on self-rule, they are primarily
accountable to their members, not the investing public. As the
914 study observed, any SRO that depends on its members for
funding is highly susceptible to industry capture.
Sharing information among State and Federal regulators is
essential to protecting investors, but the State or government
actor doctrine has become a barrier to collaboration and
cooperation under the SRO model. Any increased--FINRA has
pointed to the doctrine as a reason to refuse State regulators'
requests for investigatory cooperation. The present SRO model
is flawed, and Congress should not consider expanding it until
it is fixed. This may require addressing the State actor issue
by statute to ensure it no longer is an impediment to swift,
aggressive, and efficient enforcement.
An SRO further hobbles investor protection by its lack of
transparency. Unlike the States and the SEC, subject to FOIA,
FINRA can and does filter regulatory records, which may deprive
the public of information pertinent to their investment
decisions. SROs cannot claim the accountability of State
regulators answerable to the elected officials who appoint
them, nor can SROs duplicate State regulators' proximity to
their constituents and familiarity with the investment advisers
they routinely license and examine. To the extent an SRO may be
federally designated, government must check it.
In view of the SRO's role in the government and securities
markets today, it is critical that the SEC exercise robust
oversight. Any increased SRO role with respect to federally
covered advisers cannot displace State laws. The notion that
State law might one day be preempted by administrative rules
issued by a private corporation is unconscionable. Preemption
occurring because of industry self-made rules would undermine
basic tenets of Federalism and the democratic values from which
regulation derives legitimacy.
Thank you, Mr. Chairman.
Wait, one more thing. The subcommittee also considers today
whether the SEC should apply the same duty of care to broker-
dealers and investment advisers. Financial professionals who
provide personalized investment advice to retail investors
should be held to the fiduciary duty under the Investment
Advisers Act of 1940. Ninety-seven percent of those surveyed
believe financial professionals should put the investors'
interests before their own and disclose up front any fees,
commissions or conflicts of interest. Any minimal increase in
compliance costs will be outweighed by the direct benefit to
investors, who expect and deserve to have their interests come
first.
It is an honor to work beside State securities regulators
from throughout North America. On a mission to protect
investors, they stepped up to fill the gap in the regulation of
investment advisers.
Thank you, Mr. Chairman, Ranking Member Waters, and members
of the committee for the opportunity to work with you toward
restoring trust on Main Street in our capital markets. Rest
assured that we are all innovating, being strategic, and
maximizing all available resources to get the job done.
[The prepared statement of Mr. Irwin can be found on page
89 of the appendix.]
Mr. Schweikert. Thank you.
Richard Ketchum, chairman, chief executive officer,
Financial Industry Regulatory Authority. Mr. Ketchum.

STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, FINANCIAL INDUSTRY REGULATORY AUTHORITY (FINRA)

Mr. Ketchum. Thank you, Mr. Chairman, Ranking Member
Waters, Chairman Bachus, and members of the subcommittee. As
you note, I am Richard Ketchum, chairman and CEO of the
Financial Industry Regulatory Authority, or FINRA. On behalf of
FINRA, I would like to thank you for the opportunity to testify
today. I will just note from the earlier statement, I feel very
much today and every day as accountable to this subcommittee.
The issue being discussed today, the oversight of
investment advisers and broker-dealers, is a critical one for
investors, and I strongly believe that significant improvements
are needed if investors are to receive the protections that
they deserve. Increasing numbers of retail investors are
seeking the advice of financial professionals, both brokers and
investment advisers. At one time, these two businesses were
distinct and separate, but today in many ways they have
converged. Nevertheless, the regulation of investment advisers
and broker-dealers remains quite different. The two industries
are subject to different standards of conduct and very
different levels of oversight and enforcement.
FINRA believes that the standard of care on both channels
should be a fiduciary standard for the provision of
personalized investment advice to retail customers. We have
found under the present broker-dealer regime that too often
regulators have been forced to respond issue by issue or
violation by violation rather than addressing problems more
broadly and prospectively. Extending a fiduciary duty to all
professionals providing individualized advice to retail
customers should, of course, be done carefully in a way that
provides interpretive guidance as to the application of such a
duty to the variety of broker-dealer business models that
currently exist.
Harmonization of the standard of care is an important first
step; however, just as critical is a consistent oversight
regime to ensure investors of being properly protected.
Compliance with the fiduciary standard must be regularly and
vigorously examined and enforced to ensure the protection of
investors. The SEC study on investment adviser exams concludes
that the agency will not have sufficient capacity in the near
or long term to conduct effective examinations of registered
investment advisers with adequate frequency.
The SEC oversees more than 11,000 investment advisers, but
in 2010 conducted only 1,083 exams of those firms due to the
lack of resources. As such, the average registered adviser
could expect to be examined less than once every 11 years.
While the Commission examines only about 9 percent of
investment advisers each year, 55 percent of broker-dealers are
examined each year by the SEC and FINRA. The SEC has estimated
that it would need to double the number of examiners to
increase the frequency of adviser exams to even 20 percent.
The gap in investment adviser oversight is a significant
void and should be addressed as quickly as possible. Providing
the SEC authority to designate one or more SROs for investment
advisers subject to Commission oversight is the most practical
and efficient way to address this problem. Chairman Bachus'
draft legislation circulated for this hearing would establish
that authority and set a framework of requirements for any
entities that would be designated as adviser SROs.
The draft is a thoughtful approach to addressing the
critical need for increased adviser oversight. The draft
ensures that an adviser SRO would do regular examinations of
members and their associated persons, while not imposing
burdens on advisers that are not necessary or appropriate. The
draft sets out criteria for governance that would require a
majority of public representatives on any SRO's board, and that
members of the investment industry would be allocated a number
of the remaining seats.
Another significant issue is the scope of authority of any
investment adviser SRO. Any adviser SRO should have authority
to examine for and enforce compliance with the Investment
Advisers Act, the rules under that Act, and its own rules. We
believe that the primary regulatory structure for advisers
should remain the fiduciary standard incorporated in the
Advisers Act and related SEC rulemaking and interpretations.
Adviser SROs should have limited rulemaking authority, but the
extent of that authority should be a matter for Congress and
the SEC to determine.
The discussion draft addresses these issues, establishes a
high standard for SEC approval of SROs in the adviser area, and
a requirement for consultation with the SEC in developing an
examination program for investment advisers. We support this
approach.
The SEC and State regulators play vital roles in overseeing
both broker-dealers and investment advisers, and they should
continue always to do so. FINRA has worked alongside both in
overseeing broker-dealers, making hundreds of referrals at both
the Federal and State level, and providing information in
response to numerous requests each year. The problem at issue
today is not about coordination among regulators, but about
ensuring oversight where otherwise there is not acceptable
coverage.
Investor protection demands that more resources be
dedicated to regular and rigorous examination and day-to-day
oversight of investment advisers. SROs can help fill an
untenable gap in the protection of investment advisory clients.
FINRA is committed to working closely with other regulators and
this subcommittee as you consider how best to address the lack
of examination resources for investment advisers.
I appreciate the opportunity to testify today and I will be
happy to answer any questions you may have.
[The prepared statement of Mr. Ketchum can be found on page
101 of the appendix.]
Chairman Garrett. Ms. Roper, you are recognized.

STATEMENT OF BARBARA ROPER, DIRECTOR OF INVESTOR PROTECTION,
CONSUMER FEDERATION OF AMERICA (CFA)

Ms. Roper. Thank you, Chairman Garrett, Ranking Member
Waters, Chairman Bachus, and members of the subcommittee.
I am Barbara Roper, director of investor protection for the
Consumer Federation of America. I appreciate the opportunity to
appear before you today to talk about a topic that has been a
priority for CFA for a quarter century, improving protections
for investors in their dealings with brokers and investment
advisers.
The policies advocated in the two SEC studies that are the
subject of this hearing have the potential to plug two
significant gaps that put retail investors at risk: the fact
that brokers are allowed to market themselves as advisers and
offer extensive advisory services without having to act in
their customers' best interest; and the fact that investment
advisers are subject to inadequate regulatory oversight. My
written testimony deals with both topics.
While both are priorities, I am going to focus on the
standard of care issue in my oral statement since, of the two,
we believe it has the greater potential to increase investor
protection.
In the Section 913 study, the Securities and Exchange
Commission has proposed an approach for imposing a fiduciary
duty on brokers when they give personalized investment advice
to retail investors that has won praise, on the one hand, from
investor advocates, State securities regulators, and others who
have long advocated for a broker-dealer fiduciary duty and, on
the other hand, has won praise from the likes of SIFMA and FSI
who long resisted such an approach.
It has earned the support of the first group by pledging
that the existing standard of protection under the Investment
Advisers Act would not be weakened. It has earned the praise of
the second group by proposing an approach that would preserve
the broker-dealer business model by ensuring that brokers would
remain free to charge commissions, to sell proprietary
products, to sell from a limited menu of products, to engage in
principal trading, and to offer transaction-based
recommendations.
If the Commission moves forward with a rulemaking along
these lines, the result for investors would be the best of both
worlds. They would retain their ability to choose whether they
want ongoing account management or transaction-based
recommendations, whether they want to pay through fees or
through commissions. But they would be able to make that choice
without giving up their right to recommendations that are in
their best interest; and they could expect to see their costs
drop, not rise, if brokers had to take costs into account in
making their recommendations.
Some, including some members of this subcommittee, have
suggested that the Commission hasn't adequately demonstrated
the need to raise the standard. But here is what we know: We
know that investors can't tell brokers from investment
advisers. Indeed, they cannot tell whether their own financial
professional is a broker or adviser, even after the differences
have been explained to them. And we know this confusion cannot
be disclosed away.
We know that investors do not understand that brokers and
investment advisers are subject to different legal standards
when they perform the same functions, and we know that
investors expect that anyone who is providing them with
investment advice will be acting in their best interest. As a
result, we know that investors are simply not able to make an
informed choice among providers on whom they rely for
recommendations; and they are not sufficiently on their guard
when dealing with so-called financial advisers who are really
just selling products.
Some continue to maintain, however, that the SEC has not
done enough to demonstrate that investors are being harmed. And
it is true that the Section 913 study does not provide
extensive evidence of that harm, something that we had
advocated that the SEC do. But the simple truth is that
investors pay significant excess costs and lose out on
important long-term benefits as a result of conduct that is
permissible under the suitability standard but not under a
fiduciary duty.
Take, for example, the investor who is purchasing a
variable annuity with a guaranteed living benefit. As long as
that is a suitable investment in light of the investor's
circumstance, the broker selling the annuity is free to select
one that offers him the biggest paycheck. He doesn't even have
to check to see if another variable annuity would offer the
investor a better deal, let alone whether a different
investment strategy might be in the investor's best interest.
But the difference can amount to thousands of dollars a year in
income for investors and tens of thousands of dollars over the
lifetime of the investment. The investor who is sold the
inferior product will likely never know that he or she has been
had. But a couple of thousand dollars of income is real money
to middle-income investors, money they cannot afford to
sacrifice just so the broker can enjoy a more profitable
payday.
A well-enforced fiduciary duty would change that, not by
imposing an unrealistic requirement that the broker consider
every product available in the market, not by requiring brokers
to give up their expectation of reasonable pay for their
services, but by requiring the broker to have a reasonable
basis for believing that, among the products he has to sell,
the one he recommended is, in fact, the one that is best for
that investor. And if product sponsors had to start competing
based on benefits to investors, rather than compensation to the
broker, the change could be truly revolutionary.
The kind of harm that occurs when advice is offered under a
sales standard isn't always dramatic and it isn't easy to
quantify. But for the average investors whose retirement
security is put at risk, it more than justifies the long-
overdue rulemaking to subject brokers to the same standards all
other advisers live under when they offer personalized
investment advice.
The Commission has pledged to gather additional data before
moving forward on a rulemaking. We urge members of this
committee to support, rather than impede, those efforts.
Thank you.
[The prepared statement of Ms. Roper can be found on page
109 of the appendix.]
Chairman Garrett. Thank you.
Mr. Taft, you are recognized.

STATEMENT OF JOHN TAFT, CHAIRMAN, THE SECURITIES INDUSTRY AND
FINANCIAL MARKETS ASSOCIATION (SIFMA)

Mr. Taft. Good morning, Chairman Garrett, Ranking Member
Waters, Chairman Bachus, and members of the subcommittee.
I am the chairman of the Securities Industry and Financial
Markets Association, and CEO of RBC U.S. Wealth Management,
which has over 2,000 financial advisers serving 800,000 client
accounts. Thank you for the opportunity to testify.
Today, I will present SIFMA's views in support of
establishing a uniform fiduciary standard for brokers and
advisers and ensuring uniform examination of that standard. We
believe that such a standard is consistent with the current
best practices in our industry, and we hope it will ultimately
result in a heightened industry focused on serving the best
interests of retail customers.
Our support, however, is premised on achieving this
standard in a manner that protects investor choice, protects
investors, is cost-effective, is business model neutral, and
avoids regulatory duplication or conflict. The development of
such a standard is a complex undertaking that must be well
thought out, reflect both the statute and congressional intent,
and reflect the thorough cost-benefit analysis.
Further, it is our strong view that the Department of
Labor's expansive new proposed definition of fiduciary under
ERISA directly conflicts with Section 913. Unless DOL
reproposes, their proposal will result in decreased investor
choice and increased investor cost.
That said, Congress explicitly intended for the SEC to
craft a uniform fiduciary standard that not only protects
investors but also preserves investor choice and access to
cost-effective financial products and services. The standard
must also be adaptable to the substantially different operating
models of broker-dealers and investment advisers.
Section 913 of Dodd-Frank requires that the uniform
fiduciary standard be no less stringent than the general
fiduciary duty applied by the Advisers Act. However, the plain
language of Dodd-Frank, together with its legislative history,
makes clear that the no less stringent language does not
require the SEC to impose the Advisers Act on broker-dealers.
If the SEC did so, it would negatively affect client choice,
product access, and affordability of customer services. By
definition, such a move would not be in the best interests of
retail customers.
The general fiduciary duty implied under the Advisers Act
also provides incompatible and insufficient guidance for
broker-dealers on how to manage, disclose or, where necessary,
obtain consents to potential conflicts of interest. Imposing
the Advisers Act standard would also be problematic for broker-
dealers from a commercial, legal, compliance, and supervisory
perspective, thereby undercutting the SEC's intent to take a
business model-neutral approach.
Under our proposed framework, the general fiduciary duty
implied under the Advisers Act would be newly articulated
through SEC rulemaking under the Advisers Act and parallel,
consistent, and equally stringent rulemaking under the Exchange
Act which governs broker-dealers. The SEC would also issue
rules and guidance to provide the structure and detail
necessary to enable broker-dealers to apply the standard to
their distinct operating models.
We continue to urge the SEC to newly articulate a uniform
fiduciary standard rather than attempt to overlay the Advisers
Act, which would result in significant negative effects for
investor protection and choice.
The DOL's fiduciary proposal conflicts with Section 913 and
with SEC efforts to implement Section 913 and could subject
brokers and advisers to multiple and conflicting regimes when
dealing with retail customers. The DOL proposal also suffers
from inadequate cost-benefit analysis, particularly with
respect to retirement plans and IRAs and the impact on
retirement savings. We strongly believe that the DOL proposal
should be withdrawn and reproposed.
In conclusion, if we succeed in establishing a uniform
fiduciary standard, avoiding an Advisers Act overlay and
removing conflicts with a DOL proposal, what next? That is a
central question raised by Section 914 of Dodd-Frank, which
required the SEC to review the need for enhanced examination of
advisers.
The SEC's Section 914 study recommends three options. We
believe that the third option, the SRO option, is the most
practical and prudent. Oversight of broker-dealers is bolstered
by the examination activities of SROs like FINRA, particularly
with respect to conduct directed towards retail customers.
Consistent with establishing a uniform fiduciary standard, we
ought to hold brokers and advisers to that same standard
through uniform examination. Our SRO recommendation, however,
does not extend to institutional advisers, and we would not
support legislation that extends SRO oversight to institutional
investors.
Thank you, Chairman Garrett, and members of the
subcommittee for allowing me to present SIFMA's views on these
critically important topics.
[The prepared statement of Mr. Taft can be found on page
139 of the appendix.]
Chairman Garrett. Thank you, Mr. Taft.
Mr. Tittsworth, you are recognized for 5 minutes.

STATEMENT OF DAVID G. TITTSWORTH, EXECUTIVE DIRECTOR AND
EXECUTIVE VICE PRESIDENT, INVESTMENT ADVISER ASSOCIATION (IAA)

Mr. Tittsworth. Chairman Garrett, Ranking Member Waters,
Chairman Bachus, thank you very much for the opportunity to be
here today.
The Investment Adviser Association represents SEC-
registered investment advisory firms. Our members serve a wide
range of clients including individuals, trusts, and families,
as well as institutions such as endowments, charities,
foundations, State and local governments, pension funds, mutual
funds, and hedge funds.
Today, there are about 11,500 SEC-registered advisers. Most
of these are small businesses. More than two-thirds employ
fewer than 10 employees, and more than 90 percent employ fewer
than 50 employees. Our members engage in a wide range of
advisory activities and investment strategies on behalf of
their clients. They perform a critical role in helping
investors achieve their financial goals.
Our written statement addresses a number of issues relating
to SEC studies required under Sections 913 and 914 of the Dodd-
Frank Act. I would like to highlight a few key points about
each.
With respect to the Section 913 report, we support the
recommendation urging the SEC to propose rules or guidance
providing for a uniform fiduciary standard for investment
advisers and broker-dealers when they provide personalized
investment advice to retail clients.
Having said that, we have emphasized two core concerns.
First, we have urged the SEC not to weaken or water down the
Advisers Act fiduciary standard. This duty is well established.
It has been consistently interpreted for decades by the SEC and
the courts. One of the greatest strengths of the Federal
standard is its breadth. It provides the highest level of
protection for investors while remaining dynamic and relevant
in changing business and market conditions.
Second, we note that the range in which broker and adviser
activities overlap is actually relatively narrow. Thus, it
would be inappropriate for the SEC to import the entire sales-
based broker-dealer regime on investment advisers or, vice
versa, to impose Advisers Act rules on the nonadvisory
activities of broker-dealers.
With respect to the Section 914 report, we support
regulation and oversight by the SEC, a single governmental
regulator accountable to the Congress and the public that has
investor protection as its paramount mission. We strongly
oppose the creation of a private regulator for the advisory
profession. Many other organizations agree with this position.
We note that several reports, including one by the U.S. Chamber
of Commerce, have cataloged drawbacks, costs, and
inefficiencies of the private regulatory model and FINRA, in
particular. I would also note that other countries with mature
markets have completely discarded or are trending away from the
private regulatory model.
We have reviewed the discussion draft legislation that
would require most investment advisers to belong to a private
regulator. We do not believe this is the best approach to
enhance adviser oversight.
The draft legislation is clearly based on current laws
governing FINRA and would subject thousands of advisory firms,
including most small businesses, to broad rulemaking and
inspection authority by a private regulator, in all likelihood
FINRA. Many concerns have been documented about FINRA,
including its lack of accountability, lack of transparency, its
questionable track record, excessive costs, and its bias
favoring the broker-dealer regulatory model. FINRA's budget and
governance are not subject to direct oversight by the SEC or by
Congress. It lacks the expertise to regulate investment
advisers. It is not subject to statutory safeguards, such as
the Freedom of Information Act. It is not required to conduct a
cost-benefit analysis before imposing its rules.
On the other hand, the SEC's budget is directly accountable
to Congress. It has developed the expertise to regulate
investment advisers over many decades; and the SEC is subject
to numerous statutory requirements before it can impose its
rules, including the consideration of costs and benefits.
As an alternative, we respectfully urge the subcommittee to
consider legislation authorizing investment adviser user fees.
We would be pleased to assist in this effort, as outlined in
our written statement.
Again, thank you for the opportunity to appear today. I
would be happy to answer any questions.
[The prepared statement of Mr. Tittsworth can be found on
page 229 of the appendix.]
Chairman Garrett. Great. Thank you very much for your
testimony, and thank you to the entire panel for being here for
the last hour-and-a-half now.
I recognize myself for the first 5 minutes of questions,
and I guess I will begin my questions where I began my opening
statement.
In my opening statement I said that it would seem incumbent
upon an agency such as the SEC that before they consider and
promulgate regulations or rules that--as Mr. Tittsworth was
just saying--they do a cost-benefit analysis. And that would
indicate then, while you do that, do you actually have a
problem that you are trying to solve with the regulations that
you are going to eventually promulgate?
My question--and I will throw it out maybe to Ms. Roper
first for an answer. But to the entire panel, do we have
anything other than what I will say is anecdotal examples? We
didn't get it in the SEC study, as we pointed out. But do we
have anything other than just the anecdotal examples--hard,
factual data to show that the suitability standard is
disserving to those seeking advice from broker-dealers?
Ms. Roper. First, let me say I agree that the SEC's 913
study does not provide that evidence. In our comment to the
agency at the outset of this study, we outlined a number of
areas where we thought they could pursue that evidence. It is
not there. It is not that you can't get it, but it is not
there.
We know that, for example, the single factor that most
determines investors' long-term performance is cost. It is not
addressed under a suitability standard and is addressed under a
fiduciary duty. There is evidence that could be collected and
should be collected that would support the rulemaking. The SEC
has a study team in place. They say they are going to collect
that data. We believe it is a realizable task.
Chairman Garrett. Would anyone else like to comment on
that?
The basic question, is there actual data out there that the
SEC should have had or that we should have that can make that
come to that conclusion one way or the other? Are there studies
or data?
Mr. Ehinger. I don't believe there is data that supports
that information. I think that gets to the core of the question
of what is the problem we are working to solve. Because in my
statement, while there are differences in how broker-dealers
and investor advisers are examined and regulated, in my
opinion, in my experience, the broker-dealer model is much more
robust.
Chairman Garrett. For anyone else, is there any data that
is out there with regard to--not anecdotal--but how the
customers actually feel about the service they are getting? Is
there any data out there with regard to not just the feeling
but actually their level of satisfaction under the current
regime, the current methodology that we have right now?
Ms. Roper. Yes. There is survey data that clearly shows
investors are satisfied with the service they receive. If they
are not informed, they can't tell you whether they are dealing
with a broker or an adviser. They don't know the basic things
they would need to know if they were being disserved.
Chairman Garrett. So, in other words, they don't know that
they are being disserved?
Ms. Roper. Absolutely. If they don't know that another
product offers much better benefits than the one they were
sold, why should they be dissatisfied? If they don't know they
are losing tens of thousands of dollars over the lifetime of an
investment because they are paying excess costs, why would they
be dissatisfied?
Mr. Tittsworth. Mr. Chairman, I would just note that the
SEC will have to submit a cost-benefit analysis if it has a
rulemaking. I know you and other members of the subcommittee
have urged them to do that. And there has been a recent court
decision. As I am sure you are aware, they can be taken to
court if their cost-benefit analysis is not robust or effective
enough.
Chairman Garrett. And on that last point, just for the
whole panel, is there anyone who disagrees with the idea that
before the SEC promulgates these regulations, there should be
an effective cost-benefit analysis? Does anyone disagree with
that?
Mr. Tittsworth. No. We agree with that.
Mr. Irwin. Chairman Garrett, I don't think we need to wait.
We can't afford to wait. We, in Pennsylvania, do approximately
300 events in libraries and at fairs and others, talking to
investors on the local level. And they need to have the
confidence to come back into the markets. We really see that
every day.
If we take the position that what they don't know won't
hurt them--it is like buying a car. Did you get a good deal or
did you not get a good deal? When you find out afterwards you
got a bad deal and really feel bad about it, you are paying
more every month. That is what we are risking.
Chairman Garrett. Mr. Ketchum, just a comment with regard
to Mr. Tittsworth's comment. Your organization promulgates lots
of regulations. Do you do a cost-benefit analysis?
Mr. Ketchum. We operate from a cost-benefit analysis in a
variety of ways. I believe anytime any issues are raised in our
comment process, we do an analysis of the cost and the benefits
of the rule.
So, unlike the Federal Government, we first have
representatives of the industry and industry committees and on
our board who have a direct opportunity to raise any concerns
from a cost standpoint. We then put out any nonadministrative
rule we are proposing, unless it is an emergency, out to all
constituents, including members but also to constituents of all
sorts, to provide comments before we even provide it to the
SEC. Our responsibility at the time we provide it to the SEC is
to provide a response to comments, including any concerns with
respect to costs at that time. Then, after the SEC evaluates,
they come back to us and ask for additional details.
So, yes, I believe anytime anyone in the industry or
anywhere else has a concern with respect to cost, we are always
required to address this.
Chairman Garrett. Since my time is up, I will let Mr.
Tittsworth have the final word on that.
Mr. Tittsworth. I appreciate that, Mr. Chairman.
Just to say briefly, they may consider some costs and
benefits at FINRA, but, as a legal matter, it is not required.
And if somebody brought a lawsuit, as the U.S. Chamber of
Commerce did recently with the SEC, there is no law that would
require FINRA rules to have that cost-benefit analysis. And I
don't think you would have the same result.
Chairman Garrett. I thank both gentlemen for their
statements.
The gentlelady is recognized for 5 minutes.
Ms. Waters. Thank you very much, Mr. Chairman.
Ms. Roper, you state in your testimony that the most vocal
critics of the SEC Section 913 study have been insurance
broker-dealers because their sale of variable annuities would
come under the heightened standard of care. Do you believe that
variable annuities require a heightened standard of care? And
if so, why?
Ms. Roper. I do believe so, yes. And I am not alone in
that. Award-winning financial writer Liz Pulliam Weston has
called them the worst retirement investment you can make. They
have been called the most oversold, overhyped, least-understood
investment products. And it is estimated by one industry
observer that at least $25 billion a year in investor excess
costs are siphoned from vulnerable investors to the insurance
industry and their sales force through the sale of variable
annuities. We believe that an effectively implemented fiduciary
duty has more potential to offer in this one area than in
virtually any other area subject of broker-dealer conduct.
Ms. Waters. Thank you very much.
Mr. Ehinger. Congresswoman Waters, may I make a statement,
please?
Ms. Waters. Yes, you may.
Mr. Ehinger. I would just like to add that variable
annuities, as Ms. Roper points out, are a substantial and
important retirement savings vehicle for millions of Americans
and also that the concerns and some of the issues that have
been raised over time about some of the sales practices have
been very directly and deliberately and I think in a very
detailed fashion addressed by FINRA and specifically in rule
2330, giving us in the broker-dealer community the ability to
not only know specifically what are the actions, what are the
reviews that we should take, but providing that guidance very
directly--
Ms. Waters. Thank you very much.
I want to understand FINRA. I understand that FINRA
maintains a large investment portfolio. What do they invest in
and how do they control for inherent conflicts of interest that
arise from investing with broker-dealers when they regulate
broker-dealers? Can you help me understand that?
Mr. Ketchum. Sure. That is a great question, Ranking Member
Waters.
First, we have a substantial investment portfolio, which
allows us to defray some of our costs of regulation. Because we
formerly had responsibility for the NASDAQ stock market, and
through the spinning off of NASDAQ--we do have a substantial
investment portfolio as a result of the spin-off of the NASDAQ
stock market which our predecessor organization, the NASD,
formerly owned.
With respect to the concern of conflicts, we solve it by
not investing in broker-dealer securities or, where we do, by
doing it only with respect to fixed-income securities where
there is an absolute wall provided with respect to anybody with
regulatory responsibility with regard to those fixed-income
investments and review of those investments.
So, essentially, our investment committee and employees who
have no regulatory responsibility are the only ones who are
aware if and when we have investments with respect to fixed-
income securities.
Ms. Waters. Could you also comment on the compensation of
your 10-person board of directors? According to its most recent
financial report, FINRA paid 8 members of this 10-person board
of directors more than $1 million each in 2010. Cumulatively,
the board members earned more than $4.7 million, up from $10.6
million that the board received in 2009. Could you comment on
the procedures that you use to compensate executives and board
members?
Mr. Ketchum. Let me take board members first, and then I
will take employees, which I think is the primary focus of your
question.
Our board members receive compensation ranging from between
$50,000 and $70,000, depending on their committee
responsibilities. That compensation is reviewed regularly by
our Management Compensation Committee. That is a matter that
obviously is a substantially lower compensation than a--
Ms. Waters. This information that I have is not correct
about--in your most recent financial report, you paid 8 members
of your 10-person board of directors more than $1 million each,
is that incorrect?
Mr. Ketchum. I believe, Ranking Member Waters, you are
referring to our employees, not our board members. None of our
board members, with the exception of myself as an employee,
received more than $70,000.
Our employees are paid more. I do believe that it is a good
idea to have persons with experience and also to ensure that
they stay at an organization for longer terms than those at the
SEC--even though I am a loyal alumnus--usually manage to stay.
We do pay for experience, and we do pay for ability and
capability, yes.
From your question, the determination with respect to those
compensation levels is done by a Management Compensation
Committee composed of only public members, i.e., persons who
have no affiliation with the industry. They review our
competitors, the various places that our employees leave and go
to, or where we track employees in determining what is an
appropriate compensation level.
Ms. Waters. Thank you. I yield back the balance of my time.
Chairman Garrett. Thank you.
The chairman is recognized.
Chairman Bachus. Thank you.
In proposing the SRO, one of the bases of that was one of
the Democratic members of the SEC, Commissioner Walter, had
endorsed that approach as beneficial to--and of course, she was
General Counsel of the CFTC, and then she was appointed by
President Obama as the acting Chairman of the SEC in January of
2009. And there is some bipartisan support for the SRO.
I would like to just introduce--I am sure those of you who
are opposing that, you have looked at her testimony, her
position, and that is that the SEC would do a better job on a
lot of other responsibilities they had.
Having said that, I understand, Mr. Irwin, you mentioned--
and Mr. ``Tittsworth''--is that how you pronounce it?
Mr. Tittsworth. It is ``Tittsworth,'' believe it or not. I
couldn't believe it when my mother told me.
Chairman Bachus. My name also causes some problems.
But I do understand your concern about who oversees FINRA
and also concern State regulators that--in fact, Congress
specifically brought State regulators back into regulation
because of some failures. I think a lot of us do not want to
ignore the States' role. It is very important.
You look at the Stanford case. You had a State regulator,
and you also had the SEC. Those were the two regulators in
Stanford. And Madoff, who was the investment adviser for the
Ponzi scheme that was operated, which was the SEC's
responsibility again. I think we would all acknowledge the SEC
and sometimes State regulation has failed.
Now, with Madoff, there was an investment, there was a
broker-dealer, but he moved the fraudulent business. The Ponzi
scheme was clearly not in what FINRA regulated.
And I do understand--you have talked about accountability
and transparency, that FINRA--you are concerned about that. You
are concerned about pre-empting your role. You are concerned
about--and I do acknowledge--and I would ask Mr. Ketchum maybe,
too. And we are going to meet with Mr. Irwin, I think after
this hearing.
You have talked about if we do this enhanced oversight of
FINRA. And I think if we are able to come to some bipartisan
agreement, I think there would have to be some protection for
State regulators or roles for State regulators. There would
also have to be some enhanced maybe oversight and transparency
in the case of FINRA. I think that would be an improvement.
And I would ask Mr. Ketchum or Mr. Irwin if you all want to
comment on what I have said. I don't know if that is a
question. I usually ask short questions.
Mr. Irwin. I can assure you, Chairman Baucus, that if Joe
Borg, your securities administrator in Alabama, had gotten the
Markopolos report, things would have been different.
Chairman Bachus. I can tell you that wouldn't have happened
under Joe Borg in Alabama.
Mr. Irwin. Absolutely not.
And as to Commissioner Walter's reaching out in an SOS for
help, she absolutely is. And I understand that, without
sufficient resources, they are really hamstrung and unable to
exercise their strong, robust role of oversight over FINRA. It
takes a village. There is a role for an SRO.
Mr. Ketchum and I agree on a lot of things. We agree that
there is a gap in oversight of a large portion of investment
advisers, and Congress has set out to fix that problem with the
$25 million to $100 million.
We are prepared, the States are prepared to take on that
responsibility. We have asked for it for 5 consecutive years.
We have increased the number of exams that we have done. We
have come up with a number of strategies to speak to the
additional responsibilities that we have. We have a memorandum
of understanding that every State has signed, agreeing to do
joint examination, to work with each other, to have uniform
exam procedures, better risk analysis.
We can do this job. Give us the opportunity to do it, and
we will show you that we can.
Chairman Bachus. Mr. Ketchum and Mr. Tittsworth, if you
would like to comment?
Mr. Ketchum. Chairman Bachus, just a few things to your
both thoughtful and complex question.
First, it does take a village to regulate what has been
done on the broker-dealer side. I have the highest respect for
Mr. Irwin's program in Pennsylvania. And surely for Joe Borg's
program in Alabama.
What has worked on the broker-dealer side is the
cooperation and consistent effort with concern for investor
protection across both government and SRO resources. What is
valuable is supplementing those resources, particularly when
they are less; and not all States have the resources that the
State of Pennsylvania or the State of Alabama may have to apply
to do investment adviser oversight.
Second, I do want to make this absolutely clear, and I know
I will save a question from Chairman Garrett by doing this:
FINRA takes accountability, just as the SEC has taken
accountability, just as any State that has touched it should
take accountability, for not finding the Madoff problem. Yes,
in our situation, sadly, we did not get a Markopolos complaint.
Sadly, Mr. Madoff covered his activity on the money management
side by having zero, no records, with respect to the broker-
dealer and denying that he engaged in a money management
business on the broker-dealer.
That made it hard. Hard is not an excuse for not finding
it, and we accept that. We did a study from our board to take a
hard look at that, and we have fundamentally revised both our
examination and enforcement programs to try to get at the hard
cases.
But what is important from a regulatory policy standpoint
is that it isn't a good idea to make it hard. If FINRA had
responsibility from the standpoint of Madoff as an investment
adviser when it finally did regulate it, we would have
immediately done a membership interview, we would immediately
have done an examination of Madoff, and that was something the
SEC did not have the resources to do.
Chairman Bachus. But I think my question is, would you be
willing to accept enhanced oversight by the SEC or by the other
government regulators, including the States, in accountability?
Mr. Ketchum. Yes, we would. We feel like we have
substantial oversight from the SEC already. We accept the
Boston Consulting Group's suggestions that oversight should be
more thorough and more complete.
We recognize that if we did have responsibility for
investment advisers on the State side, which is obviously a
choice of Congress and not ourselves, that the consultation
required and the interaction with respect to State regulators
would be absolutely critical because it is State laws that
FINRA would be essentially incorporating to supplement the
State program.
I would note that never in our wildest imaginations would
we ever imagine a situation where a FINRA rule should preempt
State regulations. State rules and regulations are critical to
investor protection.
Chairman Bachus. I think in the past, the States have not
always had some transparency or access to some of the
information. If the committee could bear with me and let him
have maybe 30 seconds to respond?
Chairman Garrett. Sure, Mr. Chairman.
Mr. Tittsworth. Thank you, Mr. Chairman.
I agree this is not a partisan issue. I noted that the U.S.
Chamber of Commerce issued a recent report talking about
FINRA's lack of accountability. And all regulators have had
shortcomings. It is not a job I particularly want to have. But,
unfortunately, none of us have found the silver bullet.
I think there is an issue. We have recognized it. The
question is, how fast do you address this issue of enhancing
investment adviser examinations?
And I thought you said it best, Chairman Garrett, in your
opening statement with Madoff. There were failings all the way
around on that and I am not sure that is the best case to build
this policy around enhancing investment adviser oversight. I
think maybe we need to just take a step back and look at the
facts and try to figure out the best approach.
Chairman Bachus. Right. Let me say, Mr. Ketchum, you were
not on the job. I understand you have made a lot of reforms,
and I applaud the job you are doing. You are doing a very good
job. I wasn't trying to point out a failure. Because I think
everyone failed, everything failed, and certainly the Congress
is not without blame.
Thank you.
Chairman Garrett. I thank the gentleman.
The gentleman yields back, and we will be a little loose
with additional time on this side of the aisle as well. I
assume we are just going to go right down the aisle.
The gentleman from California.
Mr. Sherman. Believe it or not, I don't have a whole lot of
questions, but I do have one for Mr. Healy. Why does the
National Association of Insurance and Financial Advisors want
FINRA to become the SRO for investment advisers? That will be
the first question, and I will have a follow-up.
Mr. Headley. It is Mr. Headley, but that is fine.
Mr. Sherman. If I hired staffers based on their
handwriting, it would be different. Go ahead.
Mr. Headley. I think it is quite simple. Two-thirds of our
NAIFA members are registered representatives through a broker-
dealer, and 40 percent of that population are also registered
as investment advisers--investment adviser representatives
under the corporate RIA of the broker-dealer. Since there is
the dually registered representatives, it seems the most
effective or efficient and cost-effective method, since we are
already examined by FINRA through our broker-dealer compliance
areas on an annual basis through an annual face-to-face
compliance meeting, that it would be best to not layer on an
additional burden or hardship in terms of having an additional
examination process.
Mr. Sherman. Your members are willing to pay an additional
user fee?
Mr. Headley. Again, we think it would be more cost
effective if FINRA was named as that self-regulatory
organization.
Mr. Sherman. Are all of your members already paying a user
fee to FINRA? Or this would mean some of them would be paying
and others might be paying a bit more?
Mr. Headley. They are paying, obviously, registration fees
both to FINRA and, of course, to each of the States in which
they are securities registered.
Mr. Sherman. Okay. And the SEC has, I think, not been doing
all that the SEC would like to do in this area. I assume one of
the reasons is they are not collecting enough in user fees or
they are not collecting a user fee from your members to do that
work directly?
Mr. Headley. Right. Again, the majority of our members are
dealing with middle-class investors and Main Street investors
and everything else and do not have the assets under management
to kind of meet the threshold with SEC registration.
Mr. Sherman. I yield back.
Chairman Garrett. The gentleman from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman.
In going over the notes here, I had one that looked as if
the SEC was suggesting that implementation of these major
changes for broker-dealers would not have much in the way of
cost changes. Can I solicit a response on that? And why don't
we--
Mr. Ehinger. Yes. Thank you.
In my opinion, there would be significant changes. I think
you would start with--first of all, not knowing what the rule
is, the documentation expectations of interactions with
clients, decisions made regarding what was to be invested in or
what not--even decisions of what not to do. Investing is a
whole different type of scenario in terms of expectations of
what the registered representative would need to do. There
potentially are additional registration-type fees that could be
associated with the business, and the other concern would be
the model may need to shift or might potentially shift even as
a result of some of the changes being proposed.
Mr. Schweikert. Ms. Roper, the same sort of question. Do
you agree or disagree that we would see the scaling of
additional costs here?
Ms. Roper. There will clearly be additional costs in
certain areas. For example, an investment adviser has to
provide up-front disclosure about conflicts of interest and
material information that brokers don't have to provide. There
is a cost with that. Many of the brokers are doing that now for
their advisory accounts. But there is an offsetting savings to
the investor if the broker has to take costs into account in
making their recommendations.
Furthermore, the criticisms about cost ignore the fact that
the SEC took those into account in coming up with the proposal
that it put on the table. It is not going to eliminate the
broker-dealer Investment Adviser Act exclusion. There is no new
registration. They have made clear that the broker-dealer
business model, commissions, proprietary sales, all of that
stays the same. Most of the cost data that has come from the
broker-dealers has analyzed a scenario that is simply not on
the table.
The SEC has in fact been very sensitive on the issue of
costs. I think that is why you have seen groups like FSI and
SIFMA at the table in a negotiation about how to implement
rather than simply trying to prevent this rulemaking from going
forward.
Mr. Schweikert. Thank you, Mr. Chairman.
Mr. Ketchum, same question.
Mr. Ketchum. I agree with much of what Ms. Roper said. I
think the SEC is focused on costs here. We do believe that a
properly implemented fiduciary standard makes a great deal of
sense, and we also believe there should be a very careful
analysis of the costs and approach. There will be some costs
increased by changes in disclosure requirements and the type of
up-front disclosure that Ms. Roper indicates, although FINRA
already requires a variety of disclosures with respect to a
product-by-product basis consistent with its rules. It is
better to do that across-the-board. It is certainly appropriate
to make sure that there is a careful cost analysis before
making final decisions.
Mr. Schweikert. Mr. Chairman, to the entire panel--and I
said this in my opening statement, when reading through this
material, you start to say, okay, what am I missing? Where is
my law of unintended consequences? Do I wake up 2 years from
now and either with one or two more layers and have I either
narrowed consumer choice, have I started to create an
environment where my access to information--
Because I have heard a couple of folks say that we have
these cost differentials. But, before getting this job, I
remember trading stocks for $7 a share, but I also sometimes
would sit down with my investment adviser and have to write him
a check at the end of the day. I see lots of consumer choice
right now and the inherent fear is, does any of this put some
of that in peril? I was going to start with Mr. Tittsworth. And
tell me, am I engaging in a fear that is inappropriate?
Mr. Tittsworth. I can't tell you those are unjustified
fears. I guess I would have to say--I am not trying to avoid
the question, but I would have to see the SEC actual proposed
rulemaking I think before I could intelligently respond to your
question.
We certainly don't want to see consumer choice limited by
any action on the 913 study. And we make a point in our
statement that under the Advisers Act currently, there is a
huge broad range of activities that investment advisers, both
very small businesses, as well as some very global firms,
engage in. I think it accommodates--we certainly don't want to
limit consumer choice.
Mr. Schweikert. Thank you.
Mr. Chairman, my time is up. Thank you, sir.
Chairman Garrett. The gentleman is recognized.
Mr. Hinojosa. Thank you, Chairman Garrett.
First, I ask unanimous consent to enter into today's record
two documents relevant to today's hearing: one, the petition
supporting a fiduciary standard for financial professionals, as
outlined in Section 913 of the Dodd-Frank Act; and two, is the
petition requesting that the SEC extend the fiduciary standard
to broker-dealers.
Chairman Garrett. Without objection, it is so ordered.
Mr. Hinojosa. Thank you.
Mr. Hinojosa. My first question is directed to Mr. Ketchum.
Thank you for testifying today.
I would be remiss if I did not acknowledge FINRA's investor
education foundation and its solid financial literacy
activities which we strongly support. However, I am concerned
that FINRA does not provide the kind of transparency necessary
to provide investors the type of education they need to protect
themselves while operating in the capital markets. How is FINRA
qualified to be a self-regulatory organization for investment
advisers given this failure to uncover the Madoff fraud that
wrecked the lives of so many innocent Americans?
Mr. Ketchum. First, Congressman, thank you for your kind
words with respect to our education foundation. We appreciate
it.
As I indicated before to Chairman Bachus' question, no
regulator can be happy with missing Madoff. And that includes
FINRA as well as the SEC as well as State regulators. Certainly
it includes FINRA, notwithstanding the fact we did not receive
the complaints that Mr. Markopolos lodged, notwithstanding the
fact that Mr. Madoff fabricated and created zero records with
respect to the money management activity in his broker-dealer
and claimed to have no money management activity in the broker-
dealer.
Having said that, there were strings we could have pulled.
There were approaches we should have taken. We should have had
knowledge of discussions out in the industry that raised
concerns.
So I absolutely take accountability. I think any regulator
should. Though if you eliminated all of the regulators that did
not find Mr. Madoff's fraud, you would be out of regulators in
the United States.
I think the question, as I say, is not whether any of us
did it right with respect to Madoff. We didn't. The question is
whether regulation can make it less hard to find serious
frauds--put Madoff aside--to find serious Ponzi schemes.
The answer would be, if there was an SRO to supplement
government resources, an SRO that would have the ability, as
FINRA does, to do management reviews and to do membership
reviews before a firm can become a member of FINRA--and any SRO
would do the same things--you would increase the likelihood of
detecting a Ponzi scheme such as Mr. Madoff's and others. That
is why I think the addition--not as a replacement for
government, which is absolutely critical for the protection of
investors--but the addition of an SRO from a supplementary
standpoint is a very valuable thing.
Mr. Hinojosa. So the argument that we need a smaller
Federal Government does not work. I hear my friends on the
other side of the aisle that they want a much smaller Federal
Government, and you are telling me that we really need more
folks regulating.
In looking at the statement by Commissioner Irwin, I would
like to ask him a question. Commissioner, you said that the
enforcement actions by State security regulators last year
represent a 51 percent increase over the number of
investigations reported for the previous year. I was amazed at
the number of violators.
So, tell me, what are your thoughts on how we can improve
the requirements of all of these certified and listed companies
to protect investors? The Federal Government's Thrift Savings
Program makes available to us detailed information such as fund
performance, annual returns on investments, the monthly returns
on our investments, and, perhaps provides our constituents
access to market information that is detailed but easily
understood, and summaries to help our constituents estimate
their net worth. Give me some of your thoughts on that.
Mr. Irwin. Congressman, I think that one of the easiest and
best steps that we can take right away is making a fiduciary
duty applicable to all investment professionals who are
offering investment advice in a personalized nature in a retail
setting. The fiduciary duty that was proposed in Dodd-Frank
that we were pushing for at that time was much broader than the
one that ultimately was enacted. The one that ultimately was
sent to the SEC to study was one that was really very limited.
There was no ongoing obligation to supervise accounts after
that decision is made.
If we just ask investment advisers and broker-dealers who
are giving investment advice to put their clients before
themselves, it is not the best advice. It is just a matter of
putting, based on what they know, the interest of their
customer before themselves. Those customers will automatically
be better off.
We live in a time when the kind of returns that people are
seeing are very small. You just can't double your money by
putting it in, and compounding interest won't do it for you for
the rest of your investing career. We really need to provide
this.
Fiduciary duty is a very flexible answer. It is based on
the facts and circumstances of each situation. It has worked
since 1963 when the Supreme Court said in the Capital Gains
case--and investment advisers are subject to that Act. We think
that we have plenty of history, plenty of case law to build on.
Let's do that today.
Mr. Hinojosa. In closing my questions, at my request, the
Office of Financial Education was created at the CFPB. There
are numerous financial literacy programs that could help not
only high school students but community college students, the
university students, and adults.
With that, Mr. Chairman, I yield back.
Chairman Garrett. The gentleman from New York is
recognized.
Mr. Grimm. I thank the chairman, and thank you to all who
testified today. We appreciate it.
Obviously, this is a very difficult matter. We hear from
the larger institutions a little bit of a difference of opinion
from the smaller, more small-business-oriented institutions,
SROs versus SEC, and so on.
But one of the things I want to emphasize--and Ms. Roper,
if I can turn to you, you mentioned about the consumer saving
thousands of dollars and, over time, tens of thousands of
dollars. But there are other factors as well. And I am asking
you if you would agree that when a representative--when an
adviser or a registered rep is selling a product, there are
other things other than just the rate of return that are also
looked at. For example, the customer service of the company
that you are dealing with and the financial background of that
company and the stability and the track record that they may
have had for many years, is that not also something that goes
into it?
Ms. Roper. Absolutely. And we have tried to indicate that
cost is just one factor that is relevant to that assessment.
But it is a factor that shouldn't be ignored. Morningstar not
too long ago did research that indicates that cost is the
single best predictor of long-term performance and is better
than their star ratings, for example. I think you ignore it at
your peril or at least at an investor's peril.
But, absolutely, you adopt an approach, much as we do
under, say, our best execution standard where you provide
guidance regarding a variety of factors that have to be
considered. But they have to be considered, and we can't afford
to continue to ignore costs.
Mr. Grimm. In your recommendations to the SEC, you asked
the SEC to look not only at the prior enforcement actions but
at cases that could have been brought as well. You went on to
suggest the SEC should examine what could be accomplished under
an aggressively enforced standard.
I take from that--and based on my background as a former
special agent in the FBI, I worked very closely with, back then
it was the NASD and with the SEC. And when I look at a lot of
what happened--everyone keeps bringing up Bernie Madoff, and I
understand that this was such a travesty, the magnitude of his
fraud. But I would say the biggest problem we have had is a
lack of enforcement, and it is the enforcement that we really
need to focus on. And we can promulgate rules until we are blue
in the face, but if they are not enforced, they are irrelevant.
Ms. Roper. Yes, you absolutely need enforcement. And we, of
course, are strong supporters of enforcement. But if you don't
have the standard to enforce--it is two sides of the same
picture. If you can't enforce a best-interest standard because
the standard doesn't exist, tough enforcement doesn't get you
anywhere. If you have a best-interest standard and you don't
enforce it, the best-interest standard doesn't get you
anywhere. You need both sides of that equation.
Mr. Grimm. I agree that we need both. But I think
ultimately, we also need to be cognizant of the fact that it is
a balance. We have to balance making sure that investors and
consumers are protected, while at the same time balancing the
fact that our markets and our sectors within the financial
services sector are also robust and competitive not only here
in the United States but in the global markets that we are in.
That being said, if I could just switch a little bit and
ask Mr. Ehinger, can you walk us through the various levels of
the regulatory oversight facing a broker-dealer and its
registered representative, compared to the investment advisory
firm and its registered investment advisers?
Mr. Ehinger. I think one of the best examples, Congressman,
to describe that is just my recent experiences with
examinations just recently with FINRA and also the SEC. The SEC
was in and had conducted an examination both of our investment
adviser and our broker-dealer, and shortly thereafter, FINRA
was in as well. They were in on their cycle exam within 2
years. The SEC hadn't been in on the investment adviser side
for 5 years. And we are a corporate registered investment
adviser, so I would think that there would be more attention
given to some of the bigger firms.
But just the differences are the detail, the activities,
the selection of individual accounts, the reviewing with
individual supervisors in our organization about why they chose
to approve or not approve a particular product sale that had
taken place. That is the level of detail that the FINRA
examination had.
With respect to the SEC, while there are very good
individuals in all fronts working to do what they can do, there
was one individual who was looking at the investment advisory
and specifically only focused on advertising, which is, I
think, ironically where there are rules that they can really,
really audit to, as opposed to something that is vague and
amorphous like fiduciary standard.
Mr. Grimm. My time has expired. Thank you very much.
Chairman Garrett. Thank you.
Mr. Lynch is recognized.
Mr. Lynch. Thank you, Mr. Chairman.
Staying right on that, Mr. Dwyer, your testimony more than
suggests, it actually endorses the idea that FINRA would be the
body best suited to oversee inspection of investment advisers.
I have heard a couple of different people who apparently are in
agreement with you, but can you expand on why you think FINRA
is a better option than, say, a new and improved SEC or a newly
created SRO that is specifically designed and funded for this
purpose?
Mr. Dwyer. Thank you, Congressman Lynch. That is an
important question.
We heard here about problems that have arisen across the
spectrum of regulators that have been in place, and I go back
to the comments I gave in my oral testimony, that, as we look
at what is reasonable, the supervisory needs that we have, I
would turn to precedent, first of all; and the SEC has over 70
years of history of overseeing an SRO that in turn provides
oversight to the industry; and that, first and foremost, to me
sets a track record that makes FINRA an obvious choice.
Also, the reality or the practicalities of what is in
place. Today, FINRA has an elaborate structure to do audits of
institutions and offices all across the country, they have over
1,000 employees already who are out doing exams across the
country, and there is no question in my mind that they are far
and away best positioned to take on this task.
The significance of it should not be taken lightly; and I
would say that, no matter what the organization, we need to
continue to work with them to improve how they protect the
customer.
I think one of the things that needs to be called out is
who our advisers are. As I represent the Financial Services
Institute today, representing over 200,000 independent
financial advisers across the country, what that means is that
these are local business owners who are providing services in
communities all across the country. They are also community
leaders. They are also extremely philanthropic.
At the end of the day, when we surveyed our advisories a
year ago at LPL Financial, about 86 percent of them told us
that their number one source of clients is referrals. It is
paramount to them that they are able to work with clients and
build confidence with those clients to lead to additional
business. They need to operate in an environment where the
consumer has confidence and clarity about where they are going
to, who they are going to do business with, and how that will
be transpired.
Mr. Lynch. Thank you.
Ms. Roper, if I could ask you, on the fiduciary standard,
it seems from your testimony that you agree with the SEC's
position of--at least as I see it, the Department of Labor has
recommended that we adopt the ERISA standard and apply that to
both broker-dealers and advisers. How do you support that? How
do you argue in favor of harmonizing both groups under that
standard, as opposed to coming up with a standard that is more
exacting or something more--rather than lifting the standard
and simply applying something that is more targeted?
Ms. Roper. We actually have fairly significant concerns
about the Department of Labor proposal, although we recognize
it as very well intended and think there is a potential to
resolve the difficulties.
Mr. Lynch. Let me say, I may have--it seemed like you were
warm to the idea, but you really weren't beating the drum, so
to speak. But I could sense there was not clear opposition to
that idea in your testimony anyway.
Ms. Roper. The issue we addressed in our testimony is the
fact that the DOL proposal should not be allowed to stop the
SEC proposal.
The concerns that we have about the DOL proposal are that
it doesn't more closely resemble the SEC proposal, and it is in
two different aspects. One, it has a huge seller's exemption in
it and threatens to recreate in the retirement plan market
precisely the problem the SEC is trying to address here.
Sort of at the other end of the spectrum is that I think
the broker-dealer firms are absolutely right when they say, if
you apply an absolute ERISA, no conflict of interest, no third-
party compensation model in particularly the individual
retirement account arena and with the sanctions that exist
under ERISA, the broker-dealers are going to exit that
business--$2,000-a-year investors are not that enticing a
market, and there are not a lot of fee-only financial planners
or fee-only advisers who are going to step in and provide those
services.
So, yes, we have concerns about the DOL proposal. We are
not, by any stretch of the imagination, advocating that it be
adopted in the SEC world. Quite the contrary. We would like to
see something under the DOL proposal that more closely
resembled the SEC. That is primarily an issue with ERISA rather
than with the definition itself. And the key issue--one of the
key issues is how will they do the prohibited transaction
exemptions which seem to have sort of replaced ERISA as the way
the law is imposed, and I don't think you can move forward with
the proposal until you know the details of what it would look
like in practice.
Mr. Lynch. Okay, that is very reassuring and very helpful.
Thank you. I yield back.
Chairman Garrett. Thank you.
The gentleman from Florida.
Mr. Posey. Thank you very much, Mr. Chairman.
Clearly, Madoff was not empowered by a lack of loss. He was
empowered by a lack of enforcement, and there is not a single
law that would have changed that, that we could adopt now. If
we could do it all over again, the only thing that would be
needed to stop Madoff was to make some employees do their jobs,
which they were unwilling to do.
As another related issue regarding ERISA, there was a
company named TRG. It was one of about a dozen that wrote
health insurance in 49 States, every State but their own State.
No State felt like they were empowered to do anything about it
because they were protected by ERISA, protected from State
sanctions until finally Florida did break loose and in
cooperation with 13 agencies in other States they went to the
culprit State, and it was the first time in history State lines
were ever passed to prosecute health insurance fraud, and that
was done because the Federal Government did absolutely nothing
to enforce the law to those who fell under ERISA and seemingly
out of the hands or ability to prosecute by States.
I support fiduciary standards, but they must be clear, they
must be unambiguous, and they must not be conflicting. And
obviously, I think one agency is sufficient to promulgate such
standards, and I think the more agencies you have involved in
it, the worse it is going to be on everybody.
And to that point I would like to ask Mr. Headley, since it
was in his written testimony he talked about the Department of
Labor's fiduciary proposal in addition to the SEC proposal that
we have been discussing today. Mr. Headley, I would like to ask
you to explain why you believe the Department of Labor's
proposal could impact the middle-market investor's access to
professional guidance for their retirement plans, if you would
be kind enough to do that.
Mr. Headley. Thank you, Mr. Congressman.
First of all, again, on the DOL fiduciary duty, there was
no congressional directive to look at this. It clearly
conflicts with the SEC's fiduciary duty, what they are
proposing for broker-dealers and investment adviser
representatives. It clearly is using ERISA to overreach into
another section of the Internal Revenue Code as it pertains to
IRA account holders and everything, that is differentiated from
the employer context. It would require that no Commission-based
products could be implemented, requires a level fee model in
lieu of that. It could literally shut down the middle-class
access to professional advice and for IRA account owners.
I think the two areas that NAIFA members would like to see
is that, if they were to go forward, is to simply exclude IRA
advice from the rule and, secondly, to exclude any advice under
a seller's exemption that is incidental to the sales activity.
Mr. Posey. Okay, I appreciate your comments.
Would anyone else like to weigh in on that?
Mr. Headley. Thank you.
Mr. Posey. I am finished before my time, and I yield back.
Thank you, Mr. Chairman.
Chairman Garrett. How about that?
The gentleman from Colorado, I think we are skipping over,
I believe, and we go to the gentleman from Colorado. Since he
was here, we appreciate your coming.
Mr. Perlmutter. Just a couple of things.
Mr. Taft, it was your comments and your written remarks
that I want to focus on a little bit.
The rulemaking--going back and looking at 913, obviously in
913, the Congress directed the SEC to go through this
rulemaking process. It wasn't something they just went out on a
lark to do as I understand the legislation. Yes, sir?
Mr. Taft. If I could just clarify, it authorized--it
directed the SEC to study the issue. It authorized them to act
but does not require them to act.
Mr. Perlmutter. Thank you, and I think that is a perfect
description. We asked them to look at a number of different
things, including harm/benefit analysis. Whether they did or
they didn't, I am not sure, but in the directions from the
Congress, those are clearly included.
But when I really look now at the language, the standard of
conduct--because you talk about the rulemaking to articulate
the standard would address the following five key components:
core principles, articulate the scope of obligations under a
uniform fiduciary standard, define personalized investment
advice, and then a couple more.
When I look at the standard of conduct as it applies to the
Securities Exchange Act of 1934 and then the standard of
conduct as it applies to the Investment Act under what we did
in Dodd-Frank, they seem to be pretty similar. It says the
Commission may promulgate rules to provide that with respect to
a broker-dealer when providing personalized investment advice
about securities to a retail customer, the standard of conduct
for such broker-dealer with respect to such customers shall be
the same as the standard of conduct applicable to an investment
adviser under Section 211. And then it says, Ms. Roper, the
receipt of compensation shall not in and of itself be
considered a violation.
One of the things you were talking about is an
underwriter--a life underwriter might propose a product that
they make more money on, but we said specifically that really
doesn't have to be an issue.
Then it goes down to the standard of conduct for the
investment adviser. The Commission may promulgate rules for all
broker-dealers, investment advisers when providing personalized
investment advice about securities to retail customers shall be
to act in the best interests of the customer.
Do we even need any rules or is this standard of conduct
that we have stated in Dodd-Frank enough, I guess is my
question, when we say it has to be in the best interests of the
customer?
Mr. Taft. What Congress--my understanding of congressional
intent, what Congress told the SEC they need to do if the SEC
decides to write a fiduciary standard is to build a standard
the investor protection characteristics of which are no less
stringent than those in the Adviser Act, and--
Mr. Perlmutter. My question, though, to you--and I agree,
that is what it says, ``no less stringent.'' It says--in fact,
it says ``the same.''
Mr. Taft. Right.
Mr. Perlmutter. If you look at the standard of conduct.
Mr. Taft. Yes, the same.
Mr. Perlmutter. It says, ``the same.'' It says,
personalized investment advice about securities retail
customers in the best interests of the customer with regard to
the financial or other interests of the broker-dealer, etc. Do
we need any--
Mr. Taft. Yes, here is what you need: So, today, the
standard of care that is a fiduciary standard of care is
implicit in the Advisers Act and governs a set of activities
that have to do with a customer walking into their adviser and
handing over their money to the adviser to manage
discretionarily. In other words, they are ceding control in a
fundamental way of the management of those assets to an
adviser. And there have been rules and there is case law and
there is precedent built up over the years that operationalize
that fiduciary standard with respect to the things an
investment adviser does for their client.
Okay. What we need going forward, if the SEC decides to
apply a similar standard to the activities of broker-dealers
who engage in personalized investment advice, we need rules
that tell us how to operationalize that same standard to
brokerage activities, to which that standard has never applied
and for which rules do not exist today. That to me is the
single most important thing the SEC would still need to do in
writing a new standard.
And back to the many comments of Congressmen, of the
committee, it is important to note today that those rules have
not been written, and going forward there is a chance to write
them the right way, a way that aligns with the current best
practices of the industry and which is not disruptive to
investor relationships with their advisers. And there is a way
to do that the wrong way which disrupts investor's
relationships with their advisers, increases costs, reduces
access. So right way-wrong way, we are at a fork in the road.
The SEC still has the opportunity to go down either path.
Mr. Perlmutter. Okay, and my time has expired. Thank you. I
could ask the rest of the panel that same question, but thank
you.
Chairman Garrett. The gentleman yields back, and I don't
believe--no, we have no one else, at least at this moment. Mr.
Green?
Mr. Green. Thank you, Mr. Chairmanand I thank the witnesses
for appearing today.
For clarity purposes, if you are of the opinion as a
witness that we need no additional regulations, would you
kindly extend a hand into the air that things are fine as they
are, we just need more enforcement? Anyone?
Okay, we have one person who thinks so.
How do you respond, sir, to the contention that enforcement
necessitates something meaningful to enforce? I believe that is
a fair way of putting it. Ms. Roper, you may have stated it
more eloquently than I, but how do you respond to this
contention?
Mr. Ehinger. Congressman Green, first of all, I should
qualify my statement in terms of, I am not saying there
possibly shouldn't be any type of new regulation over time. I
am just answering that question with respect to what is being
proposed today.
Because I think it needs to be clear, as we stated earlier
and, actually, Chairman Garrett said before, what problem are
we trying to solve? And, also, do we really understand and have
we really done investigation regarding the broker-dealer
standards today and how that--
Mr. Green. Because my time is limited, permit me to just
intercede. And I don't mean to be rude, crude, and unrefined,
but let me ask this, please: What would you propose? I do
understand now that you don't support what we are doing today,
but what would you propose that we do?
Mr. Ehinger. I would propose a couple of different things.
One, I would agree with Mr. Taft that rules, really
guidelines, guidance that we can, as broker-dealer
organizations, really train and educate and really help our
registered reps understand--
Mr. Green. If I may, let me intercede again. Please forgive
me.
But I have in my hand intelligence from the RAND--a RAND
Report indicating that investors could not identify whether
their own provider was a broker or investment adviser, and that
confusion persists even after the investors were provided with
fact sheets on investment advisers and brokers that include a
description of their common job titles, legal duties, and
typical compensation practices.
Mr. Ehinger. Congressman Green--
Mr. Green. You seem to be implying that somehow disclosure
will do what is not being done even when people are afforded
empirical evidence to examine.
Mr. Ehinger. I think that study--that 2008 RAND study also,
and I believe one of my fellow panelists mentioned this as
well, also found that investors were satisfied with their
financial advisers or consultants or registered representatives
in whatever fashion that they engaged.
That confusion is not something I think you solve by
changing legal standards. I think confusion is addressed first
and foremost by, respectfully, proper disclosures. I think Mr.
Ketchum, in one of the rule proposals that FINRA put forward,
Rule 1054, is doing that very thing, actually I think in a very
forthright and very smart fashion. That is, simple, direct,
easy to understand and read disclosures that take advantage of
today's technology and allow deeper dives for those who want to
know.
Mr. Green. I am going to ask at this time that Ms. Roper
kindly respond. I can sense that you desire to have a word.
Ms. Roper. What you have to understand is the RAND study
was commissioned at the request of then-Commissioner Glassman
at the SEC, because the SEC had already tried the disclosure
route. As part of their fee-based brokerage account rule, they
had tried to design a disclosure for broker-dealer ads and
account statements that would help investors to understand when
they were dealing with a broker, an adviser, and what the legal
duty was. And they took that disclosure out and, thanks to
Commissioner Glassman's insistence that they test it with
investors, they did that testing. They found investors didn't
understand it. They tried to redesign it. They tested it again.
Disclosure does not work. You cannot solve through
disclosure or through investor education a policy that doesn't
make sense, and it will never make sense to investors that
their financial adviser is a salesperson and their investment
adviser is an adviser. You cannot make sense to investors out
of the fact that one person offering personalized investment
advice has a fiduciary duty to act in their best interests and
another person offering the exact same service doesn't.
Disclosure can be helpful, but it can't solve a basic
regulatory breakdown.
Mr. Green. Mr. Ketchum, let me quickly ask you a question.
Do you believe that the SEC is overpenalizing and
overinvestigating?
Mr. Ketchum. No. I think the SEC is an agency that--
Mr. Green. Since my time is running short, I will accept
the ``no,'' and let me just go on to suggest that I have
intelligence indicating that the SEC issued about $1 billion in
penalties and FINRA fined members about $43 million last year.
Similar budgets, similar issues. How do you cause persons who
would have some consternation based upon a belief that FINRA is
more lax than the SEC as evidenced by penalties imposed?
Mr. Ketchum. Much of the SEC number reflects one case with
respect to Goldman Sachs, in particular egregious and
problematic activity. A variety of others reflect major
industry cases from the credit crisis.
We strongly believe that fines should discourage behavior
and encourage far superior compliance, but fundamentally fines
have to relate to the fact situation and the actions that you
are bringing. We think if you look through the cases that we
brought with respect to that, I think the fines were stiff, and
they were appropriate.
Mr. Green. Thank you very much, and I thank the entire
panel.
Thank you, Mr. Chairman.
Chairman Garrett. The gentlelady from New York.
Mrs. McCarthy of New York. Thank you, Mr. Chairman, and
thank you for having this important hearing. I think it is very
good for all of us to hear the testimony of everybody and to
understand what we had done over a year ago.
I am interested in Section 913 because I actually had a
pretty large part in getting that in there, so I want to
explore that a little bit.
Earlier this year, I, along with about 28 of our New
Democrats, as we call ourselves, sent a letter to the
Department of Labor, the SEC, and the CFTC on this issue on
Section 913. I happen to believe it is important to maintain
investment choice, and I believe Congress showed this intent in
Section 913 of the Dodd-Frank Act.
I am concerned that the Department of Labor--and we have
had hearings here in the Education Committee talking to the
Secretary, but I do believe that what--the Department of
Labor's board of fiduciary proposal will step on the toes of
the SEC and ultimately increase the cost for the investors.
That is my concern. I believe, as written, as of now, the
selling exception in the DOL fiduciary proposal does not go far
enough. In fact, it is counter to Congress' intent and the
direction the SEC is likely to take based on the agency's
findings.
So, Mr. Taft, I will ask you, and certainly anyone else who
wants to go in there, how will the DOL's current proposal and
seller's exception impact investors and the market?
Mr. Taft. I will just give--maybe focus on one area in
which we believe the DOL's proposed rules will restrict client
access to products, services, and advice and, as has already
been alluded to, the issue with the DOL's proposal, which
expands the definition of fiduciary, okay, and creates
tremendous uncertainty on the part of industry participants as
to when and when they won't be fiduciaries. We will default to
the worst-case definition in order to defuse liability. And,
secondly, it brings to bear upon the broker-dealer model the
prohibited transaction elements of ERISA.
In the case of Section 913, the SEC has the ability--I was
talking about operationalizing a fiduciary duty through things
like disclosure of conflicts and conflict management--to do
things to allow brokers to continue to offer proprietary
products, to continue to offer new issues of stocks and bonds,
to continue to charge commissions for their services.
Under the ERISA proposal, all those things would be
prohibited transactions and would not be allowed. Now, most
problematically, they would not be allowed in individual
retirement accounts. And I would say all the financial
institutions at this table and the industry, the bulk of their
accounts, their client accounts are individual retirement
accounts. Forty percent of the accounts at our firms are IRAs,
and the predominance of those accounts are small when it comes
to assets under management, and today the predominance of those
accounts receive advice through a commission-based model.
Under the DOL proposal, what would happen--and Barbara
Roper alluded to this--is that, given the small size of those
accounts and the extreme nature of the liability under the
DOL's proposal, broker-dealers will exit that business, will no
longer provide those services to those small clients unless
they move to a fee-based model which already functions under a
fiduciary approach that restricts access to products and
services, cannot buy new issues of stocks, cannot buy new
issues of bonds, and increases costs by as much as 50 percent
on average, so increases costs, restricts access for exactly
the kinds of investors that need it the most.
Mrs. McCarthy of New York. One of the things that I think
bothers a number of us is that, going back in last January, the
Administration actually put out an Executive Order for the
different organizations when they are working on an issue to
work together. From the conversations that we have had and many
meetings that we have had, I don't think that has happened, and
that is why I am not letting this go until we hopefully come to
some solution that is fair to our consumers. And I think that
is where I am coming from.
Gee, I only have a little bit longer. A short answer.
But, Mr. Irwin, I know, listening to your testimony, we
have been concerned about the frequency of examinations and the
efficiency of the oversight investment investors. In 2010, I
wrote to the NASAA, and they sent me back a very long response.
What I am concerned about is anticipating a high volume of
firms going from Federal to State regulation as a result of the
threshold change within the Dodd-Frank Act. Does NASAA have a
comprehensive database available for investors to research the
examination enforcement process for each State as well as
disciplining actions?
I guess what I am saying is, one of the concerns we had
even with going back with predatory lending was that one broker
could leave the State, go into another State, and there was no
way of checking it. Are we looking at for the States to come
together for a database so we have that kind of information?
Mr. Irwin. Absolutely, Congresswoman McCarthy. We realize
that to take on this additional responsibility, it is going to
take us continuing to work together as we do. There is a
memorandum of understanding among the States that every State
has signed in which we are planning on doing these kinds of
things. We are streamlining exams, and improving our risk
assessment so we can more strategically undertake those exams.
NASAA is prepared to fund joint exams among different
States. And, fraud doesn't stop at the border. In Pennsylvania,
it goes into Ohio, West Virginia, etc. We are issuing cease and
desist orders every 2 weeks for scams that are coming out of
California. And we share those orders that we issue with all of
the other States. We work together on many, many different
levels. We are prepared to take on the additional
responsibility.
Mrs. McCarthy of New York. Would the States also--because
most States are having fiscal difficulties, will you be able to
handle the increased load, and financially would you be able to
do it as the States go forward?
Mr. Irwin. That is a great question.
Different States are having different experiences. In
Pennsylvania, we knew, because of the discussions over Dodd-
Frank early on, that we had to meet with our budget secretary
and talk to the governor about the possibility that this was
going to happen. And I am pleased to report that Governor
Corbett in Pennsylvania has given us five additional examiners
and additional accounting staff to deal with the more complex
kinds of examinations we are going to have to undertake.
Some States are not as fortunate. But the more exams that
we do, unfortunately, the more fines emerge. It gives us--and
those funds fall back into the States to increase our exams.
We are net revenue generators in a big way for our States.
Our budget in Pennsylvania, for example, is about $9 million.
We last year gave $30 million back to the Commonwealth. We
believe that the resources are there, and they just have to be
given to us to be able to undertake our mandate.
Mrs. McCarthy of New York. Thank you, and I want to thank
all the witnesses for taking the time to be with us today.
Mr. Chairman, thank you.
Chairman Garrett. And I thank you for the question.
I guess you can always find something wrong with an audit,
though, right, to generate the fines?
The gentleman from North Carolina is recognized for
potentially the final word.
Mr. Miller of North Carolina. Mr. Chairman, I will forgo
questions, but do not get your hopes up that that will become a
frequent occurrence.
Chairman Garrett. Okay. At this time, we will recognize the
ranking member for some documents that she wishes--
Ms. Waters. What did he say?
Chairman Garrett. He is forgoing questioning. You had some
documents?
Ms. Waters. I ask unanimous consent, Mr. Chairman, to enter
several documents into the record: a statement from the Project
on Government Oversight; a report from AARP; an article by
Mercer Bullard, associate professor of law at the University of
Mississippi; a statement from the Financial Planning Coalition;
a letter to Congresswoman McCarthy from the North American
Securities Administrators Association; and a letter to
Secretary Hilda Solis from the New Democrats Coalition.
Chairman Garrett. Without objection, it is so ordered.
And I also seek unanimous consent with regard to statements
from the Independent Insurance Agents & Brokers of America;
from the National Association of Independent Broker/Dealers;
from Paul Schott Stevens of the Investment Company Institute;
from the Financial Services Roundtable; from The American
College; from the Managed Funds Association; from The Bond
Dealers of America; from the American Council of Life Insurers
(ACLI); and I think that is about it.
Without objection, it is so ordered.
With that, I very much thank all the members of the
subcommittee for their participation and their questioning and
also very much appreciate this diverse panel that we had today
and for all of your information and dialogue that we got from
you today.
The Chair notes that some members may have additional
questions for these witnesses that they may wish to submit in
writing. Without objection, the record will remain open for 30
days for members to submit questions to these witnesses and to
place their responses in the record.
With that, this meeting is adjourned. Again, thank you.
[Whereupon, at 12:40 p.m., the hearing was adjourned.]

A P P E N D I X

September 13, 2011

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