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I watched a good chunk of the Senate Goldman hearing today and was most interested to see what it might signal about financial reform. Perhaps the most interesting signal came during Senator Collins (R-Me) questions during the first panel. Her questions of the Goldman employees (as well as her opening statement) suggested she is considering whether SEC regulated broker-dealers ought to be subject to fiduciary duties for clients. She contrasted investment advisers, which are subject to fiduciary duties and must therefore act in the best interests of clients, with broker dealers, which are not under such duties but do have more limited suitability requirements. Her press statement also signals that she is interested in exploring fiduciary duties for broker dealers.

This may seem like a small detail, but if this idea from a senior Republican gains any traction it could dramatically change the way broker dealers and Wall Street firms do business. The Goldman employees and former employees in the first panel took pains to characterize their roles as "market makers." If fiduciary duties apply to broker dealers, that role might no longer be possible. In fact many practices of broker dealers might have to be scuttled if they are forced to act in the best interests of a client. It would be harder to act as a middleman between two clients or to invest on the other side of a client trade, if the broker dealer is held to a high standard of acting in each client's best interest. Of course, "fiduciary duties" can mean different things in different contexts, as any business associations scholar can tell you. But applying investment adviser-style fiduciary duties to broker dealers would be a sea change.

Senator Collins' idea is not coming out of nowhere Harmonizing investment adviser and broker dealer standards has been discussed at various junctures in the current reform debate. For recent scholarship on the question of applying fiduciary duties to broker dealers, see Tamar Frankel, Arthur Laby, and Barbara Black.

Addendum: Larry Ribstein has just posted a response to this post that is sharply critical of the idea of fiduciary duties for broker dealers. He cites extensive litigation costs of fiduciary duties in other areas -- like the Jones v. Harris fight over mutual fund manager fees. We had an extensive debate on that case here at this blog (here are Professor Birdthistle's posts on the outcome of the case in the Supreme Court).

In terms of costs, I was thinking less of litigation as a cost and more that for many transactions imposing a fiduciary duty on broker dealers rule might possibly require parties on opposite sides of "trades" -- e.g. an originator looking to sell loans and a cdo investor looking to buy ABSs (or a hedge fund and investor each looking to enter into a series of credit derivatives like a synthetic CDO with one another) -- each to have their own broker dealer.

That would certainly reduce the potential for conflicts of interest on which yesterday's hearing focused (for close to 11 hours!). But how many clients might not like the additional cost? Would some sort of opt-in/opt-out system be better? Again, the costs and benefits of imposing a "fiduciary duty" depends on how that duty would be defined -- not all fiduciary duties are the same.

Broker dealer regulation is not my area of expertise, so I commend the Tamar Frankel, Arthur Laby, and Barbara Black scholarship mentioned above.

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I watched a good chunk of the Senate Goldman hearing today and was most interested to see what it might signal about financial reform. Perhaps the most interesting signal came during Senator Collins (R-Me) questions during the first panel. Her questions of the Goldman employees (as well as her opening statement) suggested she is considering whether SEC regulated broker-dealers ought to be subject to fiduciary duties for clients. She contrasted investment advisers, which are subject to fiduciary duties and must therefore act in the best interests of clients, with broker dealers, which are not under such duties but do have more limited suitability requirements. Her press statement also signals that she is interested in exploring fiduciary duties for broker dealers.

This may seem like a small detail, but if this idea from a senior Republican gains any traction it could dramatically change the way broker dealers and Wall Street firms do business. The Goldman employees and former employees in the first panel took pains to characterize their roles as "market makers." If fiduciary duties apply to broker dealers, that role might no longer be possible. In fact many practices of broker dealers might have to be scuttled if they are forced to act in the best interests of a client. It would be harder to act as a middleman between two clients or to invest on the other side of a client trade, if the broker dealer is held to a high standard of acting in each client's best interest. Of course, "fiduciary duties" can mean different things in different contexts, as any business associations scholar can tell you. But applying investment adviser-style fiduciary duties to broker dealers would be a sea change.

Senator Collins' idea is not coming out of nowhere Harmonizing investment adviser and broker dealer standards has been discussed at various junctures in the current reform debate. For recent scholarship on the question of applying fiduciary duties to broker dealers, see Tamar Frankel, Arthur Laby, and Barbara Black.

Addendum: Larry Ribstein has just posted a response to this post that is sharply critical of the idea of fiduciary duties for broker dealers. He cites extensive litigation costs of fiduciary duties in other areas -- like the Jones v. Harris fight over mutual fund manager fees. We had an extensive debate on that case here at this blog (here are Professor Birdthistle's posts on the outcome of the case in the Supreme Court).

In terms of costs, I was thinking less of litigation as a cost and more that for many transactions imposing a fiduciary duty on broker dealers rule might possibly require parties on opposite sides of "trades" -- e.g. an originator looking to sell loans and a cdo investor looking to buy ABSs (or a hedge fund and investor each looking to enter into a series of credit derivatives like a synthetic CDO with one another) -- each to have their own broker dealer.

That would certainly reduce the potential for conflicts of interest on which yesterday's hearing focused (for close to 11 hours!). But how many clients might not like the additional cost? Would some sort of opt-in/opt-out system be better? Again, the costs and benefits of imposing a "fiduciary duty" depends on how that duty would be defined -- not all fiduciary duties are the same.

Broker dealer regulation is not my area of expertise, so I commend the Tamar Frankel, Arthur Laby, and Barbara Black scholarship mentioned above.

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