The financial regulation bill doesn’t require it, but the Goldman mess could prompt changes.
Debate over the financial reform legislation is getting under way in the Senate. One change that had been mulled in preliminary discussions doesn’t look like it will be part of the final law: a measure to require investment banks to act as fiduciaries when selling securities to clients, rather than just meeting the standard of appropriateness. The 11-hour grilling of Goldman Sachs executives on Tuesday over their Abacus deal revived talk of such an amendment. Should Treasury support it?
Investment banks would argue that a fiduciary responsibility, on par with, say, the one investment advisors must meet, would severely crimp liquidity in the capital markets. It would be difficult to make markets at all. Most are zero-sum games making a fiduciary responsibility to both sides of a trade a nearly impossible standard to meet. Those trades that don’t involve two ready-to-deal sides (and most don’t) require the investment bank to take a position for some period, putting it by definition on the opposite side of a client.
Treasury worried about the Goldman revelations might find that such an arrangement looks good on paper but severely constrains fundraising and hedging possibilities. After all, making distinctions between counterparties and clients would be fraught with legal risks. However, the impetus for sweeping rule tightening, such as Senator Blanche Lincoln’s proposal to bar derivatives houses from access to FDIC insurance and Federal Reserve lending facilities, has grown significantly since the Securities and Exchange Commission filed its charges against Goldman—and today’s revelation that the Justice Department is considering criminal charges will only add fuel to the fire.
But rather than a fiduciary duty, which would open a floodgate of potential lawsuits, a more careful definition of the appropriateness standard might be helpful. That, and a clearer distinction—either in law or in fact—between counterparties and clients would be beneficial and wouldn’t necessarily impair the markets.