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The Financial Reform Act of 2010—How Does it Affect You? by Beth Jones, RLP®

President Obama signed the Wall Street Reform and Consumer Protection Act, sometimes called the Financial Reform Act, into law on July 21, 2010, marking the first big step toward building a more sturdy financial structure for our country.

The numerous financial bailouts that have taken place since the market plummeted in late 2008 highlighted cracks within our financial system. This new financial regulatory legislation hopes to close these gaps and potentially promote growth in the U.S. market by reviving investor confidence and trust. So, exactly how will these regulations impact you?

The Financial Reform Act is expected to change the entire structure of the financial services industry. One key piece in the 2,500 page legislation involves having the Securities and Exchange Commission (SEC) create and implement a uniform fiduciary standard.

Currently, broker/dealers and investment advisers are not held to the same standards of customer care; this presents investors with a disadvantage, as it does not allow them to uniformly compare different financial services providers. In fact, studies have shown that many investors aren’t even aware of the differences between broker/dealers and investment advisers. The SEC has just completed a six-month study of the various fiduciary standards that exist among broker/dealers and investment advisers. While we await the results of the study, we know the SEC will be responsible for writing up a set of standardized rules that are expected to “harmonize” the requirements all financial service providers must follow.

The SEC is also expected to make a recommendation to Congress as to who should be designated as the regulatory and supervisory overseer for the financial services industry going forward. Currently, oversight is shared between the SEC and the Financial Industry Regulatory Authority (FINRA), who each have different rules for the constituents they supervise.

Under the Investment Advisers Act of 1940, broker/dealers are held to a suitability standard. In other words, broker/dealers and their representatives are required to provide service that is suitable or appropriate for a client’s needs. Under the new legislation, as mentioned above, it’s expected that broker/dealers will eventually be required to provide a fiduciary standard of care similar to that of investment advisers. This means putting the needs of the client first and always acting in the client’s best interest.

The new legislation also calls for the establishment of an official investor advocate position within the SEC, and the SEC has also been tasked with creating a new consumer protection bureau to help regulate products and services and to ensure that consumers’ needs are being met.

A new financial stability oversight council will be created to monitor risks that could cause substantial damage to the entire financial system, such as the poor lending standards that contributed to the housing market turmoil. It’s unclear at this time who will ultimately be in control of this council: the SEC, which currently governs similar regulatory issues, or FINRA. Regardless of which body is chosen, we expect that financial professionals—and the financial system—will face increased regulations.

Legislation to deter “predatory lending” is in the works. Lenders will be required to verify whether a loan applicant has a reasonable ability to repay the loan; this will include examining income and credit history. Mortgage brokers and loan officers will not be allowed to receive bonuses or higher commissions from lenders for guiding customers into a high interest rate loan. “Balloon payments” will also have new limits on their size and repayment penalties.

Banks will be required to hold more reserves to cover potential losses, which will help prevent the need for big bank bailouts. Additionally, a new requirement to hold at least 5 percent of the value of any loans for lenders repackaging mortgages will help prevent against a repeat of poor lending practices from the past. The FDIC insurance limit for deposit accounts has also been raised to $250,000 to help protect individuals’ accounts from lender failure.

The Wall Street Reform and Consumer Protection Act is clearly designed to benefit investors—and to help prevent financial malfeasance (à la Bernie Madoff). It could take some time for these changes to come to fruition, as the regulatory bodies involved have been given some flexibility in conducting studies, revising rules, and eventually implementing those rules. Ultimately, what you can expect is a fiduciary standard of care, and a regulatory system designed to enhance industry efficiency and protect your best interest as an investor.

Will it affect your current relationship with your advisor? It could. For example, advisors may need to modify how they charge their clients for services or the type of information they provide at the outset of the relationship, as well as ongoing communication. It is also possible that many will see little change. I feel strongly about the fiduciary standard of care, and you must determine who you trust to work with you in creating and monitoring your financial plan. This really goes far beyond which products are in your portfolio. You want a trusted adviser who understands your life.

Beth Jones, RLP® is a Registered Life Planner and Financial Consultant with Third Eye Associates, Ltd, a Registered Investment Adviser located at 38 Spring Lake Road in Red Hook, NY. She can be reached at 845-752-2216 or Securities offered through Commonwealth Financial Network, Member FINRA/SIPC.

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