Online Brokers Face Fiduciary Spotlight

NEW YORK (TheStreet) -- Online brokers may not be completely exempt from the debate regarding "fiduciary duty" despite the assumption that any new rules will leave them largely unscathed.

Firms offering online discount services, such as Fidelity Brokerage, TD Ameritrade (AMTD), Charles Schwab (SCHW) and E*Trade Financial (ETFC), will all need to reconsider some business practices if -- or when -- new rules are adopted.

"At first glance, it looks like it may not be a big deal for them ... but if we look at their operations in greater detail arguably you could say that they could be held to a higher standard," says Dr. Yuval Bar-Or, a risk management consultant and adjunct finance professor at Johns Hopkins University's Carey Business School.

As part of the stronger consumer protections being implemented under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and signed into law on July 21, the Securities and Exchange Commission is required to conduct a study to assess "the effectiveness of existing standards of care for brokers-dealers and investment advisers, and whether there are gaps, shortcomings, or overlaps in the current legal or regulatory standards," the agency says on its Web site.

Practically, regulators are considering replacing the standard that brokers need to meet when selling products. Currently brokers are subject to the "suitability," meaning that a stock or other security must meet the needs and investment experience of a client. Under a fiduciary standard, however, the broker or RIA will need to place the client's interests before his own, or the firm's.

Investment advisers and industry participants have often complained about the lack of rigorous rules required of brokers when it comes to investor protections, arguing that consumers were steered into risky or complicated products in exchange for a hefty commission fee.

"Broker-dealers and investment advisers provide critical financial services to millions of American investors," said SEC Chairman Mary Schapiro said in a late July press release. "A system that fairly and effectively regulates these market participants is essential to protecting investors."

The SEC is in the process of collecting public input and comments related to this issue and is supposed to report its findings by early next year.

Discount brokers that do not provide advice to retail clients -- but rather execution and education on investment strategies and products - were thought to be spared the lion's share of the regulatory burden if a fiduciary standard is adopted.

But depending on what the final version of the rule change says, online brokers may have to make changes to their execution practices, Bar-Or says.