One interesting debate in the larger financial regulatory battle right now revolves around broker dealers and whether they ought to have a fiduciary responsibility to their clients. The debate has been around a while. Until now, the main question has been whether such a standard should be imposed on retail brokers, the way it is already imposed on registered investment advisors. Now, the big question is whether big firms like Goldman Sachs (NYSE: GS) should be held to a fiduciary standard when selling to and trading with big institutional clients. 

The idea of imposing such a burden on dealers heated up significantly in the wake of the SEC's charges against Goldman Sachs; the agency alleges that the firm misled big institutions by not disclosing the roles of certain third-parties in the creation of a single synthetic CDOs (CDO news). The idea has lots of intuitive appeal. And an amendment has been offered in various reform packages that would impose such a standard. 

Many people might indeed have a hard time understanding why anyone would oppose a rule that would require big dealers to act in the best interests of their clients, which would mean disclosing conflicts of interest among other things. 

But the industry argues that while such a standard ought to apply to retail investing, it's a wholly different situation at the wholesale level. Specifically, they argue that firms like Goldman Sachs and Morgan Stanley (NYSE: MS) are not acting as investment advisors but rather as market makers and counterparties. Therefore, they should not be saddled with the fiduciary burden. Goldman Sachs President Gary Cohn (Gary Cohn news) recently argued that market makers could not work if they were seen as fiduciaries. 

As for taking the opposite of a investment it sells to customers, Cohn argued that the bank should be able to offset risks related to investments, especially illiquid investments, in which it is making a market. That is hard to argue with. So the fact they the firm is a counterparty on product it created and sold is not inherently a bad thing. And it does appear difficult to separate out an advisor function as opposed to the market-making and sales functions. 

Still, this argument has fallen on skeptical ears. Some argue that while "traditional market makers promote price and market efficiency, a firm such as Goldman, as an active trader for its own account, can maximize its opportunity for profits by promoting price and market inefficiency." The fact that a market maker is also a proprietary trading complicates the picture. For these reasons--the sheer cloudiness of it all--may be one reason some are supporting a rule that would ban banks from some derivatives work. My sense is that the industry needs to come up with its own solution, before one is imposed on it from outside. - Jim