More On Legal & Compliancefrom The Advisor's Professional Library
- Registration Requirements for Investment Advisor Representatives (IARs) When individuals launch an advisory firm, they must avoid marketing themselves or the firm as investment advisors before they are properly approved and registered. Otherwise, they are subject to severe penalties.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
One of the talents you develop from being a reporter for too long is the ability to spot a "source" when you see one. I'm not talking about a Woodward-and-Bernstein-deep-throat here: I've never thought that kind of gotcha "information" truly helps readers much, even when it topples Presidents or wins Pulitzer prizes.
What really gets my nerdy journalistic juices flowing is coming across someone whose experience and perspective gives me new insight into an issue that's important--and hopefully, valuable--to independent financial advisors.
I recently had the pleasure of meeting just such a source at the annual fi360 conference in Scottsdale, Arizona. Fi360 is the leading organization for training and supporting advisors who want to assume a genuine fiduciary duty to their clients, and Kristina Fausti is the organization's new director of legal and regulatory affairs. That's not usually a position prone to produce invaluable sources (if my experience is any indication), but Fausti may well set a new standard in that regard. She had been on staff at fi360 for about two weeks when I met her at the conference, but armed with an MBA and a cum laude law degree from Georgetown, she spent the past four years as a special counsel at the Securities and Exchange Commission where she specialized in broker/dealer regulation.
If you want to know something about, say, the pending reregulation of financial advisors, how the SEC will determine its position, or how Washington, DC, works in general, Fausti is about as good as it gets. After talking with her in person and on the phone, and listening to her present two Webinars on the coming rereg, it's fair to say that she has indeed changed my perspective. By adding a healthy dose of reality to my overly idealistic notions, Fausti refocused my thinking into the realm of what's possible, and has given me a glimmer of optimism that the outcome could be better for consumers and real advisors than I had feared.
The first dose of reality that she imparted was how the SEC determines its positions on issues such as reregulating financial advice. In general, when an issue like this one comes up, the Commissioners hand it off to staff attorneys to conduct research and make recommendations. Among other things, the staffers meet with "experts" upon whom they rely for information and insight on the subject. This is important, because to have an impact on the staff (and therefore on policy), one has to be credible, and provide information on solutions that the SEC sees as reasonable.
When she made this point, a light went on in my head remembering pictures I'd recently seen in the news: I asked if that was the problem with Harry Markopoulos, the whistleblower who for years tried to tell the SEC about Bernie Madoff's fraud. She smiled, and said, "Exactly." Apparently, Markopoulos just didn't come across as credible, and was therefore easy to dismiss.
Although Fausti has no direct knowledge of this, it's possible that the financial planning organizations have suffered from the same sort of stigma by taking positions that may have been deemed "unrealistic."
My second dose of reality came in the form of what Washington insiders--regulators, legislators, the Obama Administration--would deem to be "possible." While my earlier suggestion (see my May column) of "advisor-only" firms such as exist in law and accounting might be a good solution, such a massive overhaul of the system has about as much chance of seeing the light of day as Madoff does. Washington is far more likely, Fausti gently informed me, to tweak the existing system than to rewrite the investment advisor legislation. Which is why FINRA is a more likely regulator than the CFP Board, and the SEC is spearheading the proposal process rather than an independent body.
Depressing as that may sound to independent advisors, and to interested observers like myself, Kristina's realistic assessment actually leads to more optimistic possibilities. To begin with, her contacts are now telling her that the new Administration appears more disposed, at least in the short term, to a "scaled back" reregulation rather than comprehensive reform. That means that those of us who believe the advisor legislative/regulation system needs a major reworking have more time to lobby on its behalf.
What's more, it also means that the simplest, and therefore the most likely, solution may in fact turn out to be the best. Let me explain. On May 7 of this year, SEC Commissioner Luis Aguilar gave a speech to the Investment Adviser Association annual conference in San Diego. In it, Commissioner Aguilar surprisingly broke with the SEC party line touted by Chairman Mary Schapiro, who not surprisingly seems to be leaning toward FINRA, which she was instrumental in creating as the former chair and CEO of the NASD.
Instead, Aguilar made an extremely well-reasoned, common-sense proposal that is both so simple and yet so investor-oriented that it just might be able to carry the day. Aguilar argued that when it was passed, the Investment Advisers Act of 1940 rightly exempted brokers from the duties imposed on RIAs because at that time, they were clearly acting as salespeople. But times have changed, and with them, stockbrokers now regularly dispense the very investment advice that would define them as investment advisors under that existing law.
The most direct way to solve this problem and bring securities regulation into the 21st Century, Aguilar contends, would be to redefine brokerage activity such that those brokers who act as investment advisors be regulated as such, including the well-established fiduciary duty to clients, perhaps by simply eliminating the "broker exemption." Those who remain as sales folks would continue under FINRA's supervision.
So far so good. Here's the best part: Commissioner Aguilar went on to point out that rather than look for another regulator for RIAs--FINRA, the CFP Board, or an SRO to be named later, any of which would require massive retooling and staffing--we have an existing regulator with nearly 70 years experience regulating RIAs: the SEC itself. True, this expanded scope (there are currently about 700,000 registered reps, many of whom undoubtedly would be considered investment advisors under this scenario) would require substantial additional resources for the SEC. But as Mr. Aguilar rightly pointed out, allocating more funding to the SEC would be by far the simplest--and probably the least expensive--of any alternatives.
By simply expanding the SEC's responsibilities to cover brokers who are acting like investment advisors, Commissioner Aguilar's proposal certainly meets Fausti's "reality" test. So it's no surprise that fi360 announced its support for his proposal. Despite Schapiro's FINRA connection, expanding the scope of her current agency has to hold considerable appeal.
From the perspective of professional advisors, it's hard to imagine a better outcome: They continue to be regulated by the SEC, under essentially the current standards and client-oriented duties, but with stockbrokers now having to play on the same level field, supervised not by an SRO run by brokerage firms, but by the more independent SEC.
So What's the Downside?
One of the biggest flies in this cure-all salve is the toll that recent events have taken on the SEC's reputation in Washington. Two years ago, the SEC would have been a no-brainer for this assignment. But Bernie Madoff, a series of smaller RIA debacles, and the mortgage-backed meltdown itself have brought the SEC's enforcement capabilities into question. All have been well covered, while Aguilar's speech received little notice in the media. Even worse, the SEC's failings continue to provide fodder for FINRA's relentless lobbying efforts. Call me crazy, but I doubt the B/D organization will go quietly into this good night, especially with its long-coveted RIA prize so close at hand.
According to Fausti, Chairperson Schapiro is acting quickly to address the perceived shortfalls at the SEC, but that may not be enough to head off FINRA. "We need to get the word out about Commissioner Aguilar's proposal," said Fausti, "and tell the consumer-oriented side of the debate."
Consumers, legislators, and the media all need a better understanding of what's at stake in the battle for advisor reregulation. As a country, do we want to water down the fiduciary standard and apply a rules-based, sales-oriented regulation to brokers and RIAs, as suggested by FINRA chair and CEO Richard Ketchum? Or do we want the principles-based, consumer-oriented duties, including the authentic fiduciary standard that currently applies to RIAs, to be expanded to cover everyone who dispenses financial advice to the public?
If people understand the question, the answer is pretty obvious. But to get there, says Fausti, "The SEC is going to need some outside support." Maybe the Financial Planning Coalition, as well as the independent advisory community itself, would do well to throw itself behind that proposal.
Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at email@example.com.