More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Regulatory Oversight of Investment Advisors Although the regulatory environment is in a state of flux, it is imperative that RIAs adhere to their compliance obligations. To ensure compliance, RIAs and IARs must fully understand what those obligations are.
The drive to reregulate financial advice shifted into high gear on June 17, when the Obama Administration released its white paper containing proposals for 21st Century Financial Regulatory Reform (see my June 19th blog). In this 85-page tome, the President's team proposes a five-part initiative to increase regulation across the board of American finance from banks to brokerage firms to insurance companies, expanding the power of the Federal Reserve, the FDIC, and the SEC, and creating a mind-numbing array of new councils and agencies.
To address the issue of advisors, the White Paper offers a single sentence, buried deep within the 3rd initiative, which reads: "The SEC should be given new tools to increase fairness for investors by establishing a fiduciary duty for broker-dealers offering investment advice, and harmonizing the regulation of investment advisors and broker-dealers."
With those few key strokes, the Administration both dangled the prospect of a long-awaited "level playing field" in front of professional financial advisors who already assume a fiduciary duty to their clients, and deftly punted this bureaucratic hot potato into the already conflicted hands of SEC chair Mary Schapiro. As a former chair of the NASD, and one of the founders of its successor, the Financial Industry Regulatory Authority (FINRA), Schapiro has been enigmatic in her statements regarding advisors. Always quick to don the mantle of consumer protector, she often shows a troubling soft spot for the plight of broker/dealers and their reps who often have economic agendas not, shall we say, wholly aligned with their somewhat less sophisticated customers.
Under the simple directive of the White Paper, Schapiro faces two key issues: To create a fiduciary standard for broker/dealers; and to "harmonize" regulation, whatever that means. Nowhere is the devil truly in the details like financial regulation. What fiduciary duties the SEC proposes for brokers, and who will enforce them, will make the difference between real increased consumer protection and business as usual on Wall Street.
Does Mary Get It?
On the one hand, we might assume that if Schapiro weren't on board with a true fiduciary standard for brokers as well as for RIAs, the Administration wouldn't have handed the task to the SEC. Plus, comments in support of a true fiduciary standard for brokers by SEC Commissioner Luis Aguilar on May 7 (see my July column), give us cause for optimism, assuming his speech was authorized by the SEC Chair. Yet Schapiro's frequent laudatory comments about the success of FINRA self-regulation raise questions about whether she fully grasps the issues at hand.
For clues as to Schapiro's current thinking, we can look at her response to the White Paper in a speech to the New York Financial Writer's Association on June 18th. Elevating the reregulation of financial advisors to one of four topics she covered that night, and addressing nearly one-third of her remarks to this issue, she reiterated her support for the task: "I...believe that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients."
Then for the first time, she provided some insight into what those duties might include: "The fiduciary duty means that the financial service provider must at all times act in the best interest of customers or clients. In addition, a fiduciary must avoid conflicts of interest that impair its capacity to act for the benefit of its customers or clients. And if such conflicts cannot be avoided, a fiduciary must provide full and fair disclosure of the conflicts and obtain informed consent to the conflict."
So far, so good. We now have at least three of Schapiro's elements of a fiduciary standard. But of course, life is rarely that simple. The SEC Chair went on to hint about the issue of the regulator: "If both broker/dealers and investment advisors are providing virtually identical services to retail investors, then the regulatory regimes that govern those activities should be virtually identical as well."
What could this mean? Two "identical" regulators, such as FINRA and the SEC, one for brokers and one for RIAs? Sounds inefficient, doesn't it? If you were angling for one regulator who wasn't acceptable to all concerned, you might start out with something like this: We need identical regulators, which would look very much like FINRA. So, instead of creating another regulator identical to FINRA, wouldn't it just be smarter to give the whole job to FINRA? If that's not what Schapiro meant, why didn't she just say: 'We need one regulator for securities sales people--FINRA--and another regulator (the SEC) for anyone who gives investment advice to the public'?
Gang of Eleven
As for the fiduciary standard itself, let's look to a more objective source-- the recently formed and aptly named Committee for the Fiduciary Standard, founded by Knut Rostad, compliance officer of advisory firm Rembert Pendleton Jackson in Falls Church, Virginia. It has grown to eleven industry leaders including Harold Evensky, Roger Gibson, Sheryl Garrett, Ron Roge, and Wealth Manager's editor-in-chief, Kate McBride.
In a press release dated June 29, the Committee put forth five core principles of an "authentic" fiduciary standard:
o Put the client's best interest first;
o Act with prudence; that is, with the skill, care, diligence, and good judgment of a professional;
o Do not mislead clients; provide conspicuous, full, and fair disclosure of all important facts;
o Avoid conflicts of interest; and
o Fully disclose and fairly manage, in the client's favor, unavoidable conflicts.
"These five core principles are essential in any legislation or rule making," said Matthew Hutcheson, president of Independent Pension Fiduciary and a Committee member. "To do otherwise undercuts the investor protections available in ERISA law today."
Now, I'm not a lawyer, but as I understand it, the ERISA standard is similar to the fiduciary duty that RIAs have under the '40 Act, except that there is a far larger body of case law involving pension advisors, creating far clearer protections for participants in qualified plans.
Notice that while Schapiro mirrored three of the committee's five points, the two she omitted--professional prudence and not misleading clients--are the two most likely to be a problem for brokers, who do not receive formal professional training, nor do they often have much incentive to disclose all the facts.
The fundamental issue at stake here--and the one that Schapiro seems to be on the fence about--is the difference between sales standards and professional principles. Sales standards provide a safe harbor for sales practices that may or may not be in the customers' best interest. They are rules, such as suitability or disclosure, which if followed to the letter, protect the salesperson from liability.
Professional standards, on the other hand, rarely have any such "safe harbor." Instead, a professional's fiduciary duty involves open-ended principles that are a matter for courts to interpret. A professional's duty is not to follow any particular rule: it's to do the right thing.
Is Schapiro interested in having brokers do the right thing? As far as I can tell, the jury is still out. Seems to me a good first step toward a fiduciary standard for all would be to simply eliminate the broker exemption to the Advisers Act: If you provide investment advice to the public, you'd have to register as an investment advisor under the SEC, period.
A good second step would be to expand all financial fiduciary standards to the ERISA model. Why should investors have less protection in their investment portfolios than in their 401(k)s? To my mind, anyone who can't jump on board with this--including Schapiro--is more interested in protecting sales people than protecting consumers.
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.