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.
- Recent Changes in the Regulatory Landscape 2011 marked a major shift in the regulatory environment, as the SEC adopted rules for implementing the Dodd-Frank Act. Many changes to Investment Advisers Act were authorized by Title IV of the Dodd-Frank Act.
Did you ever get the haunting feeling that something was going too well? That's how I'm starting to feel about the reregulation of the advisory world, which is part of the Obama Administration's overhaul of the financial services industry. For professional advisors and the rest of us who believe that all advisors should have a fiduciary duty to their clients, so far rapidly moving events have been essentially all good news. First, on June 17, the Administration's White Paper on Financial Reregulation called for "a fiduciary duty for broker/dealers offering investment advice" and "harmonized" regulation of investment advisors and broker/dealers. In mid-July, the Treasury Department followed up with proposed legislation that would empower the SEC to hold brokers to a fiduciary duty to their clients, end commissions for brokers who give investment advice, and require that investment disputes be heard in open court. Cool, huh?
Then on July 29, the Committee for the Fiduciary Standard (comprising advisory industry leaders including Harold Evensky, Roger Gibson, Knut Rostad, Sheryl Garrett, Ron Rog?, fi360's Blaine Aikin, and Wealth Manager Editor-in-Chief Kate McBride) met separately with SEC Commissioners Elisse Walter and Luis Aguilar, briefed an official from Treasury, and then talked with some Congressional staffers. While Committee members declined to talk specifically about their conversations, they expressed a surprisingly high level of optimism. "Our takeaway was that all participants understand and believe in the application of the five core fiduciary principles to any and all who provide (or purport to provide) investment advice."
Is Something Rotten in the state of Denmark?
So when is good news not good news? Maybe when it's just too good. What we're talking about here is ending commissions and arbitration, and most importantly requiring that brokers and their firms be held liable if they don't act "solely in their client's interest." This reregulation could fundamentally change the retail brokerage industry away from very lucrative product distribution and into more restricted client-oriented advice.
So why aren't we hearing more wailing and gnashing of teeth from Wall Street? I suspect it's because they're too smart for that. They're also masters of picking their battles. They've figured out that now is no time for a frontal assault. With virtually all of the wirehouses shaken to their foundations by the self-inflicted subprime meltdown, and high-profile securities frauds such as Bernie Madoff, Wall Street's capital--both financial and political--is at its lowest point since 1929. So, with the public and the Administration crying out for reform, the brokerage industry finds itself in no position to oppose it.
That doesn't mean they're just going to lie back and take what's coming, however. These guys are far too good, and there's far too much as stake, for that. How are they going to deal with this latest onslaught to business as usual? That's what I've been asking myself lately, and I think we may have a clue in a little publicized article ironically called "The Madoff Opportunity" written for the June issue of Wall Street Lawyer magazine by Legg Mason general counsel Thomas Lemke and securities attorney Steven Stone. It's a masterful piece of work: so high-minded, and reasonable, and compelling, and so completely misleading that it could have been written by the Prince of Darkness himself.
Lemke and Stone based their article on "universal standards" recently proposed by SIFMA. They propose to jump on board the whole "fiduciary duty" thing, and then help the Administration, Congress, and the SEC to "reasonably" implement it: "Though the stars (finally) seem to be aligning for this much-needed reform, a question remains as to whether long-standing competitive distrust, jockeying over legalistic distinctions, and focusing on 'labels' could derail the 'opportunity' for reform..."
Not bad, eh? "We're so behind this rereg that we're concerned industry squabbling will screw it up," they seem to be saying. Just makes you thankful that the brokerage firms are here to help, doesn't it? The article goes on to make one reasonable sounding point after another, culminating in their final goal: "Presumably, however, as this standard is defined, it will build on principles found in the existing broker/dealer regulatory scheme."
If the advisory world is going to have any chance of avoiding the fate of a FINRA "regulatory scheme," it needs to fully understand the seductive, sugar-coated steps that lead us there, and be able to counter them will an equally high-sounding, but more truthful version of reality. Here's how Lemke and Stone made the FINRA/SIFMA/BD case:
#1 This is about business ethics (not professional standards).
"Not unexpectedly, the broker/dealer and investment adviser industries--who are keen competitors in the business world--seem split on the appropriate overarching standard of care, with rhetoric flowing freely from segments on both sides." This is a deceptively clever point, unfortunately made possible by the CFP Board's and the FPA's failure to create a true profession of financial planning. By positioning the debate as a competitive turf war, rather than a professional vs. sales approach, the B/Ds try to take consumer protection out of the conversation.
This allows them to make the logical follow-up:
"An investor's relationship with his or her financial professional should be subject to an overarching standard of care that reflects high standards of business ethics..." Fair business practices are the rules upon which the current securities sales industry thrives. It assumes two equal parties who merely require fair dealing for a satisfactory transaction, affording no more protection to one party or the other.
The reality, of course, is a far different picture. Because of their superior knowledge about a vital subject (medicine, law, accounting), professionals are in a position to take advantage of their patients or clients (that's why we don't call them customers). Professional duties and ethics restrict professionals from abusing their advantage. To my mind, financial advice clearly falls into this category, and therefore financial clients warrant professional protections--such as a fiduciary duty--not merely "fair business practices" where both sides can, and are expected to, put their own interests first. This is the crux of the whole debate; consumer advocates and professional advisors can't fail to make this point and carry the day.
#2 Broker and advisor regulation are essentially the same anyway.
"Despite the current rhetoric, any reasonable comparison of the current regulatory schemes for broker/dealers and investment advisors who give investment advice reveals that they are far more similar than they are different." Right. This may be true, except for the above pesky point about professional responsiblies versus sales rules. The truth is that the FINRA regulatory structure is designed to provide safe harbor rules under which brokers can sell products. It usually protects the brokers, but almost always protects their firms. Professional principles, on the other hand, open one up to myriad liabilities--that is, of course, unless you simply do the right thing by your clients.
#3 Both B/Ds and RIAs already have a fiduciary duty to their clients.
This, of course, ignores the "broker" exemption to the '40 Act, which enables brokers to avoid putting their clients' interests first. The same "broker exemption" that the SEC and FINRA tried to expand to include managing assets, under the Merrill Lynch Rule, which was successfully challenged by the FPA in Federal Court. I would argue that all we need do is remove the broker exemption, make all brokers work under the '40 Act as it is, and forego any additional legislation. If brokers already have the same fiduciary duty...
#4 Brokers and advisors play very different roles and therefore need flexible regulations.
"The new [SIFMA] standard will focus largely on the common standards of conduct shared across those professions in a measured way that also reflects the differing roles they play and obligations they have...fiduciary duty...must be defined and applied...in a way that recognizes the different roles financial professionals may play when giving investment advice...."
This is what all the foregoing preamble has been angling toward, and perhaps not surprisingly, it's not a new argument at all. In fact, it's our old friend, the "scope of the engagement" defense, under which brokers are said to have a fiduciary duty to their clients when they are acting as advisors, but to have no such duty when acting as brokers for the same clients.
In my view, the "scope of the engagement" principle is the sole source of the vast majority of investor confusion about just what duties are owed them, and of abusive sales practices. It seems unreasonable that clients be expected to differentiate when their broker is their advisor, and when the same broker is representing his or her brokerage firm as a salesperson. Any legislation and/or regulation that doesn't force everyone who deals with the financial public to openly declare whether they are always an advisor or always a salesperson is essentially enabling the current business-as-usual financial services industry. Which, of course, is where the financial services industry would prefer reregulation to end up.
Despite our current string of seeming victories, if the fragmented financial advisory profession is going to get that long awaited level playing field, I suspect they are going to have to aggressively paint a more realistic picture than the one that the minions of the B/Ds are schlepping 24/7 to the Administration, Congress, the SEC, and the press. It's an up-hill battle.
Groups such as the Financial Planning Coalition (the FPA, CFP Board, and NAPFA), and the Committee for the Fiduciary Standard, both made up of part-time volunteers, are up against an "A Team" of the best, mostly highly financed lawyers and marketers that money can buy. To beat these guys, and get true comprehensive fiduciary protection for financial consumers, we'll have to bring our A game, and tell a world-class, consumer-oriented story.
Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at firstname.lastname@example.org.