More On Legal & Compliancefrom The Advisor's Professional Library
- U.S. Securities and Exchange Commission Information This information sheet contains general information about certain provisions of the Investment Advisers Act of 1940 and selected rules under the Advisers Act. It also provides information about the resources available from the SEC to help advisors understand and comply with these laws and rules.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
Over the past months, I've written rather extensively about the Obama Administration's proposed securities industry reregulation, the various proposals of what that might look like, and the myriad initiatives to influence its ultimate form. I even offered my own suggestions about what might be best for financial consumers and the independent advisory world, along with a few predictions of what the likely result will be.
Recently, the hiatus created by the controversy over healthcare reform has given us a little time to sit back and reflect upon how things are shaping up on the financial services front. It seems to me that what we all need now is an objective assessment of what we know, what that's likely to mean for the future, and how soon that future might happen. We need an insider/outsider who's removed from both a Washington-inside-the-beltway mentality and from advisory industry politics, yet still is plugged into the latest thinking on Capitol Hill.
To get just such a perspective, I caught up with Harold Evensky, who at present is in Lubbock, Texas, nursing his wife Deena Katz's recovery from successful knee reconstruction surgery. As many of you know, Harold is one of the eminences grise of the independent advisory world: a former chair of the IAFP and of the CFP Board, he now practices (almost) quietly with Deena in Coral Gables, and in their recently opened office in Lubbock (they both are also professors in the financial planning program at Texas Tech University). He's also kept up on the reregulation debate as a member of the board of the Committee for The Fiduciary Standard, participating in meetings too numerous to count in Washington, D.C. over the past year.
From that vantage point, Evensky is encouragingly more optimistic about the reregulation than I've been, and truth to tell, probably a bit more practical as well. As a former broker turned professional fee-only advisor, Harold has always demonstrated an understanding of the realities of the financial services industry. Over the years, that sensibility has led to some uneasiness in my more idealistic mind, but it's more than fair to say that I've learned a great deal from his well-reasoned observations, and often find myself rethinking my views after our conversations.
Today's chat was no exception. Evensky is convinced that we'll have a financial services reregulation as soon as the dust clears from the healthcare debate; probably not before you read this, but possibly sometime this spring. He also reports that the folks involved in the financial advisor portion of the new legislation/regulation--at the SEC and in Congress--all seem to be talking about expanding the duties under the Investment Adviser Act of 1940 to everyone who gives investment advice to the financial public. That would include stockbrokers, insurance agents, and those financial planners who until now have fallen through the cracks of existing regulation.
That's encouraging news for those of us attracted to the simplicity of improving the current lot of financial consumers by eliminating the "broker exemption" that currently enables many advisors to avoid registering as investment advisors. Evensky bases this prediction on his observation that the conversations he's been involved in have assumed a shift away from the current "rules oriented" regulation of FINRA, and toward a "principles" based fiduciary duty. It seems the Washington regulators and legislators have increasingly been focused solely on the nuts and bolts of just how such principle would be applied.
Frankly, I continue to be somewhat amazed--and more than a little puzzled--at discussions which apparently are occurring in Washington, in the insurance community, and by industry observers, such as Steve Winks (see his responses to my recent blogs at InvestmentAdvisor.com). The tone of these debates is that the notion of a fiduciary duty for advisors is completely new and unprecedented, and that this baffling, alien concept needs to be analyzed from scratch. The reality, of course, is that investment advisors have been operating under a fiduciary duty for some 70 years, pension advisors since ERISA was enacted in 1974, and private bankers for centuries. Suffice it to say that the principle is fairly well established, both in law and regulation.
Even the brokerage industry has had an up close and personal experience with the fiduciary duty in recent years. The apparently unforeseen fiduciary implications of its forays into the asset management business caused such consternation, hat the industry petitioned the SEC for relief. The Commission, of course, responded by extending the brokerage exemption to managing assets, under the infamous "Merrill Lynch Rule." Even after the FPA successfully challenged that attempt, Wall Street simply avoided the "F" word by having brokers simply sell asset management rather than manage assets themselves.
In any event, as Evensky rightly points out, a fiduciary standard would be dramatically new to the brokerage industry, so a certain amount of thinking will be required to apply it in the context of a broker-client relationship. The good news is that people have stopped talking about "whether" a fiduciary standard should be applied, and are now focused on "how." He also added more good news--at least to my ears--with his assessment that current discussions don't include the old "scope of the engagement" loophole, through which a broker (or CFPs, until recent changes in the Board's cannons of ethics) might sometimes be a client's advisor, and at other times, merely her broker. It seems the tenor of the current conversations in Washington is that once you're a client's advisor, and therefore their fiduciary, that would be the basis of your ongoing relationship. "No one is talking about advisors being able to flip back and forth," he said.
However, Evensky went on to enlighten me about the legitimate application of an engagement's scope. Financial consumers have many needs: some are complex, some not so much. A fiduciary standard--that is, the duty to act in a client's best interest--is by necessity limited to what a client is asking their advisor to do. "For instance," he explained, "suppose a client simply wants advice about how to allocate this year's IRA contribution. An advisor wouldn't have a duty to do financial planning or even inquire about other elements of the client's financial life. Requiring more would make it very difficult for brokers to give cost-effective advice to many people."
Rethinking My Positions
This sensitivity to how brokers would exercise a fiduciary duty in the real world forms Evensky's, and presumably the SEC's, vision of what the final rereg will look like. The short answer that the SEC and Congress aren't likely to do anything that will cause a massive overhaul of the brokerage business. That means sensitive issues such as commission compensation, proprietary products, arbitration, and even disclosure are likely to be treated with kid gloves. "These are the kinds of questions," he reports, "that the people in Washington are asking: How would we apply the '40 Act's fiduciary standard to the way brokers currently do business?"
I have to admit, after my conversation with Harold, and other advocates such as Knut Rostad, founder of the Committee for The Fiduciary Standard, and Marilyn Capelli Dimitroff, chair of the CFP Board, I've softened my position on a number of these issues, and simply become willing to give in on others. Fees paid directly by the client seem to me unquestionably in the client's best interest. Yet, bank trust officers are employees--and while they may sometimes deliver a debatable quality of advice, undeniably work well under a fiduciary standard. So, perhaps commissions can, too.
Proprietary products, on the other hand, seem to be a clear conflict of interest. However, the banks offer them, the CFP Board accepts them, and I'm willing to concede that in this round, it's extremely unlikely that Washington is going to do anything but write some regs about how one can recommended them and fulfill their fiduciary duty. (I'm still secretly holding out hope that the courts will eventually inject some consumer-oriented common sense on the proprietary issue.)
Harold even brought me around on the arbitration issue. Having served on many arbitration panels over the years, and acting as an expert witness for both sides, he offers a pretty compelling perspective: "The problem with arbitration has not been fairness: In my experience, arbitrators make every effort to be fair. The problem is the rules they are constrained by, which are largely designed to protect the brokers. A fiduciary duty would change that. I don't see a problem with arbitration under a principles-based system." Hard to argue with that.
In fact, I find it hard to argue with much of anything in Evensky's assessment of the current outlook for reregulation. It's certainly not everything I'd hope for in protection for financial consumers. On the other hand, it's a lot more than I expected we'd get. Giving everyone who offers investment advice a fiduciary duty to his or her clients may take years to sort out, but it's a giant step in the right direction. I guess the thing to hope for now is that Harold is right.
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.