More On Legal & Compliancefrom The Advisor's Professional Library
- Trading Practices and Errors When SEC-registered investment advisors conduct annual audits of firm policies and procedures, they should pay close attention to trading practices. Though usually not required to, state-registered advisors should look at their trading practices and revise policies that do not fully protect clients.
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
As the language in the financial services reform bill, which the Senate passed, 60-39, on Thursday, July 15, gets parsed, rumors still abound about how it all will affect financial services firms, regulators and investors.
From an investor perspective, probably the most important change is that the bill, "Gives SEC the authority to impose a fiduciary duty on brokers who give investment advice--the advice must be in the best interest of their customers," according to the summary release from the House Financial Services Committee.
The SEC is tasked with a six-month study of whether brokers who provide advice to investors should have to provide that advice under a fiduciary standard of care as embodied in the Investment Advisers Act of 1940. There will also be comment period, and if it deems it to be necessary, the SEC will then write guidelines and rules for brokers who provide advice to do so under the fiduciary standard of care.
There are a few differences in points of view as the ball rolls forward here. But many of those views are not as divergent as they might at first appear.
As a member of The Committee for the Fiduciary Standard, I have been part of many meetings this past year in which thoughtful discussions took place among practitioners, regulators, legislators and advocates--thoughtful even though participants were not always on the same team--regarding the impact and practices, fact and fiction, about applying the fiduciary standard.
While the setting may change, the fiduciary standard, based on 800 years of common law, remains the same. First and foremost, it is a duty of loyalty to the client. Brokers who work with ERISA or discretionary accounts are no strangers to the fiduciary standard. And the majority--53%--of brokers--have said that, "all financial professionals who give investment and financial advice should be required to meet the fiduciary standard," according to a Fiduciary Survey from SEI and The Committee for the Fiduciary Standard.
However, whether most advisors are prepared in terms of firm support is another issue entirely. Only 20% of advisors said it "would be difficult to conform their practice to meet a new, industry-wide higher fiduciary standard," according to another recent survey, the Envestnet Fiduciary Standards Study, which provides systems that will help advisors document their fiduciary process--a fundamental part of practicing under the fiduciary standard.
Envestnet's study reports that most advisors making the transition to fiduciary duty will need firms' support for: such "key relationship functions as developing a full view of the client's life goals and financial situation; development and maintenance of the investment policy statement; ongoing client communications, updating the financial plan for changing circumstances, and disclosure of investment costs and fees."
First Things First
Here are a few places where rumor has run hotter than fact: While it is impossible to know what any regulator or SRO will do in creating a framework to apply fiduciary duty in a brokerage setting, there is a substantial body of discussion and precedent in the investment advisor world that could logically apply here.
What will be different for firms and brokers who want to make the transition is that the fiduciary standard is principles-based--not rules-based. That's a sea change from FINRA regulation that is much more rules-intensive.
In addition to controlling and disclosing all costs to the investor, here are the Five Core Principles of the fiduciary standard, developed by The Committee for the Fiduciary Standard:
o Put the client's best interests 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
o Fully disclose and fairly manage, in the client's favor, any unavoidable conflicts
One pervasive myth is that all broker/dealer reps would be held to the fiduciary standard even if they do not give advice to investors, and that all broker/dealer functions would be under fiduciary rules. That is not the case. The fiduciary standard would apply only to those brokers who provide advice to retail investors. Self-directed brokerage, in the order-taking, with information provided but not personalized advice sense, would go on as before. Selling IPOs or acting as a brokerage salesperson--albeit with proper disclosure as to the nature of the relationship with customers, titles etc., could be a career choice for some representatives who do not want to provide advice, and would not fall under the fiduciary standard.
Another rumor is that commissions would be prohibited. The fiduciary standard does not prohibit commission compensation--it does require advisors to control costs for their clients and to disclose all costs that the investor pays to the advisor or firm. Does that mean that fiduciaries always have to choose the lowest cost option? Not necessarily--as long as there is a fiduciary process in place for selecting that option and documentation that the recommendation is in the investor's best interest.
What About Ongoing Monitoring and Serving the Smaller Investor?
As Don Trone, founder of the Foundation for Fiduciary Studies puts it, you'll hear a lot about a "comprehensive and continuous" fiduciary relationship. However, there is nothing that prohibits an investor from "walking into a registered investment advisor and asking for five fund suggestions for their IRA," Trone says.
As long as that investor understands that the "scope of engagement" does not cover ongoing monitoring (and it is documented clearly), then ongoing monitoring is not a requirement for the fiduciary relationship with that investor, Trone acknowledges. But the recommendations would have to be made in the investor's best interest, of course. This should address the misconception that small investors could not be served under the fiduciary model. And there is a point at which, because of a smaller amount of assets, it is difficult to diversify enough to prudently guide a very small investor, but that is true no matter what the model may be. This should be addressed by the financial services community.
What About the 'Mad Money' Investment?
When an investor wants to have a portion of their money for more speculative purposes, or to invest on their own, an advisor may want to have a separate account for that, with documentation showing that this is an account in which the advisor has no advisory or fiduciary responsibility, and does not participate in any benefit.
Investment advisors have run their firms under the fiduciary standard for decades--it's important to remember that they are not paupers. Over the long haul, having all who provide advice to investors do so under the fiduciary standard is good for the financial services industry. It will help to regenerate trust, sorely lacking; enable investors to begin investing with more confidence again; and provide a long-term, steady revenue stream to financial services firms, which will smooth growth and cushion the effects of market gyrations much as a dividend does for investment portfolios.
To see how the securities and brokerage industry is pondering compliance with the reform bill, follow Wealth Manager's Kate McBride's tweets from the SIFMA conference.
Comments? Please send them to firstname.lastname@example.org. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.