From the August 2010 issue of Investment Advisor • Subscribe!

August 1, 2010

Clark At Large: Can't Beat 'Em? Then Stall 'Em

A fiduciary duty for brokers is back on hold, but there's a light at the end of the tunnel

By the time you read this, the Dodd-Frank financial services reform bill--The Wall Street Reform and Consumer Protection Act of 2010--will have been approved by both houses of Congress. As I'm writing, the Senate is still dragging its feet over passing the reconciled bill, so there may be a few more tweaks to the bill the House approved. As far as I can tell, however, no one is talking about changing the compromise wording concerning the fiduciary duty for brokers, so it's a pretty good bet that how it reads now is how it will read in the final Act.

Beyond that, not much else is clear about the fiduciary standard, enabling both camps--those folks who are pro-fiduciary-standard-for-brokers and those anti-fiduciary-standard-for-brokers--to be claiming victory. Yet I still stand behind my proposition as it appeared in my July column. To wit, now that the mainstream media and the investing public are beginning to grasp which financial advisors are--and more importantly, which advisors aren't--fiduciaries for their clients, it's only a matter of time before the financial services industry morphs into some equivalent of "fiduciary-only" advice. What's more, those advisors who already afford their clients a fiduciary duty can accelerate the transition to an industry-wide client-first standard by making the most out of the marketing advantage their fiduciary standard has suddenly become.

The ambiguity over expanding the fiduciary standard to brokers starts with the Dodd-Frank bill failing to give brokers a duty to put the interests of their clients first. Instead, Section 913 of the Act requires that the SEC conduct a six-month study of the ramifications of implementing such a standard, including "The effectiveness of existing legal or regulatory standards of care for brokers...," and "whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for brokers, dealers, investment advisers... ...for providing personalized investment advice about securities to retail customers that should be addressed by rule or statute."

Of course, we and the SEC already know the answers to those questions thanks to a 2008 study conducted by the Rand Corporation for the Commission (which "explored industry and investor perspectives on customer relationships with financial service providers"). So, it would be easy to conclude the directive for a "new" study is simply a stalling tactic, designed to give the appearance of addressing the fiduciary question, while actually doing nothing except giving the media's infantile attention span time to move on (not unlike our "closing" of the Guantanamo Bay prison).

Stalling Tactic That Backfired?

That undoubtedly was the thinking of opponents of a broker fiduciary standard who pushed for the study "solution." But the pro-fiduciary forces in Congress weren't so easily thwarted, inserting a clause of their own stating that should the SEC study warrant it, "...the Commission may promulgate rules to provide that, with respect to a broker or dealer, when providing personalized investment advice about securities to a retail customer, the standard of conduct for such broker or dealer with respect to such customer shall be the same as the standard of conduct applicable to an investment advisor under section 21 of the Investment Advisors Act of 1940."

For those of us who support a fiduciary standard of care for all financial advisors that give investment advice to the public, the use of the phrase "may promulgate rules" rather than "shall promulgate rules" is bad news, indeed. It means that even if its own study reveals the glaring need to protect retail customers with a broker duty to put the clients' interests ahead of their own, the SEC can, at its own discretion, decide not to take any further action.

The good news, though, is the clear specificity of what action the Commission is ...

... to take, should it decide to act: Rules that give brokers the same standard of care for their clients as investment advisors currently have under the '40 Act. Make no mistake: This is big. It means that if the SEC decides to act, or feels politically compelled to act, it has very little wiggle room to create a watered-down standard for brokers. In essence, at least to my reading, Section 913 creates an all-or-nothing decision by the Chairman Mary Schapiro and her four co-commissioners.

Well, almost all-or-nothing. The securities and insurance industry lobbies did manage to insert a few business-as-usual clauses, just in case the SEC does act. The first guards against brokers having a continuing duty to their clients (Heaven forbid!). More troubling, it opens the door to the traditional "scope of the engagement" defense, under which a broker may have a fiduciary duty to a client for part of their relationship but not for the entire relationship. Specifically, "Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities." So at least to my skeptical mind, this clause would allow a broker to render investment advice about, say, a portfolio's general allocation under a fiduciary standard, but then "sell" the client mutual funds to go into the portfolio under the current sales "suitability" standard.

Protecting the Brokerage Industry

Of course, the life-blood of the brokerage industry--proprietary products--must be protected at all costs: "The sale of only proprietary or other limited range of products by a broker or dealer shall not, in and of itself, be considered a violation of the ['40 Act RIA] standard..."

Why should they be? How could a limited array of heavily loaded, underperforming products be considered not in the clients' interests? Forgive my sarcasm here, but I simply have a hard time understanding how allegedly consumer-protection legislation can exempt one of the industry's most consumer-abusive practices.

Still, the silver lining in even this clause is the term "...shall not, in and of itself, be considered a violation..." Again, to my mind, this leaves open the potential for other evidence, such as loads and fees that are, say, twice as high as the open-market industry norm, for a court or jury to consider. So, while the limited range of products isn't "in and of itself" evidence of a breach of fiduciary duty, perhaps the uncompetitive nature of the proprietary products recommended might be. Just a thought.

Perhaps I'm being a bit na?ve here, but I find it encouraging that the anti-fiduciary forces felt sufficiently threatened that the SEC might actually enact a bona fide client-centered standard for brokers that they felt the need to include these clauses in the Act. Which brings us to the question of determining just how likely is it that the SEC will decide to act. Advocates of the broker fiduciary standard appear split on this one, but contrary to my generally skeptical nature, I'm feeling pretty good about the chances they will.

Love That Mary

I think perhaps Knut Rostad, chairman of The Committee for The Fiduciary Standard, captured the optimistic sentiment best: "It's true she comes from the FINRA world. But her public support over the past year for a genuine fiduciary standard for brokers suggests she basically agrees with the majority of brokers in the field who support the fiduciary standard. Plus, there are four other commissioners, the majority of whom appear to support a fiduciary duty as well. That makes me cautiously optimistic that we'll have an authentic fiduciary duty for brokers and RIAs when all is said and done."

For my two cents, I'm also encouraged that the Obama Administration has shown continuing and unwavering support for a "harmonized" fiduciary standard for all investment advisors. That is, of course, what we'll get if the SEC does decide further consumer protections are necessary. But at the end of the day, what will ensure that the Commission moves to enact a fiduciary duty for brokers is when the brokerage industry itself realizes that it is losing customers to advisors who fall under a fiduciary standard.

The media can go along way toward educating the public on this, but as usual, my brothers and sisters in the consumer press need help. One key will be for the organizations that support the fiduciary duty for all advisors to keep the advantages it offers in front of the media. On an equally important front, advisors who currently are fiduciaries can leverage the public's growing awareness of the issue by intensifying the use of their fiduciary difference in their current marketing efforts. Not only will they undoubtedly attract more new clients (and firmly brand themselves as client fiduciaries for all future marketing), but the marketing power of putting your clients' interests first will not be lost on the brokerage community. One thing they've never been able to resist--from limited partnerships, to annuities, to fee compensation--is giving the public what it wants.


Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at rclark7000@aol.com.

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