More On Legal & Compliancefrom The Advisor's Professional Library
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
The Committee for the Fiduciary Standard (the Committee), with co-sponsors the Certified Financial Planner Board of Standards (CFP Board), Financial Planning Association (FPA), Financial Services Institute (FSI), and National Association of Personal Financial Advisors (NAPFA) brought together the leading thinkers in fiduciary duty on Friday for a full-day symposium, the Fiduciary Forum: Exploring The Fiduciary Standard in a Brokerage Setting. This editor is a member of the Committee.
At issue: to an investor, the functions of a broker and an investment advisor look substantially the same--they each provide advice to the investor, and their titles are, since the late '90s virtually identical. But the investment advisor must act with fiduciary duty to the client--putting the interests of the client first at all times--while the broker does not. And so, the advice from the broker can lead an investor to take action that makes the broker and their firm the higher fees and/or commissions, because the broker does not have to put the investor's interests first.
While many brokers do want to put clients first, there is an intrinsic conflict of interest built into the BD model that cannot be ignored. Many BDs manufacture products and of course they want to distribute them. The broker can legally give the client advice that induces a product sale even if the advice is not in the client's best interest, but in the broker's or firm's interest. An investment advisor is prohibited from doing that--the advice must be in the best interest of the client--even when it is not in the investment advisor's interest.
So, under the Dodd-Frank Wall Street Reform and Consumer Protection Act,
The SEC is studying whether brokers--whose roles have evolved from simply executing securities transactions to advising clients--should have fiduciary duty to clients under the Investment Advisors Act of 1940 which governs the fiduciary conduct of investment advisors.
Why is this so important? What is fiduciary duty anyway? Why can't brokers just disclose the conflicts to investors and let them decide?
Because fiduciary duty applies when there is an uneven level of knowledge about a subject--just as there is between patient and doctor, client and lawyer, or client and accountant. As Tamar Frankel, Professor of Law at Boston University and a top scholar on fiduciary and securities law, put it at the Forum, "we are a specialized society; we must rely on other experts." In other words, everyone cannot know everything.
When you "entrust" your property--money, in the fiduciary case--to another person who can be reasonably expected to know more than a lay person would, that is a fiduciary relationship, Frankel explained. When a broker wears an advisor title, or engages in financial planning or other advisory capacity, it is reasonable for investors to believe the broker is acting as a fiduciary, according to Frankel. So the law needs to catch up with the reality that brokers are acting in what should be a fiduciary capacity, advising clients about their money--but current law allows them to act in their own self interest--not the client's best interest. One cannot give advice and pretend it is in the client's best interest when the advice is just being used to distribute the firm's products. That's the issue.
Can a regular investor reasonably be expected to know as much about the complex world of investing as a broker? Of course not. And if the Goldman Sachs Hearings before Congress's Financial Crisis Inquiry Commission showed us anything, it is that even professional investors can't always figure out what is going on in a security now. Even institutional investors cannot always understand these complex securities. Because brokers are not required to act in the best interest-fiduciary standard for their clients, but rather under the lower suitability or sales standard--a caveat emptor or buyer beware standard--brokers can even sell clients securities that they are betting against--which is, in part, what happened in the Goldman-ABACUS case.
For regular investors, most of whom must save and invest for their own retirements now, this is an issue that materially affects the quality of their life.
Advice to the SEC
In the final panel at the symposium, moderated by Arthur Laby, Associate Professor Rutgers School of Law, panelists Daylian Cain, Assistant Professor of Organizational Behavior, Yale School of Management; Robert A. Prentice, University of Texas; and Barb Roper Director of Investor Protection Consumer Federation of America offered advice to the SEC.
What would they tell the SEC if they were sitting down to chat? Some participants had actually delivered their views in person to the SEC in the days before the Forum--notably Roper, and Mercer E. Bullard, associate professor of law, University of Mississippi School of Law, and founder of the investor advocacy group Fund Democracy, who spoke at the forum in the morning.
There was debate during symposium about whether the SEC will be able to stand up the extremely intense pressure from insurers and broker-dealers to protect the status quo of regulating brokers. Some insiders are concerned that the outcome of the study may be more disclosures in lieu of a true fiduciary duty, or a watered down version of fiduciary duty that is not actually fiduciary duty--thus further confusing investors. Either of those outcomes, it was said, is likely to cause more harm than good for investors.
Cain's research indicates that disclosures generally do not work well, and that once disclosures are made, the advice was not as good because, "You're warned!" He added that "When you didn't know, the advice was good." So when disclosures were not made, advice givers acted more responsibly than when disclosures were made. That's disturbing on so many levels, but most apropos is the concern that disclosures don't replace a fiduciary duty to clients. Disclosure is a part of fiduciary duty but that's nowhere near enough. "Act as if disclosure works a lot less than you think," Cain advises.
His advice to the SEC: "Cooling off periods work well," meaning that an investor could be given a period in which to change their mind about buying an investment. He also warns: "Any gray language at all is extremely dangerous," to investors, "more than you think."
Prentice echoed the warning on using disclosures in lieu of fiduciary duty: "Beware of taking the easy way out--that's disclosure." He added, "Be bold," and "shape that [BD] culture with law." That has worked, he said, with "insider trading laws and civil rights." In those instances, new law helped shape people's moral" compasses and their behavior. When laws make it clear that certain behaviors are prohibited, it changes the culture, he noted.
Roper advises the SEC to eliminate the BD exclusion, "as an earlier version" of the "Senate bill would have." She also recommends that new rules adopted by the SEC be a "broad-based affirmation of the principles that constitute fiduciary duty--not a list of sales rules." She added, "People need to be held liable for violation of the principle," of fiduciary duty, and advised that the SEC "put teeth behind the provision."
Roper also noted that it isn't just broker-dealer reps that need to be held responsible for fiduciary duty. There is a provision in the Dodd-Frank Act that allows firms to have a limited list of products and if the best of those is selected for a client, they can still be considered to be acting as fiduciaries. But, Roper cautions, the SEC should think about the "firm's obligation to put together a list of products that allow reps to sell products that are best--if the products stink," rethink.
Broker-dealers may still push hard for a rules-based regime rather than a principles-based one, Roper explained. But, she said, the current broker standard of "suitability is just as principles based as fiduciary duty; it's just a lower standard,' than fiduciary duty.
There are a related articles and blogs about this today:
Roper has an opinion article in The Washington Post Monday,
The New York Times Dealbook blog covers it too, "The Debate over Broker Standards"
And Committee for the Fiduciary Standard Chairman Knut A. Rostad wrote commentary for Investment News about disclosures, in "Why disclosure is insufficient to ensure a fiduciary standard."
Comments? Please send them to firstname.lastname@example.org. Kate McBride, AIF(R), is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.