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.
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
On Jan. 22, the staff of the SEC delivered to Congress a report called the “Study on Investment Advisors and Broker-Dealers" that was mandated under Section 913 of 2010’s Dodd-Frank financial services reform law. The report is the most significant, if not final, step in the long debate over whether the fiduciary standard should apply to all who provide investment and financial advice to individual investors.
In a three-part series on AdvisorOne, we are charting the process under which this fiduciary standard became a central issue for advisors of all kinds, along with the companies that they are employed by or with whom they choose to affiliate. In part one, we provided a timeline on how extending the fiduciary standard to all advice givers developed up until early 2010.
In part two below, we discuss how financial services reform took a circuitous route that resulted in the compromise reform legislation known as Dodd Frank, which among many other provisions and mandated studies called for the SEC to deliver within six months of the bill’s passage a recommendation on whether a fiduciary standard should be extended to all advice givers.
In part three, we will discuss the SEC’s recommendations and suggest the next rulemaking and business steps that extending such a standard might entail for brokers, RIAs and their affiliated partners. -Ed.
Dodd Frank and the Fiduciary Standard
For a moment in Fall 2009, it seemed that the Democratically controlled U.S. House of Representatives and Senate would duel over who could pass a stronger fiduciary standard for those who provide financial advice to individual investors. The House proposed treating all who provide advice to investors as fiduciaries, no matter what their affiliation. The Senate went a step further, proposing that advice providers would have to register as investment advisors and thereby act with the fiduciary duty imposed by the Investment Adviser Act of 1940.
When the House passed its version of financial reform legislation in December 2009, the bill included the requirement for a fiduciary standard of care for all who provide advice. This was due, in large part, to efforts of then House Financial Services Committee Chairman Barney Frank (D-Mass.), who rebuffed big financial services lobbying efforts to excise the fiduciary standard and other provisions from the bill.
The SEC’s Chairman, Mary Schapiro (left), became a frequent visitor to Capitol Hill during the financial reforms discussions, testifying before Congress and various committees including the Financial Crisis Inquiry Commission (FCIC), before which in January 2010 she clearly stated the need for the fiduciary standard for investors. Schapiro compared the FCIC’s work to the investigation of the stock market crash in 1929: "Ferdinand Pecora uncovered widespread fraud and abuse on Wall Street,” Schapiro said then, recalling the 1930s-era investigation by the Senate Banking and Currency Committee whose chief counsel was Pecora, “including self-dealing and market manipulation among investment banks and their securities affiliates."
Politically, though, the atmosphere in Washington more than 75 years later regarding financial services legislation was a bitter tug-of-war between the big Wall Street companies who were more focused on issues that loomed larger in the press than the fiduciary standard, like murmurs of a Glass-Steagall redux, executive compensation issues and derivatives legislation. On the other side of the argument were consumer lobbying groups that wanted an extension of the fiduciary standard and a regulatory entity of some kind that would better protect consumers from financial predators. The partisan feeling was evident.
In the midst of this battle, Senate Banking Committee Chairman Chris Dodd (D-Conn.), a strong proponent of extending the fiduciary standard, announced he would retire at the end of his term.
Disagreement in the Senate on Dodd’s View
By February 2010, there were indications that not all Senators shared Dodd’s view. Some Senators led by Sen. Tim Johnson (D-S.D.)—who was in line to chair the Senate Banking Committee after Dodd retired—moved to amend the strong fiduciary provision in the Senate's proposal by substituting instead a call for a two-year SEC study of broker and adviser obligations, with no provision for the SEC to enact rules unless the Commission went back to Congress for that power. Thought by many advocates of a broader application of the fiduciary standard as a prelude to cutting such a fiduciary duty entirely out of the final law, the Johnson Amendment had support from the insurance and bank-wirehouse camps.
The Committee for the Fiduciary Standard (of which this writer was a member) published a statement arguing that the proposed Johnson study was unnecessary. Much of the information it requested was already known to regulators, the Committee argued. Johnson’s office called and invited the Committee to discuss his proposal in person. His staff asked the Committee to analyze the research that had already been conducted and point out what was already known to regulators. The Committee conducted its own analysis and provided that to the Senator. The meetings on Capitol Hill with the Committee continued.
Meanwhile, several Nobel laureates, prominent academics and investment industry leaders became involved, advocating for extending the fiduciary duty to all those who advise investors. The battle over what to retain and what to exclude from what would eventually come to be known as the Dodd-Frank bill continued.
In mid-April 2010, the SEC charged Goldman Sachs with fraud in connection with a CDO deal. The case underscored the conflicts-of-interest and lack of transparency that investors—even large, sophisticated institutional investors—can face under the broker-dealer suitability standard instead of a fiduciary standard. Goldman executives testified at Congressional hearings. (A video excerpt from the 13 hours of Goldman testimony is posted on the Committee for the Fiduciary Standard website.) Goldman Sachs settled the charges with the SEC in July 2010, paying a record $550 million fine.
As much as in Fall 2009 the contest appeared to be over who could extend the fiduciary standard most strictly, in Spring 2010 the situation with the Senate’s version seemed tenuous. This uncertainty would continue until the Senate’s version of Dodd-Frank passed in June 2010. Now the reconciliation of the two bills in Congressional conference would offer another opportunity to the interest groups on both sides: those who wanted to strip the fiduciary standard from the final bill and those who wanted to extend the standard to all advice givers.
The road to passage of the final bill was like a roller coaster. As the Senate and House versions of financial reforms became reconciled, it seemed that the fiduciary standard might get swapped
out in return for retaining larger pieces of reform. While the debate continued, the SEC geared up for an enormous set of studies and rulemakings—including one on whether investment advisors should be regulated by an SRO like FINRA, which it delivered to Congress on Jan. 19, and one on the fiduciary standard.
The final Dodd-Frank bill, signed into law by President Obama on July 21, 2010, did, indeed, contain a provision for the SEC to study the fiduciary standard for six months and then commence rulemaking according to its findings. Public comment and meetings commenced.
The SEC continued a series of meetings with many groups of various points of view, including meetings with members of the Committee for the Fiduciary Standard. Other groups who met with the SEC on the issue were: the Investment Advisers Association (IAA); the Consumer Federation of America (CFA); Fund Democracy; the National Association of Personal Financial Advisors (NAPFA); the Certified Financial Planning Board of Standards (CFP Board); the Financial Planning Association (FPA), and the North American Securities Administration Association (NASAA), the state securities regulators group.
FINRA, the broker-dealer SRO that is supervised by the SEC but funded by its self-regulated membership, occupies an unusual place in the regulatory sphere. As the self-run group of brokerage firms that supervises brokers, it must balance investors’ needs with its members’ desires to distribute products to investors and maintain its commission- and fee-based business models.
The SEC and legislators also met with SIFMA, the broker-dealer lobbyist, the Financial Services Institute (FSI), the Financial Services Forum, The Financial Services Roundtable, The American Council of Life Insurers, the National Association of Insurance and Financial Advisors (NAIFA), as well as many individual banks, broker-dealers and insurance companies and their advocates.
Most independent broker-dealer leaders argued that they were in effect already operating under a fiduciary standard, in no small measure because IBDs do not, for the most part, manufacture and distribute their own investment products, thus limiting some conflicts of interest.
History and Suggestions for Regulation
The Committee called for academic papers from all points of view on application of the fiduciary standard in a brokerage setting, and held a Fiduciary Forum in Washington. The Committee provided the SEC with The Fiduciary Reference, an 1,100-page compendium of the best fiduciary papers and articles published over the prior seven decades, and responded to requests from Senators for analyses and assistance.
The Financial Planning Association (FPA) proposed a professional regulatory organization (PRO) for financial planners, some of whom fall under no regulatory body presently.
Many RIAs share the view that the SEC still is the best entity to regulate investment advisors. In part because it oversees BD-RIA firms, FINRA’s desire to regulate RIA firms, as well as BDs, is on the record, and the independent broker-dealer group FSI in January formally endorsed FINRA as
its preferred SRO. Both the SEC and FINRA recognize the differences between the ways these very different professionals operate, and one would hope a very thoughtful and pragmatic approach will be taken with this very sensitive issue.
In the end, the SEC on Jan. 19 presented Congress with its report on an SRO for advisors, leaving it to Congress to decide on whether there should be an SRO such as FINRA, or institute a different funding mechanism for the SEC under which RIAs would be charged a fee to help support the SEC’s Office of Compliance, Inspections, and Examinations. Specifically, three options were given to Congress:
- Authorize the Commission to impose user fees on SEC-registered investment advisers to fund their examinations by OCIE;
- Authorize one or more SROs to examine, subject to SEC oversight, all SECregistered investment advisers; or
- Authorize FINRA to examine dual registrants for compliance with the Advisers Act.
The Fiduciary Study Is Released, and Next Steps
The SEC sent its report on the Fiduciary Study to Congress late Jan. 21, and released it to the public on Saturday, Jan. 22. The report contains SEC staff recommendations on whether to extend the fiduciary standard to brokers. In reporting about the fiduciary report, AdvisorOne Washington Bureau Chief Melanie Waddell writes that the SEC decided to “move forward in creating a new uniform fiduciary standard of care for broker-dealers and investment advisors when providing advice to retail customers.”
The report, however, isn’t the final word on the fiduciary standard.
In part III of our special report on the process of Dodd Frank, we will discuss the next steps on the issue: how the SEC rulemakings are likely to play out, and how politics are not out of the equation yet. In fact, the two Republican members of the SEC issued a joint dissent statement, writing that the staff report “fails to adequately justify its recommendation that the Commission embark on fundamentally changing the regulatory regime for broker-dealers and investment advisers providing personalized investment advice to retail investors.” Stay tuned.