More On Legal & Compliancefrom The Advisor's Professional Library
- The Few and the Proud: Chief Compliance Officers CCOs make significant contributions to success of an RIA, designing and implementing compliance programs that prevent, detect and correct securities law violations. When major compliance problems occur at firms, CCOs will likely receive regulatory consequences.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
All eyes this year will be focused on the exchanges that will ensue between lawmakers and the Securities and Exchange Commission (SEC) regarding putting brokers under a fiduciary mandate and appointing a self-regulatory organization (SRO) to help the SEC oversee advisors.
By the time you read this, the SEC will have delivered its report to Congress regarding whether to put brokers under a fiduciary standard of care and whether the agency will seek help from an SRO—which is likely inevitable seeing as the agency’s budget has been significantly hamstrung by the lack of any additional funding from Congress to carry out its mandates under Dodd-Frank.
At press time in early January, industry groups were voicing their concerns about what an SEC-crafted fiduciary standard of care may look like. For instance, the Committee for the Fiduciary Standard fears the SEC will institute a “disclosure-based” standard for brokers instead of a fiduciary standard, while the Investment Adviser Association (IAA) worries about the prospect of the SEC “defining” a fiduciary standard.
The SEC was to have sent its studies under Sections 913 (fiduciary duty) and 914 (need for SRO) of Dodd-Frank to the two newly installed Congressional chairmen: Rep. Spencer Bachus, R-Ala., of the House Financial Services Committee; and Sen. Tim Johnson, D-S.D., of the Senate Banking Committee.
A draft report requesting Congressional authority to appoint an SRO for advisors was also said to be circulating among the SEC Commissioners; the request did not specifically mention the Financial Industry Regulatory Authority (FINRA) as the preferred SRO, but industry officials say that a “general” recommendation regarding the need for one or more SROs was expected all along, and that FINRA is indeed still a candidate.
David Tittsworth, executive director of IAA, says that “FINRA is in the middle of this [SRO] debate, whether the [SEC] report says so or not.” FINRA, he continues, “has hired lobbyists to make their point on Capitol Hill and they are actively working the SEC. FINRA has a very large war chest—over $1 billion—and they are using it to make the case that they are ready and able to become the SRO for all or some portion of the investment advisory profession.”
The sticking point here is that Congress has the power to designate which SRO the SEC would use to help it oversee advisors. But as Tittsworth notes, “the SEC would probably seek broad authority” to designate any SRO for investment advisors. Remember that it was Rep. Bachus who wanted to insert FINRA as an overseer of advisors into the language of Dodd-Frank during the Congressional conference debate.
‘Fundamental’ Change on the Way
No doubt “fundamental changes” in how investment advisors are overseen are on the horizon this year, adds Barbara Roper, director of investor protection at the Consumer Federation of America (CFA). If Congress appoints an SRO, “that’s just the first step,” she says. “There are still a whole host of questions that arise on how that [SRO] is structured and, if FINRA plays a role, what changes it is required to make in its governance and structure to accommodate that expanded responsibility. How those decisions are made will determine whether this new approach to investment advisor oversight delivers appropriate protections to investors.” What is clear, she continues, “is that the status quo—with the SEC dependent on appropriations that allow for a once-a-decade inspection cycle—is not acceptable.”
How will the debate on fiduciary duty play out this year? Recent meetings the Committee for the Fiduciary Standard has had with the SEC as the agency was completing its study of the regulation of brokers and investment advisors prompted the Committee to shoot off a Jan. 3 letter to the SEC imploring the securities regulator to not adopt a disclosure-based standard. “Disclosure of conflicts, as opposed to avoidance or mitigation of conflicts, has become the central battlefield over whether the fiduciary standard survives,” Knut Rostad, chairman of the Committee for the Fiduciary Standard, told Investment Advisor. “The securities industry is pressing very hard for a casual disclosure-based standard that would, effectively, remove fiduciary duties when material conflicts are present.”
Rostad told the SEC in his comment letter that “modern research has provided overwhelming evidence that disclosure is, at best, insufficient for addressing conflicts of interest.” Indeed, he continued, “there is convincing evidence that disclosures are frequently confusing and misleading for investors, even when made under the best circumstances with the purest of intentions.”
Tim Ryan, CEO of the Securities Industry Financial Markets Association (SIFMA), alluded to the SEC taking a disclosure-based approach to fiduciary duty in comments he made in late October. Appearing before the Washington Economics Club, Ryan said that the uniform fiduciary standard that the SEC is busy crafting will likely be a “modified ’40 Act standard” that incorporates additional disclosures. But, he said, it will be “disclosure that’s understood.”
Disclosures as Flexibility, or Nightmare?
While most advisors and brokers would concur that a fiduciary duty should apply when retail investment advice is needed, Don Trone, CEO of Strategic Ethos, says there is disagreement about whether a fiduciary duty should apply “to all client relationships, and the ability to use disclosures is perceived as a way to provide broker-dealers greater flexibility in deciding whether a client relationship should be subject to a fiduciary or suitability standard.” Yet, he continues, the flexibility provided by disclosures “will generate a compliance nightmare for supervisory personnel.”
How can a branch manager properly supervise a broker if the broker can serve one client under a suitability standard, and another under a fiduciary standard? Trone wonders. “The branch manager will have to carefully review and consider the facts and circumstances of every client situation to determine the appropriateness of a particular standard.”
The more practical long-term solution for SIFMA, Trone argues, “is to bifurcate the sales force: Require brokers to choose to be supervised under one standard, or the other, but not both.” Branches, he proposed, “will be segmented by brokers and advisors, and it will be made clear to clients and prospects which professionals are serving in the different capacities. SIFMA firms may even decide to form a separate and independent RIA for its fiduciary advisors, similar to what the wirehouses did several years ago when the independence of security analysts became an issue.”
While it’s “certainly possible” the SEC could adopt a disclosure-based standard for brokers, Tittsworth says, the IAA’s biggest fear is that the SEC would attempt to “define fiduciary duty, which many brokers would prefer.”
One of the greatest strengths of the fiduciary duty, Tittsworth argues, “is that it is an overarching duty to put the client’s interest first, which includes the duty to disclose potential conflicts of interest. Defining fiduciary duty could erode one of the greatest strengths of the fiduciary standard—as well as provide a roadmap for wrongdoers: everything that is not defined as a fiduciary activity would fall outside of the standard.”
While the report that the SEC will hand to Congress by Jan. 21 will provide clarity on where the SEC is headed regarding fiduciary, Tittsworth says “the real proof will be the SEC’s subsequent rulemaking proposal.”