More On Legal & Compliancefrom The Advisor's Professional Library
- Where Are We Headed? The ultimate compliance goal is to help ensure that everyone associated with an advisory firm acts ethically at all times. Advisors and RIAs should do the right thing, even when regulators are not looking over their shoulders.
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
Now that the euphoria (in some quarters) that followed the SEC’s Jan. 21 release of its “groundbreaking” Study on Investment Advisors and Broker-Dealers has waned a bit, it’s time to take a more somber look at what this much-awaited document says—and what it doesn’t say. I have to admit to a strong sense of optimism upon my initial read of the Study; which after reflection, I now suspect was driven as much by relief as anything else.
I suspect that was a reaction shared by many who believe financial consumers would be far better served by the Dodd-Frank Act’s mandate that brokers be subject to the same duty of client care that is currently required of investment advisors. In the months leading up to the release of the Study, it was beginning to feel as if the SEC’s commitment to a strong fiduciary standard for brokers was wavering under relentless pressure from the brokerage industry. So, when the SEC Study finally came out, containing what appeared to be strong support for a ‘40s Act-type standard for brokers, we all breathed a collective sigh of relief.
But does the Study really say what it appears to say at first blush? Although it doesn’t say “no” to a fiduciary standard for brokers, does it really say “yes?” The few lines that have received most of the attention certainly sound promising. Yet, there is plenty of room for other ideas—perhaps even conflicting ideas—and other perspectives that may not be internally consistent. Perhaps most troubling, the Study isn’t a statement by the commissioners themselves; it came instead from the SEC staff in the form of recommendations that the commissioners can either accept or reject as they see fit. After further consideration, I can’t help but wonder if, in the cacophony of premises and analyses that make up the Study, the key point doesn’t get lost: that people who give investment advice to the public should be required to put their clients’ interests first, and people who don’t accept that duty of care should not be allowed to masquerade as if they do.
The causes for celebration, or at least relief, among proponents of a strong fiduciary standard for everyone who provides retail investment advice are stamped throughout the Study. Part IV: Analysis and Recommendations, captures the heart of it: “First, the Staff recommends that the Commission engage in rulemaking specifying a uniform fiduciary standard of conduct that is no less stringent than currently applied to investment advisers under Advisers Act Sections 206(1) and (2) that would apply to broker-dealers and investment advisers when they provide personalized investment advice about securities to retail customers.” That is, there should be one standard for everyone who gives investment advice, and it should be at least as strong as the fiduciary standard that investment advisors currently have under the ‘40 Act.
Understandably, the reaction of advocates of a strong fiduciary standard across the industry was extremely favorable:
• fi360 commented in its blog on Jan. 24: “We are pleasantly surprised and heartened by the strength of the report’s analysis… . The numerous references to the twin duties of loyalty and care as a basic framework for any rulemaking are an encouraging sign that the SEC recognizes the special responsibility entrusted to a fiduciary.”
• The Committee for The Fiduciary Standard: “The SEC staff has written an excellent study which reflects a keen understanding of the differences between the suitability and fiduciary standards… . This study is a bold blueprint and provides an excellent foundation for the rulemaking to follow, where the standard will be shaped.”
Of course, we might put some of this glowing praise down to pure politicking: No one wants to get on the bad side of the SEC staff. A good counterbalance to what its supporters are saying about the Study is what its detractors are saying and who they are. In this case, the brokerage industry appears to be less than happy about much of the Study:
• On the AdvisorOne website, Melanie Waddell quoted Ira Hammerman, general counsel for SIFMA, following the Study’s release: “SIFMA remains concerned about a uniform fiduciary standard’s possible effects on broker-dealers… . SIFMA will continue to work with the SEC to ensure that the broker-dealer role is not hindered.”
• A Charles Schwab Corp. statement on Jan. 24 (reported in RIA Biz): “We believe that requiring better disclosure and application of the best interest standard can and should be accomplished while keeping RIAs and broker-dealers distinct under the existing statutory and regulatory frameworks… . We believe there is no need for broker-dealers to become investment advisers when giving transactional advice.”
Yet, before we herald the SEC Study as a major victory for financial consumers—and fiduciary advisors who have long sought a level playing field with brokers—we might want to delve a little deeper into the remainder of those 200-plus pages. As fi360 CEO Blaine Aikin told Investment News: “There’s room for mischief in some of the language [of the Study].”
For example, Section IV part C begins ominously with a quote from an opinion written by Supreme Court Justice Benjamin Cardozo: “The description of the standard as fiduciary is by itself only a general characterization.” [emphasis added] While the Study goes on to say that the “Staff interprets the uniform fiduciary standard to include at a minimum duties developed under the ‘40s Act,” it concludes that “guidance will be especially beneficial to broker-dealers,” and that such “clarification will be particularly important in applying the obligation to eliminate or at least disclose all material conflicts of interest, as contemplated by the Dodd-Frank Act.”
The use of disclosure is troubling to consumer advocates because it has been so often used to shift the burden of responsibility from the advisor (to eliminate or mitigate conflicts of interest) onto the client (who must determine whether they are acceptable), usually with insufficient information or knowledge to fully understand what they are being told. Aiken stated that he would fight any effort to make disclosure at the outset of a financial advice relationship sufficient to meet the fiduciary standard. “That doesn’t just weaken the fiduciary standard,” he said. “It guts it.”
Another area where the SEC has the potential to “gut” a fiduciary standard for brokers is in how it defines “personalized investment advice,” which seems likely to be the only activity of brokers to fall under the standard. Here’s what the Study says on the subject: “The Staff recommends that the Commission…define and/or interpret ‘personalized investment advice about securities’ to provide clarity… . The Staff believes that such a definition at a minimum should encompass the making of a ‘recommendation,’ as developed under applicable broker-dealer regulation, and should not include ‘impersonal investment advice’ as developed under the Advisers Act.” As you’ve probably already inferred, how broadly or narrowly the SEC “defines” investment advice as given by brokers will largely determine whether brokerage clients will receive any meaningful new protections at all.
Concerns over the wiggle room created by some of the language in the Study are exacerbated by the fact that two out of five of the SEC commissioners, Kathleen Casey and Troy Paredes, issued a statement also on Jan. 21, voicing a lack of support for its conclusions: “In our view, the Study’s pervasive shortcoming is that it 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… . Indeed, the Study does not identify whether retail investors are systematically being harmed or disadvantaged under one regulatory regime as compared to the other and, therefore, the Study lacks a basis to reasonably conclude that a uniform standard or harmonization would enhance investor protection.”