More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Books and Records Rule Thorough and complete books and records enable RIAs to demonstrate that they have fulfilled their fiduciary obligations to clients and complied with applicable rules and regulations.
I don’t usually write about politics, except when it has a direct impact on financial advice, and this appears to be one of those times. It’s extremely unfortunate that political discourse in America these days has devolved into being either very much for something, or very much against it—polarizing virtually every serious issue far beyond the actual facts or clear-headed analysis. We pass massive “reform” legislation without first determining the cause and nature of the “problem” (or apparently even reading the laws themselves); we’re absolutely sure humans are dramatically altering the global climate with no review of or even knowledge of the scientific evidence either way; and the debacle in Iraq undoubtedly would have come out far differently if we’d had a serious debate about our plans, our goals, and how we’ll know when it’s time to come home. I suspect much of the blame for our polarization falls on the media—nuance, subtlety and rational thought don’t seem to fit well into sound bites—and politicians who play to that audience.
It’s equally unfortunate that the fiduciary standard for brokers seems to have fallen into one of our ideological non-debates: over government regulation. The Democrats seem to feel that virtually all of our problems can be solved with increased regulation, while the Republicans apparently are driven to reduce regulation indiscriminately. Now that the Republicans are in the control of the House of Representatives, they’ve directed the SEC to hold off on the fiduciary duty standard, pending further study of the need for this additional regulation. The irony is that if done right, expanding the fiduciary standard to include brokers would actually reduce regulation, not increase it.
The Republicans made their wishes regarding the fiduciary standard known in a letter on March 17, 2011 from the party’s members on the House Financial Services Subcommittee led by Chairman Scott Garrett, R-N.J., to SEC Chairman Mary Schapiro. The letter states that although the Dodd-Frank Act’s Section 913 gives the SEC the “discretion to adopt a fiduciary duty rule [for brokers]…it does not mandate it, ands in no way suggests a congressional intent that the Commission move forward on such a rulemaking without sufficient basis.” The House Republicans go on to say that in their view “the Commission has not identified and defined clear problems that would justify a rulemaking and does not have a solid basis upon which to move forward.”
This letter, of course, echoes the dissenting statement by Commissioners Kathleen Casey and Troy Paredes that was attached to the SEC’s Jan. 21, 2011 Study on Investment Advisors and Broker-Dealers. In their statement, the two Commissioners say the SEC Study “…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.”
Both of these statements are curious and, I believe, revealing of the various agendas at play in this increasingly complex debate. The central issue here is whether brokers should be subjected to the same fiduciary standard to put their clients’ interests first that currently governs registered investment advisors. It seems to defy common sense that such a standard could fail to “enhance investor protection.” But notice that the dissenting commissioners don’t directly take issue with a fiduciary standard, but rather with “changing the regulatory regime for broker-dealers and investment advisers providing personalized investment advice to retail investors.”
Likewise, the House Republicans don’t take issue with a fiduciary standard for brokers either, but merely claim the SEC hasn’t identified a clear problem for which new “rulemaking” would be the solution. Section 3 of the Study, entitled “Retail Investor Perceptions and Confusion Regarding Financial Service Provider Obligations and Standard of Conduct,” cites numerous “comment letters” and three major studies that clearly spelled out the scope of “the problem.”
In 2004, the SEC hired SSG Consulting Group to determine how well investors differentiate between investment advisors and broker-dealers. SSG concluded that, “in general, [investors] did not understand that the roles and legal obligations of investment advisers and broker-dealers were different.” Then, in 2008, the SEC hired the RAND Corporation to interview investment advisor and broker-dealer firms. According to the Study: “RAND found that the firms believed that investors tended to trust a particular firm, without necessarily understanding of the firm’s services and responsibilities.”
RAND further found that “the primary view of investors was that the financial professional—regardless of whether the person was an investment adviser or a broker-dealer—was acting in the investor’s best interest.” More recently, the Consumer Federation of America submitted the results of a survey confirming that investors do not understand the differences between investment advisors, broker-dealers and financial planners, and are not knowledgeable about the different standards of conduct that apply to the advice or recommendations made by such financial services providers.
These studies and other commentary led the SEC staff to the following conclusion: “The foregoing comments, studies, and surveys indicate that, despite the extensive regulation of both investment advisers and broker-dealers, retail customers do not understand and are confused by…the standards of care applicable to investment advisers and broker-dealers when providing personalized investment advice and recommendations about securities. […] Investors have a reasonable expectation that the advice that they are receiving is in their best interest. […] Therefore, it is important that the personalized securities advice to retail investors be given in their best interests, without regard to the financial or other interest of the financial professional, in accordance with a fiduciary standard.”
Call me crazy, but that sure looks like a well-documented problem along with a rational and clearly workable solution. Can it be that neither the dissenting commissioners nor the House Republicans actually read the SEC’s report? I know; silly thought. I suppose we really shouldn’t blame the congressmen or commissioners for focusing on the process (rules and regulations) rather than the actual problem and its obvious solution. The fault really lies with the entire Congress, which passed Dodd-Frank Section 913, thereby punting the fiduciary issue over to the SEC to sort out.
As we know, the only tool bureaucrats seem to have is more regulation, so the SEC’s inclination to take a simple solution—create a fiduciary standard for brokers—and blow it up into re-regulating all of financial advice shouldn’t really come as much of a surprise. And the SEC didn’t disappoint: It’s report calls for not only more regulation (including more regulation of RIAs, who weren’t even the subject of Sec. 913), but so much more regulation that the Commission either needs a lot more money, or another SRO to help with the additional regulation, or both. It was like putting alcoholics in charge of the Jack Daniels distillery.
Fortunately, the solution for the House Republicans and those of us who want to see a fiduciary standard for brokers (in our lifetimes) is simple—which is why it doesn’t have a Tea-Partier’s chance on The View, I’m sure. The original Senate version of what became the Dodd-Frank Act had it right: Eliminate the broker exemption to the ‘40s Act, which would then confer a fiduciary standard on anyone who provides investment advice, including brokers. Brokers would then have the same legal duty as RIAs, which couldn’t be regulated into meaninglessness by FINRA or even the SEC.
All we need do is to politely point out to the SEC that Dodd-Frank does not give it the authority to create new, unnecessary regulations, only the regulations needed to give brokers a fiduciary duty to their clients. All this talk about being “industry neutral,” or “increasing RIA regulation” or new SROs is simply out of bounds. To “harmonize” the regulation of investment advice and increase investor protection, we just need to make everyone who provides retail investment advice a fiduciary for her clients, just like RIAs, under the same “regulations” that RIAs have now. This would greatly reduce the need for regulation.