From the July 2011 issue of Investment Advisor • Subscribe!

Fiduciary D-Day Arrives

As the SEC launches into rulemaking, lots of ‘thorny issues’ will surface

D-day has arrived: Later this month the Securities and Exchange Commission (SEC) will turn its attention to the daunting task of not only crafting a fiduciary duty rule for brokers, but also reworking mutual fund distribution fees under Rule 12b-1. As SEC Chairman Mary Schapiro said recently—the Commission will deal with these two issues “in tandem.”

The House, too, still plans to hold hearings on the SEC’s studies under Sections 913 (fiduciary duty) and 914 (self-regulatory organization) of Dodd-Frank before Congress’s August recess. As Schapiro said recently, all three options put forth in the SEC’s study to Congress—one or more SROs, extension of FINRA oversight over advisors, or imposing user fees to fund advisor exams—would require legislation to “move forward.”

As the July deadline approaches, lobbying efforts have heated up in the past few months, with industry executives like Mark Casady, CEO of LPL Financial, publicly airing his views on what he sees as an “extremely uneven” regulatory playing field that favors advisors over brokers.

Even Rep. Barney Frank, D-Mass., ranking member of the House Financial Services Committee, shipped a letter to Schapiro urging the SEC not to put brokers under the Investment Advisers Act fiduciary standard. Frank told Schapiro that while Section 913 of Dodd-Frank gives the SEC the authority to establish a new fiduciary standard of care for broker-dealers, “the requirement that the new standard be ‘no less stringent’ …was not intended to encourage the SEC to impose the Investment Advisers Act standard on broker-dealers, but to ensure the new standard would not be a ‘watered down’ version of the investment advisors’ fiduciary standard.”

It was Frank who fought vigorously to have a fiduciary standard for brokers inserted into Dodd-Frank, so industry executives have been somewhat perplexed by his insistence that a newly crafted fiduciary standard “recognize and appropriately adapt to differences” between brokers and advisors. Despite his comment that the SEC should not “simply copy” the Investment Adviser Act standard for brokers, Kristina Fausti, director of legal and regulatory affairs for fi360, says that it is “notable” that Frank stated in his letter to Schapiro that “Congress wanted to ensure that a fiduciary standard for brokers would not be a ‘watered down’ standard.”

In crafting a fiduciary standard for brokers, the SEC will have to grapple with a number “thorny provisions” in Dodd-Frank, says David Tittsworth, executive director of the Investment Adviser Association (IAA) in Washington. First, he says, Section 913 of Dodd-Frank applies when a broker is providing “personalized investment advice” to “retail customers,” he says. “What do these terms mean?” he asks. Section 913 also states that the SEC may extend the fiduciary duty to “other customers,” Tittsworth says. “Will the SEC exercise this authority or will [the agency] only deal with ‘retail’ customers?”

Then there’s the portion of Section 913 that states “it will not be a violation of the standard of care, in and of itself, to engage in proprietary trades or to charge commissions,” Tittsworth explains. “Both involve potential conflicts of interest. How will the [fiduciary] standard of care treat these types of activities?”

According to Barbara Roper, director of investor protection for the Consumer Federation of America (CFA), the SEC’s study under Section 913 of Dodd-Frank “made absolutely clear that the agency has every intention of pursuing an approach that retains the ability of brokers to offer transaction-based advice compensated through commissions and to sell both proprietary products and from a limited menu of products.”

Moreover, she says, the SEC “has delayed dealing with principal trading restrictions so that they can be addressed as part of the larger fiduciary rule in a way that preserves brokers’ ability to conduct such trades.”

Casady of LPL says that putting brokers under a fiduciary standard “doesn’t go far enough” in leveling the “uneven” playing field that exists for brokers and advisors. LPL, along with a lobbying firm the company hired, has been telling the SEC as well as members of Congress that making sure a fiduciary standard for brokers “has the same teeth” as the one applied to RIAs is just the starting point.

As the Rand study pointed out, Casady says, consumers don’t understand the differences in regulatory, business or educational requirements that brokers and advisors are held to. “If you are a broker, you have a testing mechanism and a continuing education process that keeps you up to date on the latest industry issues,” he says. But when acting “purely as an RIA, none of those requirements exist—there is no capital requirement for the firm, no insurance requirement, no continuing education requirement—there are best practices for RIAs, but no national CE” requirements. “There may be states that have some CE requirements, but there are no national requirements for CE, and it’s not extensive if it’s state driven,” Casady maintains.

So if brokers are to be held to a fiduciary standard, then it’s only fair to then “harmonize” the rules for RIAs and brokers, Casady says. The SEC should ensure RIAs adhere to capital, insurance and CE requirements “as a way of making sure the consumer is assured” the same standards are being applied along with a fiduciary requirement. Of course, he adds, harmonizing the standards “doesn’t mean that everything that needs to happen to a broker needs to happen to an advisor because you have a very different mechanism for compensation.” Maybe some brokers’ practices should end, he says, and “never bother to take [those practices] to RIAs. And there may be some things to stop doing on both sides or things to start doing on the RIA side.”

Harmonization of advisor and broker rules may or may not get rolled into the fiduciary standard rulemaking, as a top SEC executive told me in a previous interview that an extensive harmonizing of advisor and broker rules would require a separate rulemaking.

The next natural step after harmonizing fiduciary duty and rules that apply to brokers and RIAs, Casady says, is to “harmonize oversight [of advisors and brokers] and create an SRO for RIAs.” While that SRO body doesn’t necessarily have to be FINRA, Casady says, LPL supports FINRA as the SRO “because we think [FINRA] has the means to do it and it would be most cost effective.” Also, he adds: “Remember that 80% (maybe 88%) of the brokers in the industry are also RIAs—so there is a high overlap of advisors that are already being overseen by FINRA.”

Close single page view Reprints Discuss this story
This is where the comments go.