More On Legal & Compliancefrom The Advisor's Professional Library
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
- 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.
The lead story on the advisor reregulation front these days is that our friends at FINRA continue to position themselves as the increasingly obvious choice to become the regulator of investment advisors—to the point of becoming overkill. Speaking at that organization’s annual conference at the end of May, FINRA chairman and CEO Richard Ketchum called for making his industry’s disclosures more understandable to consumers: “We need to get away from today’s environment in which account statements contain too much legalistic information, leaving them downright turgid, and causing investors to simply ignore them. This is a fundamentally flawed approach to disclosure.”
Ketchum went on to say that his BD constituents should be asking: “How do we interact in an effective way with investors? How do we foster knowledge and understanding among investors? And how do we deliver that message, both with respect to existing technology tools and with respect to how your financial advisors go through the message?” He also mentioned that they are enhancing their examination teams to be “more focused on those areas that present a real risk to investors.” And, of course, he reiterated FINRA’s embracing of a “uniform fiduciary standard,” carefully noting the key elements of such a client-centered relationship are “to avoid conflicts of interest where possible, fully disclose them where not, and take actions—and be able to justify those actions—as being in the best interests of the customers.”
Now, a skeptical mind might ask whether Ketchum has only now noticed that disclosures are verbally impenetrable to English-speaking clients, that BDs have not been particularly concerned with investor education, or that the “real risk” to investors is frequently overlooked. It sounds as if he’s critiquing a regulator other than the one he heads. And if FINRA is so gung-ho about a uniform fiduciary standard, why did it push the SEC to enact the now struck-down Merrill Lynch Rule which exempted brokers from such a fiduciary standard?
No, Ketchum and FINRA have had their epiphany on the road to Damascus just in time to become the regulator of investment advice as well as brokerage activities. But if they succeed, it will not be a sudden victory. FINRA and its predecessor, the NASD, have been angling to regulate independent investment advisors at least since I started covering financial planners back in 1984.
This time, however, they may succeed, and the consequences for independent advice could be disastrous. Admittedly, I haven’t been excited by the prospect that the best hope for advice to retain its independence could be an SRO for RIAs launched by law students at the University of Mississippi under the tutelage of their professor, Mercer Bullard. Yet, after hearing Professor Bullard speak at the fi360 Conference in San Antonio in May, I can see now that there may be some encouraging method to his
For the past three decades, the securities industry and its SRO have been right about two things: The first is that independent advice has indeed posed a serious threat to the traditional brokerage model. In its short history, it has forced the transition to fees, to assets under management, to comprehensive advice, and now to a fiduciary standard. Yet, despite these dramatic “me too” changes by BDs, the defection rate of brokers into the independent ranks is higher than ever.
But the securities industry also has a firm grasp of another, equally essential point: The Achilles heel of the independent advisory world is costs. The independence of independent advisors has, at least historically, translated into small businesses with limited resources: resources that are further limited by revenues that come solely from the clients, rather than being subsidized by the highly lucrative product distribution end of the financial industry. Consequently, most independent advisory firms are extremely sensitive—and vulnerable—to increases in costs, such as the costs of regulation. One way to force independent advisors back into the securities industry fold would be to increase regulation, which not coincidentally is FINRA’s forte.
This agenda was not lost on Mercer Bullard. An experienced securities lawyer, Professor Bullard is a former assistant chief counsel at the SEC, and currently sits on the Commission’s Investor Advisory Committee. As a former regulator, he realized early in the process that led to Dodd-Frank that despite all the hoopla surrounding a fiduciary duty for brokers, when it came time to implement whatever was finally decided, independent advisors would be at a severe disadvantage; they had no cohesive organization to step up. This situation was exacerbated when the CFP Board-led Coalition for Financial Planning decided to focus its efforts on establishing a regulator for financial planners, effectively taking itself out of the RIA game.
To fill this void, Bullard and his law students have created an alternative
To fulfill Dodd-Frank’s mandate that the regulation of brokers and investment advisors be “harmonized,” Bullard envisions SROIIA would need to become involved in the same areas that FINRA now regulates: Customer communication, advertising, supervision, licensing, continuing education, registration, arbitration, book and records, and relationships with finders and solicitors. The difference would be SROIIA would approach these issues from a “principles” perspective based on a fiduciary duty to clients, rather than FINRA’s rules-based approach, which currently appears to be more concerned with creating defensible safe harbors, rather than actually doing the right thing for the client.
Of course, SROIIA would also set rules and standards for a fiduciary duty to the clients. These would cover the content of brochures, and when and how they are delivered, how conflicts would be disclosed, and setting acceptable basis for investment recommendations. The timeline for SROIIA depends largely on the SEC and Congress: First, the SEC needs to recommend to Congress that RIAs need an SRO. Then Congress would have to authorize the SEC to approve the SRO. Then the SEC would accept applications to become an SRO for investment advisors. Given its recent posturing, FINRA undoubtedly would apply, as would SROIIA. Once the SEC grants approval for any or all of the applicants, RIAs could then sign up.
If the current rate of progress on the SEC’s Dodd-Frank mandates is an indication, we’re probably looking at much later rather than sooner for any new advisor SRO. The way things are going now, I’m guessing that’s just fine with many independent RIAs. Unfortunately, change in their little corner of the world appears to be inevitable—the only real question is whether it will be change they can live with. Like many supporters of a uniform fiduciary standard, I’m dismayed that the reregulation of investment advisors seems to have been shoehorned into the equation. In fact, FINRA’s recent actions make one wonder whether this was the plan all along.
At this point, with reduced funding rendering the SEC unlikely to remain as the regulator for RIAs, Mercer Bullard and his team appear to be right: The best outcome that independent advisors can hope for is to establish their own alternative to FINRA. At least that way, they could create a genuine fiduciary standard, be evaluated and regulated by their peers, and exercise control over the costs of all this new regulation—which holds the potential to put the entire industry out of business. It is indeed unfortunate that none of the independent advisory world’s current organizations have the ability or the vision to fill this role. I suspect that for years to come, we’ll be speaking of Mercer Bullard and his University of Mississippi law students in the same reverential tones as we currently do when remembering the founders of the old ICFP and IAFP, and their efforts to launch a profession of independent advice.