More On Legal & Compliancefrom The Advisor's Professional Library
- Disaster Recovery Plans and Succession Planning RIAs owe a fiduciary duty to clients to prepare for disasters and other contingencies. If an RIA does not have a disaster recovery plan, clients financial well-being may be jeopardized. RIAs should also engage in succession planning, ensuring a smooth transaction if an owner or principal leaves.
- 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.
SEC Chairman Mary Schapiro’s recent comments in the media about the Commission’s objective to develop a uniform fiduciary standard that is “business-model neutral” have caused quite a stir. They should not, if SEC rule-making remains true to Dodd-Frank and the plain meaning of its plain language. Consistent with Dodd-Frank, the standard should be “no less stringent than the standard applicable to investment advisers.”
“Business-model neutral” has come to refer to brokerage practices explicitly not banned under Dodd Frank, such as commission-based compensation or only offering proprietary products. Either practice does not, “in and of itself” violate the uniform fiduciary standard. The SEC staff “Study on Investment Advisers and Broker-Dealers” notes that these provisions “should not prohibit, mandate or promote particular types of products.” “Business-model neutrality” then is essentially “neutrality” regarding “types of products,” not neutrality regarding individual transactions which are evaluated on their individual merits.
Fiduciary law scholar Tamar Frankel notes fiduciary law has survived through the centuries because it is “open-ended” and can “accommodate new situations and changes in social morals and norms, yet maintain its core values and norms, without which no society can survive.”
The essential and widely acknowledged fiduciary values are evident in the duties of loyalty, professional judgment and good faith. Fiduciary law exists to restrict the discretion of experts in relationships of trust and confidence. Fiduciary loyalty means, essentially, to adopt the client’s ends or objectives in order to mitigate the widely acknowledged and large information asymmetry between the expert and the investor.
SEC rulemaking on Section 913 of Dodd-Frank will determine if core fiduciary values permeate a uniform fiduciary standard, or not. Whether the rationale for fiduciary duties—to restrict the discretion of experts who render advice in relationships of trust and confidence— is adopted , or not. As well, whether the magnitude of information asymmetry between investors and investment professionals, so thoroughly documented in independent research, is reflected in the stringency of the rules, or not.
The Securities Industry Financial Markets Association (SIFMA) argues vigorously for “business-model neutrality” in SEC rule-making and, through repeated statements, that “the guiding principle that underpins this uniform standard is to act in the best interest” of the investor. SIFMA’s emphasis on securing the investor’s best interest is stressed in comment letters and Congressional testimony.
Thus, SEC rule-making that is both “business-model neutral” and in an investor’s best interest
Further, such a transaction marred by a clear and present material conflict cannot be easily justified by a disclosure, even one that receives an “intelligent, independent and informed” consent.
Yale Management Professor Daylian Cain, a leading researcher in the field, offered a sobering view of what academic research reveals regarding how disclosed information is used when conflicts are present at a September 2011 Fiduciary Forum, Crafting Effective Disclosure—Is it Possible? Cain concluded: “Conflicts of interest are a cancer on objectivity. Even well-meaning advisors often cannot overcome a conflict and give objective advice. More worrisome, perhaps, investors usually do not sufficiently heed even the briefest, bluntest and clearest disclosure warnings of conflicts of interest.”
SIFMA and the Standard
SIFMA’s expressed commitment to underpinning the uniform fiduciary standard on a foundation constructed with “best interest” practices and procedures suggests its support for principles of business-model neutrality, and wide product and service access and choice, is a gallant call to the industry to raise its standards. This echoes a similar call of FINRA CEO, Richard Ketchum to the industry two years ago to abandon products and services designed to only meet a “minimally acceptable standard.”
For SIFMA to not urge the industry to raise its standard and instead do otherwise would be effectively urging the SEC to subordinate fiduciary values, principles and practices to interests inconsistent with the investor’s best interest. Doing otherwise would be to essentially reject extending the fiduciary standard to investors serviced by broker-dealers, as called for in Dodd-Frank.
A concise reply to a question addressed by SIFMA’s general counsel, Ira Hammerman, at the Institute for the Fiduciary Standard Fiduciary Forum, 2011 on September 9, 2011, is noteworthy:
Q. When a conflict is disclosed and a consent provided by the investor, do you agree that to proceed with the transaction it must still be in the investor’s best interest?
A. Yes. (Though) I would have said it in the reverse way. First, what ever you do must be in the best interest of the customer.
On this we should all also agree.