More On Legal & Compliancefrom The Advisor's Professional Library
- 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.
- Client Commission Practices and Soft Dollars RIAs should always evaluate whether the products and services they receive from broker-dealers are appropriate. The SEC suggested that an RIAs failure to stay within the scope of the Section 28(e) safe harbor may violate the advisors fiduciary duty to clients, so RIAs must evaluate their soft dollar relationships on a regular basis to ensure they are disclosed properly and that they do not negatively impact the best execution of clients transactions.
While SEC Chairman Mary Schapiro said in mid-December comments first reported on Bloomberg that the agency would issue a proposed fiduciary rule this year, she also stated in the Bloomberg interview that a fiduciary rule proposal will be “business model neutral” and allow brokers working with retail investors to sell proprietary products and charge commissions.
Industry officials say exactly how the SEC crafts this “business model neutral” approach will be crucial to determining whether the agency actually ends up putting brokers under a fiduciary mandate.
“If by ‘business model neutral’ the intention is simply to make provision for commissions and proprietary product, I am neither surprised nor too concerned,” says Harold Evensky, president of Evensky & Katz Wealth Management in Coral Gables, Fla., and a member of the Committee for the Fiduciary Standard. “That is assuming that the core elements of a fiduciary relationship are included” in the final fiduciary rule.
However, “if by ‘business neutral’ the result is the one sought by many in the brokerage and insurance industry, i.e., redefine ‘fiduciary’ as enhanced ‘suitability’ with opt-out provisions, then we will end up with the worst of all worlds.”
Yet others say that taking a “business model-neutral” approach is the “balanced” way to go. While there’s no doubt that the SEC is “trying to walk a fine line given the political and economic realities” as it develops the fiduciary rule, says Brian Rubin, a partner in the law firm Sutherland Asbill & Brennan, “promoting a ‘business model-neutral’ formulation is a very balanced approach,” and is “consistent with what [Schapiro] has been saying for a while.”
A strict fiduciary standard, Rubin adds, “would have called into practice and likely prohibited many common practices such as selling proprietary products.”
The SEC has been receiving pressure from Congress and broker-dealer trade groups since Dodd-Frank was written into law about how the agency should write an expanded fiduciary standard. Rep. Barney Frank, D-Mass., ranking member on the House Financial Services Committee, told SEC Chairman Mary Schapiro in a May 31 letter 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 [of 1940] standard on broker-dealers, but to ensure the new standard would not be a ‘watered down’ version of the investment advisors’ fiduciary standard.”
Section 913 of Dodd-Frank allows principal trading and proprietary products as well as charging brokerage commissions, says David Tittsworth, executive director of the Investment Adviser Association in Washington. “It’s no secret that Section 913 of Dodd-Frank represented a compromise among competing interests,” he said.
The question of whether brokers should have the same fiduciary duty as investment advisors has been and “continues to be very controversial,” Tittsworth says, and “Section 913 reflects that controversy.”
Indeed, Knut Rostad, president of the Institute for the Fiduciary Standard, adds that while Dodd-Frank “states clearly that commissions and proprietary products ‘in and of themselves’ do not presumptively breach the fiduciary standard,” Section 913 “does not state that any particular commission transaction and its facts and circumstances are ‘protected’ from fiduciary requirements.” Like a non-commission transaction, Rostad continues, “it needs to be evaluated on its own merits. In this sense, there is less than meets the eye in applying ‘business model neutrality.’”
Section 913 creates a “fairly complicated roadmap” the SEC must follow in crafting a fiduciary standard, Tittsworth adds. For example, “it gives the SEC explicit authority to issue rules that would apply the same standard of conduct that investment advisors have. But it also states that the receipt of commissions and sale of proprietary products will not, in and of themselves, be a violation of that standard. And it would apply when brokers are providing “personalized investment advice about securities to a retail customer.”
Warns Tittsworth: “The SEC must take into account each and every word of Section 913 as it considers crafting a rule.” The agency must be “very mindful of potential legal challenges that may result, including providing a robust cost-benefit analysis that would pass judicial scrutiny. If the Commission proposes a rule, it will be subject to the Administrative Procedures Act process that allows all interested parties to comment.”
Barbara Roper, director of investor protection for the Consumer Federation of America (CFA), said at a recent CFA conference that she believed the SEC was “paralyzed” in moving forward on a fiduciary rule by a small portion of the broker-dealer community who she said are dependent on variable annuity sales. That group, she suggested, would likely challenge a fiduciary rule proposal in the courts.
While she said there is broad consensus that this fiduciary rule should move forward, Roper also lamented that “it seems almost impossible to make progress. We hope by sometime next year we’ll see something, but don’t bet the farm.”
Roper added that another stumbling block for the SEC is pressure from Capitol Hill on the agency to perform a more robust economic analysis on the rule.
Still, other industry executives are “encouraged” by Schapiro’s comments that a fiduciary rule will be business model neutral. Dale Brown, president and CEO of the Financial Services Institute says that FSI “has been calling for a uniform fiduciary standard since the beginning of the regulatory reform debate” and that FSI is still working “to ensure the proposal creates a new uniform fiduciary standard while maintaining client choice and client access to affordable advice.” With Schapiro’s comments, “the SEC is showing a real willingness to understand our industry and our clients’ needs, which is refreshing.”
Dan Barry, the Financial Planning Association’s managing director of government relations, said Schapiro’s reported comments “are consistent with the language in Dodd-Frank and with what has been expected,” preserving proprietary products and commissions. What will be important, he said, is setting up rules that allow for proprietary products and commissions while “making sure that investors are getting advice that is in their best interest.”
The National Association of Insurance and Financial Advisors (NAIFA) says that a new fiduciary standard of care rule “should respect the business differences between investment advisors and broker-dealers.” On average, NAIFA says that most of its members serve investors with annual household incomes of less than $100,000. “Therefore our fundamental concern is that the potential additional costs and increased potential for liability of applying a ‘one-size-fits-all’ fiduciary standard of care to the broker-dealer business model could result in middle market investors having less access to affordable financial services that are currently being delivered by our members.”
Whatever form the fiduciary rule proposal takes, as Tittsworth notes, like the 3,500 comment letters that the SEC received when it was drafting the Section 913 study, “there will be no shortage of opinions about every aspect” of the SEC’s rulemaking.