More On Legal & Compliancefrom The Advisor's Professional Library
- Dealings With Qualified Clients and Accredited Investors Depending upon an RIAs business model and investment strategies, it may be important to identify “qualified clients” and “accredited investors.” The Dodd-Frank Act authorized the SEC to change which clients are defined by those terms.
- Anti-Fraud Provisions of the Investment Advisers Act RIAs and IARs should view themselves as fiduciaries at all times, whether they meet the legal definition or not. Deviating from the fiduciary standard of full disclosure while courting clients may cause the advisor significant problems.
While attending the last in a series of events to celebrate what the Institute for the Fiduciary Standard christened as Fiduciary September, one comment stood out: The No. 1 compliant in Financial Industry Regulatory Authority (FINRA) arbitration cases is breach of fiduciary duty.
I’ve been covering quite extensively the Securities and Exchange Commission’s (SEC) efforts to write a rule to put brokers under a fiduciary mandate since the Dodd-Frank Act gave the agency the go-ahead to do so. The debate over how the agency should write such a rule—and whether one should be written at all—has been relentless during this two-year process.
The comment about fiduciary failures being the biggest complaint in FINRA arbitration cases was made by Marcus Stanley, policy director for Americans for Financial Reform. He argued that fiduciary advice for retail clients is particularly “pressing” due to the rise of complex structured products and because of the large volume of fiduciary breach complaints to FINRA.
A FINRA spokesperson confirmed to me the same day of Stanley’s assertion that fiduciary duty is indeed the biggest complaint in arbitration cases.
This fact highlights one of the biggest problems that arises in the debate over whether brokers should be held to the same fiduciary standard when giving retail investment advice as advisors under the Investment Advisers Act of 1940: The undying confusion among investors about if, and when, a broker is a fiduciary. Also at issue, and perhaps more importantly, is their inability to understand what acting as a fiduciary actually means.
As Tom Giachetti, chair of the Securities Practice Group at Stark & Stark, told me, the “discussion (noise) about fiduciary standards for brokers” must stop because “the public, those for whom the ‘noisemakers’ seek to benefit, will never understand it.” Advisors, he declared, must “stop trying to hold brokers to such a [fiduciary] standard. Unless the advisory community is prepared to take on clients who have $10,000 of investable assets, brokers are their source for investment advice. Non-fiduciary services [and] commission compensation does not equate to dishonesty, but it does require the seller to maintain supervisory procedures to make sure that the recommendation was appropriate for the investor.”
Indeed, after I wrote the original article for AdvisorOne.com on the FINRA fiduciary arbitration stats (See “Breach of Fiduciary Duty No. 1 Complaint in FINRA Arbitration Cases”), one reader commented that brokers’ ability to “pick and choose” when they are operating under a fiduciary standard or a suitability standard has only added to investor “confusion and increases arbitration.”
Brokers, the reader said, “do not want to adopt a fiduciary standard because operating under a ‘suitability’ standard is more profitable. So be it. Let them keep their profits. Don’t change the standards.” Changing the standards, the reader argued, “will only cloud matters further for uninformed investors. The solution is simple: Require brokers to issue a statement with ALL transactions and services that they do not operate within fiduciary standards.”
Stanley of Americans for Financial Reform cited during his remarks that the SEC staff study on putting brokers under a fiduciary standard as mandated under Section 913 of Dodd-Frank “contains extensive documentation” regarding investors’ inability to understand the difference between a broker and an advisor. He argued that the principles-based fiduciary standard under the Investment Adviser Act of 1940 is “inherently flexible and it can be adopted by brokers.” But, he said, “we have to make sure that flexibility doesn’t mean watering down” such a standard.
This is where the biggest sticking point lies—putting brokers under the Advisers Act fiduciary standard. Kevin Carroll, managing director and general counsel for the Securities Industry and Financial Markets Association (SIFMA)—Wall Street’s trade group—declared from the audience that the panels at the event jointly held by the Institute for the Fiduciary Standard and the CATO Institute were behind the times and asked, “How do you implement a fiduciary standard” for brokers? “We don’t want the [Investment Advisers Act of 1940] standard imposed on us,” he told the panelists. The issue now is: “How do you articulate a [fiduciary] rule for both industries?”
Former SEC Chairman Harvey Pitt, who sat on the same panel with Stanley, agreed that “many customers don’t understand the differences in suitability [standard for brokers] versus fiduciary duty and many lawyers don’t either.” But Pitt argued that a fiduciary standard can be “simple” and not result in a voluminous regulation like the Dodd-Frank Act. Pitt told me in a separate interview that he believes brokers should be held to the same fiduciary standard as advisors, but “with carve outs.” The real “issues,” he said, “are what services the professional is providing and what are the customers’ expectations.”
Pitt stated in his comments during the panel discussion that “if all you do is execute a transaction, not [make] a recommendation, you can define that in fairly simple terms.”
However, Ron Rhoades, assistant professor and chairman of the financial planning program at Alfred State College, another panelist with Pitt and Stanley, argued that “brokers have always been fiduciaries under state common law.” If an advisor or broker is providing “personalized investment advice you are a fiduciary—period.” And, he said, the advisor or broker “must ensure that the client understands” that fiduciary standard. “Any educated investor is going to insist on the fiduciary standard,” Rhoades said.
While SEC Chairwoman Mary Schapiro told me in a previous interview that the agency’s fiduciary rulemaking is moving forward internally, Rhoades said what’s holding up the process is two of the five SEC commissioners’ reluctance to release the final request for comment from the agency economists regarding the SEC’s economic analysis of a fiduciary rule.
But Schapiro will more than likely not be at the helm of the agency next year, raising yet another question mark on when, or if, a fiduciary rulemaking process will move forward. If Daniel Gallagher’s comments are any indication—the newest SEC commissioner—a fiduciary duty rule for brokers isn’t high on the agency’s agenda.