More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- 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.
Taking time out over the holidays to reflect on the past year has become one of my favorite exercises. It helps to bring recent events into sharper focus and to better anticipate what the new year might hold. On a macro level, certainly the presidential election was the biggest event of 2012. Yet, there’s very little left to say about it other than: Let’s hope the slim majority of Americans know what they’re doing.
On the independent advisory front, the story of the year has to be the non-story of the SRO that didn’t happen—yet. While the future of advisor regulation is anything but certain, it seems as if the Pickett’s Charge of FINRA trying to envelope RIAs into its regulatory ranks may have reached its high-water mark a bit short of its intended goal, just as Lee’s army did in Pennslyvania 150 years ago. It’s a turn of events that could afford independent advisors a brighter future than what was once considered the more likely alternative: a slow death at the hands of the FINRA bureaucracy, which has been one of the securities industry’s goals at least since FINRA’s predecessor, the NASD, tried to capture independent financial planners back in 1985.
FINRA’s congressional campaign was dealt a major setback this fall when term limits ended Spencer Bachus’ chairmanship of the House Financial Services Committee. Bachus, R-Ala., you may remember, is the sponsor of bill H.R. 4624, which calls for an SRO for RIAs, and he strongly supported FINRA to fill that role. Now, Rep. Jeb Hensarling, R-Texas, who is Bachus’ heir-apparent, is rumored to be less than enamored with Bachus’ SRO bill, which may not bode well for FINRA.
At the same time, in what (at least to this observer) appears to be an unprecedented act of political savvy, the Coalition for Financial Planning, which comprises the CFP Board, the FPA and NAPFA, is attempting to exploit FINRA’s weakened position on the Financial Services Committee. Melanie Waddell, Washington bureau chief for Investment Advisor, originally reported in November that the Coalition is pushing for a bill in the Democratic-controlled Senate that would support the SEC continuing to regulate RIAs, with the authority to collect user fees to fund it (see “To Thwart SRO Bill, Coalition is Pressing for Senate User Fees Bill,” AdvisorOne.com). The Coalition’s strategy seems to be that presented with a bipartisan Senate SRO bill, the dwindling support for the Bachus bill in the House may evaporate altogether, leaving the SEC in charge of investment advisor regulation.
Of course, regulation by either FINRA or the SEC is a far cry from self-regulation for RIAs. The SEC retains close ties to the securities industry SRO, with many former FINRA executives and staffers filling key roles at the Commission, including outgoing Chairman Mary Schapiro, and Commissioner Elisse Walter, who will fill Schapiro’s spot for at least a year. Consequently, despite its mandate to protect financial consumers, the SEC often exhibits a disturbing tilt toward the brokerage business model.
Still, the SEC would be a distinctly better regulator for independent RIAs than FINRA. For one thing, historically at least two of the five SEC commissioners are not openly pro-Wall Street, adding an important balance as the Commission traditionally tries to achieve a consensus on its more important decisions. What’s more, for political reasons, the SEC strives to maintain, at a minimum, the semblance of impartiality (I believe the current catchphrase for this is “business model neutrality”) in the actions it takes.
During the debate about the reregulation of advisors and brokers initiated by Dodd-Frank, this concept of being “business model neutral” has been used by pro-Wall Street proponents (both in and outside of the Commission) to support a watered-down version of a fiduciary standard for brokers, so as not to impair their ability to conduct business as usual. Ironically, in the discussion of increased regulation for investment advisors, business model neutral has become a two-edged sword: Now it’s an argument in support of carefully considering any changes in the regulation of RIAs, many of whom practice in firms that are small businesses, which are very sensitive to any increases in costs, such as additional regulation. As many others have noted, it’s very likely that many independent RIA firms would not survive the financial burden of a FINRA-style bureaucratic regulatory structure.
As I mentioned, this isn’t the first time the securities industry has tried to gain control of the financial planning and advisory world through FINRA. Years ago, its motivation was the (quite astutely) perceived threat that the fledgling financial planning movement represented a more powerful way to distribute financial products than the traditional brokerage model. Today, the threat is independence.
With brokers breaking away from brokerage firms in droves to form their own RIA firms, Wall Street appears on the verge of panic. This time the threat is far more acute. In years past, the brokerage firms could write off defectors as unsuccessful brokers. In the ‘80s, the IAFP (the forerunner of the FPA) was known on Wall Street as the International Association of Failed Producers. Not anymore—today’s breakaway brokers tend to be top producers with hundreds of millions, if not billions, of client assets under management. To my mind, FINRA’s current usurpation of the Dodd-Frank mandated fiduciary standard for brokers and the “harmonization” of advisor regulation to gain control of the independent advisory industry is a transparent attempt to stop these defections by eliminating the independent alternative.
Rather than creating an opportunity for FINRA to finally gain control of independent advice, the Great Recession, which began in 2007, may have simply accelerated the inevitable decline of the retail brokerage model. The resulting, well-documented loss of confidence in Wall Street by the public, combined with increased awareness of the lack of fiduciary protections for brokerage clients, might have finally shifted public sentiment in favor of truly independent financial advice.
As regular readers of this column well know, I have long believed that the ability of brokers to render financial advice without the protections afforded the clients of RIAs was a mistake in the law (created by the “broker exemption” to the Investment Advisor Act of 1940). Perhaps it’s wishful thinking on my part, but my hope is that this new realization of how Wall Street works will result in a new structure for the retail financial industry, possibly even a Glass-Steagall type of division that separates firms that create, package or market financial products from firms that deliver financial advisory services to clients.
I realize it’s still a long way from here to there, from the slowing of FINRA’s “advisory SRO” momentum to the complete separation of retail advice from sales. The fact that Elisse Walter, the most pro-Wall Street commissioner, is SEC chairman, doesn’t appear to be a step in that direction. Still, if FINRA is indeed thwarted in its attempt to regulate RIAs in favor of the kinder, gentler SEC with a new mandate to collect fees to upgrade its efforts, that additional momentum might create a tipping point for the first real change in the delivery of financial advice in America in over 70 years.