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.
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
Mary Jo White has a clear opportunity to kick off her leadership at the SEC with a strong signal on investor protection. The Chairman can express support for the requirements of Dodd Frank Section 913 and the importance of the fiduciary duties required of investment advisors by rejecting aspects of the March 1 SEC release that sharply depart from the Advisers Act.
In that SEC release, explicit assumptions are set out on a uniform fiduciary standard and loyalty. In a new paper released Tuesday by the Institute for the Fiduciary Standard (available at www.thefiduciarysinstitute.org), the Institute concludes if these assumptions were adopted in rulemaking, fiduciary duties would be sharply restricted, effectively removed when brokers and advisers render investment advice. The era of FINO—fiduciary in name only—will have arrived.
How could this be? Dodd Frank provides parameters for the uniform fiduciary standard. Advice must be "in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser,” It "shall be no less stringent than the standard applicable to investment advisers under sections 206 (1) and 206 (2) of the Advisers Act.”
The starting point for a standard “no less stringent” than the Advisers Act of 1940 should be the Act itself, and Section 202(a) (11) defines, “Investment Adviser” broadly and includes, “the business of advising others ….as to the advisability of investing … ” The broker exclusion is explicit and narrow.
The SEC Release provides guidance through its expressed assumptions regarding the uniform fiduciary standard and the duty of loyalty. The SEC Release states these assumptions may not represent the views of the SEC, but their guidance matters. It provides a picture of fiduciary duties that are far more restricted and far less stringent than the fiduciary duties required by the Investment Advisers Act of 1940. In a few short pages, this guidance upends established legal precedent developed over 73 years. In summary, it:
- Sharply restricts communications deemed fiduciary advice, and creates new uncertainty.
It narrowly defines written or oral communications and circumstances that are clearly deemed “fiduciary advice,” limiting much investment advice and excluding many investors from the fiduciary standard. In suggesting a ‘facts and circumstances’ exploration is necessary to determine whether communications constitute fiduciary advice, creates new uncertainty that will confuse investors. The SEC Release does not require a broker to explain the difference between fiduciary and non fiduciary language.
- Allows fiduciary duties be waived.
Fiduciary duties can be waived through contract provisions, marketing materials or disclosure, disclosure with no informed consent.
- Suggests disclosure is the optimum action for addressing conflicts.
Discussing disclosing conflicts at the exclusion of discussing avoiding conflicts may be interpreted to suggest disclosure is the optimum course of action to address conflicts. This interpretation would be plainly wrong. Further, there is no mention that the conflicted recommendation must still be in the best interest of the client. This omission implies disclosure alone is sufficient.
- Omits mention of more rigorous disclosure requirements.
It allows more casual disclosure and oral disclosure (disclosure that is more “efficient” for the firm to deliver) while not requiring the more rigorous disclosure with “client consent” or “informed client consent” of material conflicts (disclosure that is more effective for the client).
- Rebrands conflicts.
It minimizes the stigmas associated with conflicts. It rebrands them. It questions whether principal trading is always a conflict. It omits any mention that harms are associated with conflicts. It omits any mention of associated benefits or appropriateness of avoiding conflicts. It omits urging broker-dealers and investment advisors to avoid conflicts of interest. By these omissions, conflicts of interest are deemed to be less problematic, less harmful.
- Redefines loyalty.
By minimizing the importance of conflicts, it effectively redefines loyalty. In its essence, the ‘duty of loyalty’ today means “Do the right thing.” In this discussion it means “disclose doing the wrong thing.”
Individually, each of these assumptions—restricting the broad concept of advice implicit in the Advisers Act, permitting the waiver of fiduciary duties, framing disclosure as the optimum measure of loyalty and omitting the strongest disclosure requirement (of informed consent)—could materially undermine the stringency of a uniform fiduciary standard as compared to the Advisers Act fiduciary standard.
Together, these assumptions represent a profound departure from the Advisers Act. If adopted in final rulemaking, fiduciary duties would effectively be removed. The question of whether such a uniform standard meets the Dodd Frank requirement that the uniform standard be “no less stringent” than the Advisers Act is clear. It does not.
Proceeding with rule making as outlined here would be a large step backwards, and invite comparisons to the 1920s. Then, according to a 1940 Senate report, "fraud and misrepresenta- tions of unscrupulous tipsters and touts" helped prompt enactment of the Advisers Act. The 1920s were not the best of times for investor protection. Lets not return to these years again.