More On Legal & Compliancefrom The Advisor's Professional Library
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- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
The debate over the outcome of the Securities and Exchange Commission’s fiduciary rule is bringing to light what could turn out to be an even more contentious issue: whether such a rule will include harmonizing advisor and broker rules.
While we’ve heard the term harmonization raised before in the debate over what a fiduciary rule should ultimately look like—and how harmonization should potentially be used to minimize investor confusion about whether they are dealing with a broker or advisor—the issue received renewed momentum when SEC Commissioner Elisse Walter released the SEC’s March 1 request for information on the costs and benefits of promulgating a uniform fiduciary rule for brokers and advisors.
At the time, Walter (then chairwoman) said that the comments received would also help the agency in its “ongoing consideration of alternative standards of conduct for certain broker-dealers and investment advisors, as well as potential harmonization of other aspects of regulation in this area.”
Under Dodd-Frank, the SEC has the authority to not only pass a rule to put brokers under a fiduciary mandate, but to also harmonize the rules for advisors and brokers—both without going to Congress for approval.
Walter’s comment that the agency is considering meshing fiduciary and harmonization into one rule is putting advisors and some custodians on red alert.
Bernie Clark, executive vice president of Schwab Advisor Services, told me during an interview in Washington in early May that Schwab’s mission is to ensure that a fiduciary rule is not coupled with harmonization of broker and advisor rules.
“We are trying to delink those concepts”—coupling fiduciary duty and harmonization in one rule, Clark said. “The sense we have is that the SEC is linking the two [and] that’s where the breakdown has occurred.”
Harmonization of advisor and broker rules brings with it a “harsh reality,” Clark said: The principals-based RIA model—which currently adheres to about 40 rules—would be forced to comply with the nearly “800 broker-dealer rules.” This, Clark said, would essentially “topple” the RIA model and drive a lot of the smaller RIAs out of business.
Clark argued during our discussion that the Securities Industry and Financial Markets Association (SIFMA), Wall Street’s trade group, along with the broker-dealer industry are “very supportive of harmonization because the migration of assets away from those models into the independent space has been great.” If the SEC harmonizes broker and advisor rules “then you are drawing the RIA back into the more traditional model, which doesn’t serve the RIA well or their clients.”
But Clark—who was in Washington as part of the Investment Adviser Association’s (IAA) Lobbying Day—says one bright spot is that members of Congress agree that the SEC should not mesh fiduciary duty and harmonization into one rule.
After meeting with House Financial Services Chairman Jeb Hensarling, R-Texas, House Capital Market Subcommittee Chairman Scott Garrett, R-N.J., and the ranking member on the Senate Banking Committee, Mike Crapo, R-Idaho, Clark said each of them “believe that RIAs and broker-dealers are fundamentally two different business” models, and that “harmonization and the fiduciary standard should be separate and distinct.”
By the time you read this, the SEC’s comment period on its March 1 request for information will be coming to a close (it ends on July 5). Clark said that Schwab planned to include in its comment a survey of advisors who custody assets with Schwab and their views on the harmful consequences they see in harmonizing advisor and broker rules.
Indeed, David Tittsworth, executive director of IAA, said that IAA will also be “raising concerns” about harmonizing BD and advisor rules. “The fact of the matter is that investment advisors already are comprehensively regulated,” Tittsworth said. “Further, as we pointed out in our August 2010 comment letter on the [Dodd-Frank Act] Section 913 study, broker-dealer and investment advisor regulations differ but are substantially equivalent in key areas.”
Imposing broker-dealer rules on advisors, Tittsworth added, “is wrong-headed and unnecessary. Doing so would impose additional and needless costs on investment advisors without any additional investor protection.”
Bill Lowe, president of Sammons Retirement Solutions, weighed in with his comments on harmonization in a June 4 letter to the agency. While he noted that harmonizing BD and advisor rules “seems appropriate when both are providing similar services,” he wondered if a new fiduciary rule that included harmonization around “a principles-based model” would eliminate the rules-based model that BDs operate under.
In other words, Lowe said, “if a registered representative is providing advice and is held to a fiduciary standard (the same as an investment advisor), would they have different requirements for advertising, supervision, books and records, etc.? Would a self-regulatory organization, such as FINRA, be viable?”
If harmonization around a uniform fiduciary standard is desired, as SEC staff has stated previously (the agency’s 2012 Financial Report stated that the SEC would “continue to assess” ways to better harmonize advisor and BD rules when they are providing similar services), Lowe said, “it would be logical” that the SEC would seek to harmonize regulations around the following areas: advertising and other communications; supervision; dispute resolution; licensing and registration of firms; licensing and continuing education requirements; and books and records.
Harmonization in these areas, Lowe argued, “will also effectively level the playing field from a competitive standpoint. If under a uniform fiduciary standard one business model has higher costs due to regulatory compliance but both are held to the same standard of care, then obviously the one with less regulatory compliance has a built-in advantage from an efficiency and cost standpoint. Clearly, such a resulting dynamic would be an unintended consequence.”
But, as industry officials have said before, not every BD and advisor rule would necessarily fall under the harmonization sword. For instance, it has been argued previously that advertising is one area that deserves harmonization, as broker-dealers can air their client testimonials but advisors cannot.