More On Legal & Compliancefrom The Advisor's Professional Library
- 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.
- 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 attending the Schwab IMPACT conference in mid-November, a comment from retirement industry expert Brian Graff about how Dodd-Frank says the Securities and Exchange Commission must write its fiduciary rule for brokers — if the agency chooses to do so — caught my attention.
Graff, a Capitol Hill veteran who’s the executive director of the American Society of Pension Professionals and Actuaries, said to advisors in attendance that if the agency follows Dodd-Frank’s directive it may end up creating “two kinds” of fiduciaries.
Dodd-Frank “explicitly” says that if the SEC develops a uniform fiduciary standard the agency “cannot preclude the advisor from getting commission-based compensation and cannot require the advisor to monitor investments,” Graff told the attendees.
Now, I’ve been covering the SEC’s progress on whether or not it would craft such a fiduciary rule since Dodd-Frank was passed into law in 2010, and while what Graff said about commissions and ongoing monitoring of investments wasn’t something I hadn’t heard before, it was the first time I’d heard an industry official use the term “two kinds” of fiduciaries.
I asked a few more industry experts to parse out the “two kinds” of fiduciaries concept. Here’s what they said.
David Tittsworth, executive editor of the Investment Adviser Association in Washington, told me that two fiduciary standards could be a “possible” outcome.
Section 913 of Dodd-Frank states that any rule promulgated by the SEC “cannot make the receipt of commissions, in and of itself, a violation of the fiduciary duty; and that such a rule cannot make the sale of proprietary products, in and of itself, a violation of the fiduciary duty; and that Section 913 does not require the ongoing monitoring of investments,” Tittsworth explained.
While the law “does not necessarily mean that there will be two different fiduciary standards — the existing fiduciary standard under the Advisers Act and a fiduciary standard for brokers that provide investment advice to retail customers,” that result is “possible.”
Jeff Brown, senior vice president of Legislative and Regulatory Affairs for Schwab, told me during an interview at the Schwab event that he believes that’s exactly what the SEC will do. Under the SEC’s fiduciary rule proposal, which Brown said we’ll likely see sometime next year, “you’ll have advisors operating under the Advisers Act standard and state common law, and then you will have BDs subject to a fiduciary standard at the moment they give advice” about securities to retail customers — what he called a “transactional” fiduciary standard.
Duane Thompson, senior policy analyst at fi360, said that while he doesn’t agree with Graff’s “two kinds” of fiduciaries characterization, he does agree that there “could be differences for another reason — and that is if the SEC does not permit common law to apply to brokers under a uniform fiduciary duty as the same case law applies currently to investment advisors.” In this regard, he said, “the brokerage industry is currently lobbying the SEC to throw out the fiduciary baby with the bath water.”
The Investment Advisers Act, Thompson continued, “did not prohibit commissions prior to Dodd-Frank,” and a “handful of RIAs prior to Dodd-Frank registered as commission-only, and I assume some retain that status.” The Department of Labor, he said, is also “agnostic on receipt of commissions by fiduciary advisors, so long as the compensation is level and not excessive.”
As to Dodd-Frank precluding monitoring of investments under a fiduciary standard, Thompson said that “as a blanket statement, this is a red herring.” Brokers — and investment advisors — “have never been required to monitor client accounts unless it is in the service agreement.”
Thompson went on to say that Dodd-Frank clarified, “and in reality only confirmed, the traditional practice of brokers to ‘switch hats’ from fiduciary status so that they may execute transactions wearing their broker hat after giving personalized investment advice wearing their RIA hat,” which has always been the case, “as long as the dually registered broker/advisor discloses the change in status.”
Fi360, Thompson said, “believes that the language in Dodd-Frank could have been much stronger in extending fiduciary status to all areas of the client relationship where the financial advisor is being relied upon to act in the client’s best interest.”
But Barbara Roper, director of investor protection for the Consumer Federation of America, explained that Dodd-Frank gave the SEC latitude to interpret an “ongoing duty of care” for brokers. “There is some indication in the SEC’s request for information that they know how to interpret that in a way that would apply an ongoing duty of care where there is ongoing account management.”
The sticking point, she said, is whether you can have “an ongoing duty of care that allows for one-time transactional-based advice without watering down the existing fiduciary standard when there is ongoing account management. There is a concern that the SEC might not do that well, but there is room under Dodd-Frank for them to do that well.”
Dodd-Frank is “explicit in that the fiduciary standard has to be both the same for brokers and advisors and to be no less stringent than the existing standard,” Roper said.
“It is certainly possible that the SEC could write a bad rule that would apply a watered-down fiduciary duty to brokers, but that would be inconsistent with what Dodd-Frank directs them to do, and it’s not inevitable. The question is: Can you take the fiduciary standard that exists … and adapt it to the broker-dealer transaction-based business model? This has been done in the context of fee and commission planners, and there’s no reason it can’t apply to brokers,” she said. However, “if the conclusion is that you can’t, then brokers have to be taken out of the advice business.”
SEC Chairwoman Mary Jo White has stated that the fiduciary rule is a “high priority” for the agency. As she was recently quoted: “Any time you have the same conduct regulated differently, you need to take a very close look at that and see what to do about it.” Very close indeed.