The Empire Strikes Back

Well you didn’t think they’d take it lying down, did you? I’m referring, of course, to the Wall Street wirehouses, and the drubbing they took from the FPA over the so-called Merrill Lynch rule. Yes, I know that technically it was the Securities and Exchange Commission that lost Financial Planning Association vs. SEC, but it was Wall Street that has to pay for it: Thanks to the ruling, stockbrokers who manage client portfolios for a fee can no longer claim exemption from their fiduciary duty because they were “just salesmen.” And who would want that? Consequently, the wirehouses had to radically change the way they do business by converting one million accounts holding $300 billion to either an advisory account or a commission-only account, at what one can only surmise was some considerable cost.

But as I may have mentioned before, and as you probably already know, Wall Street firms are the best marketers on the planet, backed up by the best attorneys that money can buy. They will tell you black is white, and night is day (and fees are commissions, and brokers are advisors, and prospects are clients, and, well, you get the picture), and have most people believing it all. That’s why they’ve been able to roll with some punches that would have KO’d lesser industries and still come out on top: the deregulation of commissions, the death of proprietary products, the replacement of commissions by fees, and the public preference for advisors rather than salespeople, to name but a few haymakers. Indeed, to borrow a line from the PGA Tour: These guys are good.

Yet, I have to admit to a grudging sense of awe for the subtle brilliance of their current ploy, “The Rand Technical Report: Investor and Industry Perspectives on Investment Advisers and Broker-Dealers.” First, if you’re not convinced that the SEC is pushing whatever Wall Street is selling, I would direct you to what the SEC tried to do with the broker/dealer exemption rule, also known as the Merrill Lynch rule. They attempted to expand the exemption from registration as investment advisors for brokers who manage assets for fees, even though the ’40 Act clearly states that the exemption only applies to “any broker or dealer whose performance of [advisory] services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.” As the Court in FPA vs. SEC noted, “special compensation therefor” means anything other than commissions on the sale of securities. You gotta love that kind of chutzpah.

(Why, you might ask, is the SEC in bed with the Wall Street? Well, that’s anybody’s guess [insert your conspiracy theory of choice here]. But as John Le Carre’s George Smiley used to say: “If you want to get to the bottom of something, just follow the money.” And when it comes to who benefits from ruling after ruling from the SEC, it doesn’t take George Tennant to connect the dots.)

Finding the Flaws

Now, let’s get back to the genius of the Rand Report itself. As the only independent advisory organization (that I can find) actually to respond to the Report (the FPA managed only a politely worded request for a roundtable discussion), NAPFA steps up and identifies the report’s flaws: The report asks the wrong questions, it tells us what we already know, and it ignores the key difference between brokers and advisors: fiduciary duty. All true. Yet, I don’t get the sense from their written response, that the NAPFA writers Tom Orecchio, Diahann Lassus, and Ellen Turf fully appreciate the subtle brilliance of the Report.

As NAPFA points out, the first step the SEC took to control the Report was to alter its stated goals. In a release on April 12, 2005, the SEC noted: “The staff is also to report on options and recommendations for a study to compare the levels of protection afforded retail customers of financial service providers under the Securities Exchange Act and the Investment Advisers Act, and to recommend ways to address any investor protection concerns arising from material differences between the two regulatory regimes.”

Seems reasonable. Yet, following the SEC’s shellacking in FPA vs. SEC in March 2007, the actual charge for the Rand Institute seems to have taken on a different character, as the Report itself states: “…the U.S. Securities and Exchange Commission (SEC) commissioned RAND to conduct a study of broker-dealers and investment advisers from two perspectives: first, examine investment advisers’ and broker-dealers’ practices in marketing and providing financial products and services to individual investors; and second, evaluate investors’ understanding of the differences between investment advisers’ and broker-dealers’ financial products and services, duties, and obligations.”

So the focus of the report was perhaps not-so-subtly changed from looking at consumer protection under the current regulatory structure to examining how brokers and RIAs are different, and whether consumers understand that difference. This might be called a classic misdirection play. Instead of addressing the uncomfortable (for Wall Street) subject of how well consumers’ interests are being protected, Rand looked only at two things that folks in the industry already know: that brokers and independent advisors are offering largely the same services theses days, and consequently, consumers are having a hard time distinguishing the differences between them. No kidding. I don’t know how much Rand charged the SEC to conduct this study, but I’m pretty sure I would have done it for half what they paid.

Now, here’s the really brilliant part. Even though technically it doesn’t seem to be within the scope of their mission in the Report, Rand goes on to offer its own conclusion as to why the gap between brokers and advisors is closing, and why people are confused: “In the past few decades, the functional difference between investment advisers and broker-dealers has arguably become more blurred…” This is what we writers call a “passive sentence.” It states that something has happened–differences have become blurred–without making any reference to who or what might have caused such blurring.

In this case it’s also pure genius, because it allows Rand to suggest a cause without any support or analysis: “…thereby calling into question the wisdom of traditional definitions and regulatory and legal distinctions between the two types of service providers.” In other words, Rand is cleverly implying here that consumers are confused because the law and regulators are trying to distinguish between two things–brokers and advisors–that in reality have become the same. Therefore, said two things presumably should be subject to the same laws and regulated by the same bodies.

How’s that for waving Wall Street’s banner? Sound hauntingly similar to what the NASD has been arguing for the past 20 years as to why it should take over regulating independent advisors?