Recent discussion in some quarters has focused on the “similarities” between the fiduciary and “arm’s length” standards. The clear implication appears to be: What’s all the fuss about whether investors retain fiduciary advisors or not?
One paper, in the June 2009 Wall Street Lawyer, “The Madoff ‘Opportunity’–Harmonizing the Overarching Standard of Care for Financial Professionals Who Give Investment Advice,” by Thomas P. Lemke and Steven W. Stone, suggests that the “broker-dealer regulatory scheme…clearly reflects fiduciary principles.” The paper adds that, from recent “guidance” from FINRA, “there can be no doubt that [this guidance's] DNA flows from fiduciary principles and the policy rationales on which those principles are based.” As evidence, the paper stated that the guidance “frequently reflects the following core fiduciary or quasi-fiduciary principles.”
They note six “principles”
- Just and Equitable Practices
- Suitability of Recommendations
- Best Execution of Transactions
- Fair and Balanced Disclosures to Investors
Clearly, two of these principles (they would more accurately be characterized as either policies or practices) are shared by RIAs: best execution and supervision. The remaining principles are not shared with RIAs; they are not fiducial in nature. For example, product sales training, on its face, would seem to be more a management practice aimed to prevent fair dealing violations than it is a quasi-fiduciary principle.
Suggesting that the legal requirements of brokers and RIAs are “more similar than they are different” is only accurate in a relatively narrow sense.
More broadly, the differences are clear and material. Click here for more detail. The meaning of loyalty for the client in fiduciary law and the meaning of caveat emptor and ‘fair dealing’ for the customer in commercial contract law place these principles (and the standards) in their clearest possible focus. In the commercial contractual relationship, the broker may generally put his own best interest first; in a fiduciary relationship, the advisor must put the client’s best interests first. From the investor’s perspective, they put the broker and advisor in opposing roles.
Think about it. If an investor is wronged by a broker, the investor’s burden is to prove the broker is wrong; if the investor is wronged by a fiduciary advisor, the advisor’s burden is to prove he is right.
These opposing roles have practical consequences for investors. The RIA is required to put investors’ best interests first; act in a prudent manner; disclose conflicts and all important facts; avoid or manage in the investor’s interest all material conflicts; disclose fees and control expenses; follow and document a due diligence process in making decisions; and diversify investments. A broker, just meeting the minimum legal requirements, has no such duty.
This is what the fuss is about.
Knut A. Rostad ([email protected]) is the regulatory and compliance officer at Rembert Pendleton Jackson (RPJ), a registered investment advisor in Falls Church, Virginia, and a founder of The Committee for the Fiduciary Standard. The views expressed here are Mr. Rostad’s own and do not necessarily reflect views of the Committee.