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Regulation and Compliance > Federal Regulation > SEC

Too Rich or Too Thin?

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The question du jour is whether the same philosophy of promoting consumer education and more individual responsibility also works for applying the fiduciary standard. More than differences of registration or even compensation, opposing views of how to apply the standard–to manage conflicts in the investors’ best interest–are fast becoming a central line of demarcation, separating interested groups.

On one side is a broad coalition of groups and interests, whose adherents range from unabashed free-market champions to equally unabashed “big government” regulators. While disagreeing on many regulatory policies, they still seem to share a fundamental premise. The premise, viewed through a free-market lens, is that the “problem” (with the financial system regulatory structure), is consumers. Consumers who behave badly or irrationally, that is. The solution is, invariably, making consumers responsible via consumer education and (you guessed it), still more disclosures.

On the other side is a similarly diverse group of economic conservatives and liberals whose fiduciary lens focuses on the responsibilities of the advisor as much as (or more than), on the responsibilities of the consumer. Their reason is at the heart of what’s different about a relationship based on trust (a fiduciary relationship), as opposed to a transaction based on commercial fair dealing.

Fiduciary status exists in law to mitigate the unlevel playing field or the “knowledge gap” between the professional (lawyer, doctor, investment advisor), whose expertise is deemed inherently vital to the consumer. The Tully Report noted this gap between registered representatives and investors: “RRs and their clients are separated by a wide gap of knowledge–knowledge of the technical and financial management aspects of investing… It is a rare client who truly understands the risks and market behaviors of his or her investments.”

With such a gap between the knowledge, experience and skills of the parties, a “relationship of trust” necessarily makes the consumer reliant on the professional’s judgment; the importance of the duties of loyalty, care, and good faith are evident. It is this inherent reliance on–and trust in–their vital professional advice that legally distinguishes our relationship with, and the responsibilities of, our lawyer, doctor and investment advisor, from the responsibilities of, and our commercial contacts with, our butcher, car dealer, Verizon store rep, or restaurant owner. In commercial contacts, there is a presumed level playing field, caveat emptor reigns, and “disclosures” can be an effective tool.

Yet, the distinction between fiduciary and commercial worlds frequently appears overlooked in discussions about “conflicts.” Rather, all too often, the reaction to “conflicts” is “disclosures.” One B/D exec tells me that the remedy for conflicts is, “Disclosures, and let the market decide!” Another one writes, essentially, that conflicts can be waived with disclosures and client consent, all day long. Yet another one writes, very compellingly, of investors’ responsibilities to keep a vigilant eye on their advisor and records. (Well, of course, investors should be “responsible,” but that’s not the point.)

The point is that disclosures’ effectiveness is limited. While basic disclosures are beneficial and can be effective, addressing complicated conflicts through disclosures is something else, again. There is something askew. In a relationship premised on a material knowledge gap, and based on trust and the legal duty to put investors first, why do we presume disclosing conflicts suffices to keep the investor first? Is it because, (applying a core assumption of the commercial standard), we also presume that disclosing calories will make people eat healthy food? Does this mean we believe that our advisor should bear no more responsibility for our wealth than does a restaurant owner for our health?

To be continued…

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 chairman of The Committee for the Fiduciary Standard. The views expressed here are his own and do not necessarily reflect views of the Committee.

See more of Knut Rostad’s Regulatory Reason Blog posts:

A Tail is Not a Leg October 16, 2009 As the rhetoric heats up over regulatory reform one is reminded how much political life has not changed all that much since Abraham Lincoln was quoted noting the following: “How many legs does a dog have if you call the tail a leg? Four…” …
SEC Chairman Speaking the Fiduciary Language September 28, 2009 SEC Chairman Mary L. Schapiro’s September 24th speech, before the Financial Services Roundtable, included her most recent public remarks on the fiduciary standard. The Chairman’s remarks are important. …
Rakoff’s Bank of America Opinion: “The Tipping Point” September 16, 2009 In September 2013 when we look back on Lehman Bothers’ demise, will we also see a “reformed” financial system and regulatory structure? One that may be hard to recognize compared to today’s structure? If “yes,” look to Judge Jed S. Rakoff’s opinion. …
Listen to Chuck August 31, 2009 When Chuck Schwab talks do people listen? They ought to–even when he is off base, as he was in an August 19 opinion piece, “Brokers Aren’t Responsible for Bad Bets,” in The Wall Street Journal….
Disclosures and Evoking the Lewis Liman Defense August 14, 2009 Why did the SEC accept a $33 million settlement in light of its allegations that Bank of America failed to disclose that bonus payments were authorized for up to $5.8 billion? Judge Jed Rakoff wants to know. …
The Authentic Fiduciary Standard–What’s the Fuss About? August 11, 2009 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? …
Blog: Talking the “Fiduciary Talk” in Washington July 07, 2009 The Obama Administration proposes that brokers giving investment advice should meet a fiduciary standard. SEC Chairman Mary Schapiro states strong support for a fiduciary standard. How will this translate into legislation?…


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