Leading fiduciary scholars and advocates drew a fiduciary symposium in Washington to a close Friday with words of advice to the SEC, as the Commission continues its study of a fiduciary duty for brokers who provide advice to investors.
The Committee for the Fiduciary Standard (the Committee), with co-sponsors the Certified Financial Planner Board of Standards (CFP Board), Financial Planning Association (FPA), Financial Services Institute (FSI), and National Association of Personal Financial Advisors (NAPFA) brought together the leading thinkers in fiduciary duty on Friday for a full-day symposium, the Fiduciary Forum: Exploring The Fiduciary Standard in a Brokerage Setting. This editor is a member of the Committee.
At issue: to an investor, the functions of a broker and an investment advisor look substantially the same–they each provide advice to the investor, and their titles are, since the late ’90s virtually identical. But the investment advisor must act with fiduciary duty to the client–putting the interests of the client first at all times–while the broker does not. And so, the advice from the broker can lead an investor to take action that makes the broker and their firm the higher fees and/or commissions, because the broker does not have to put the investor’s interests first.
While many brokers do want to put clients first, there is an intrinsic conflict of interest built into the BD model that cannot be ignored. Many BDs manufacture products and of course they want to distribute them. The broker can legally give the client advice that induces a product sale even if the advice is not in the client’s best interest, but in the broker’s or firm’s interest. An investment advisor is prohibited from doing that–the advice must be in the best interest of the client–even when it is not in the investment advisor’s interest.
So, under the Dodd-Frank Wall Street Reform and Consumer Protection Act,
The SEC is studying whether brokers–whose roles have evolved from simply executing securities transactions to advising clients–should have fiduciary duty to clients under the Investment Advisors Act of 1940 which governs the fiduciary conduct of investment advisors.
Why is this so important? What is fiduciary duty anyway? Why can’t brokers just disclose the conflicts to investors and let them decide?
Because fiduciary duty applies when there is an uneven level of knowledge about a subject–just as there is between patient and doctor, client and lawyer, or client and accountant. As Tamar Frankel, Professor of Law at Boston University and a top scholar on fiduciary and securities law, put it at the Forum, “we are a specialized society; we must rely on other experts.” In other words, everyone cannot know everything.
When you “entrust” your property–money, in the fiduciary case–to another person who can be reasonably expected to know more than a lay person would, that is a fiduciary relationship, Frankel explained. When a broker wears an advisor title, or engages in financial planning or other advisory capacity, it is reasonable for investors to believe the broker is acting as a fiduciary, according to Frankel. So the law needs to catch up with the reality that brokers are acting in what should be a fiduciary capacity, advising clients about their money–but current law allows them to act in their own self interest–not the client’s best interest. One cannot give advice and pretend it is in the client’s best interest when the advice is just being used to distribute the firm’s products. That’s the issue.
Can a regular investor reasonably be expected to know as much about the complex world of investing as a broker? Of course not. And if the Goldman Sachs Hearings before Congress’s Financial Crisis Inquiry Commission showed us anything, it is that even professional investors can’t always figure out what is going on in a security now. Even institutional investors cannot always understand these complex securities. Because brokers are not required to act in the best interest-fiduciary standard for their clients, but rather under the lower suitability or sales standard–a caveat emptor or buyer beware standard–brokers can even sell clients securities that they are betting against–which is, in part, what happened
in the Goldman-ABACUS case.
For regular investors, most of whom must save and invest for their own retirements now, this is an issue that materially affects the quality of their life.
Advice to the SEC
In the final panel at the symposium, moderated by Arthur Laby, Associate Professor Rutgers School of Law, panelists Daylian Cain, Assistant Professor of Organizational Behavior, Yale School of Management; Robert A. Prentice, University of Texas; and Barb Roper Director of Investor Protection Consumer Federation of America offered advice to the SEC.