The Empire Steps Up

“FINRA rules such as the suitability rule do not create obligations enforceable in private damages actions. For an unsuitable recommendation to rise to the level of an actionable Rule 10b-5 violation, a client would have to prove that the broker-dealer acted with intent to defraud, while the comparable standard in the Investment Advisers Act for violations of Section 206(1) is only negligence.” [emphasis added]

The suitability standard lacks common legal protections, such as precedent, public forum or appeal. “Because suitability cases are ordinarily resolved in an arbitration forum without any written decision and essentially no right of appeal, the law of suitability is not well-developed or consistently applied, unlike the law of fiduciary duty.”

The suitability standard is too narrowly applied. “The suitability standard only applies to recommendations of securities, while the fiduciary standard applies to the entire relationship between the adviser and the retail customer. Moreover, the ‘provision of investment advice’ standard under the Advisers Act is much broader than [the suitability standard's] ‘in connection with a purchase or sale’ requirement…, and covers (for example) situations in which the investment advice does not result in a transaction at all.”

Then the Coalition captures the “big” problem that the SEC studies, and the whole of Section 913, are trying to solve: “In summary, a transaction-based suitability standard is not tailored for an ongoing advice relationship, where the best advice in some situations may be a non-securities product, or not to engage in any transaction. … And as the Dodd-Frank Act makes clear, that standard should be no less stringent than the existing fiduciary standard under the Investment Advisers Act.”

The Best for Last

Finally, the section of the Coalition’s Comment Letter that most impressed me addressed the “loopholes” that exist not only in current brokerage practices, but in the CFP Board’s own definition of the fiduciary duty for CFPs. But in doing so, their suggestions for the form of the disclosures of all the conflicts involved are so complete, unambiguous, and client-centered, that should they be adopted by the SEC, I’d have no doubt as to the fairness of each:

Commissions. “To the extent a firm or investment professional chooses to use a commission-based pricing model … the firm or investment professional must disclose that potential conflict of interest to the customer before the beginning of the relationship and at regular intervals thereafter, and obtain fully informed consent to that model from the client. Moreover, the burden must remain on the firm and the investment professional, not the customer, to justify each and every transaction (and the sum total of the transactions) as consistent with the client’s best interest. And, if the firm offers both commission-based and asset-based pricing models, the firm and the investment professional have the obligation to recommend to the retail customer the pricing model that is in the customer’s best interest, and to monitor regularly to assure that the customer remains in the account structure that is in the customer’s best interest.”

Wearing Two Hats. “If the customer and the investment professional agree to create an ongoing relationship involving investment advice, then the fiduciary standard must continue throughout the course of that relationship. As the Commission has long held, an investment adviser cannot provide personalized advice to a customer, and then take off the investment adviser ‘hat’ and act as merely a broker when executing transactions for that client.”

Proprietary Products. “The decision to offer only a limited range of products, and particularly the decision to offer a proprietary product, does create a potential conflict of interest with the customer. As a result, the firm and the investment professional must have a duty to make full and fair disclosure of this conflict of interest to the customer, and obtain the customer’s fully informed consent, before offering the product in these circumstances. Moreover, an investment professional … has the ‘prudent investor’ obligation to inform himself fully about the comparable products available in the marketplace, even if those products are not available through his firm. The burden must be on the investment professional, not the customer, to justify the transaction in these circumstances.”

Like I said, really good stuff: justifying every commission transaction to be in the best interest of the client, ongoing services requiring an ongoing obligation, and informing clients of comparable outside products and justifying the use of proprietary alternatives. Talk about client-centered handling of conflicts. I only wish the Board had made this case sooner; perhaps Congress would have included a broker fiduciary standard in the Dodd-Frank Act itself.