In late January, the SEC delivered to Congress its six-month report, “Study Regarding Obligations of Brokers, Dealers, and Investment Advisers,” mandated in the Dodd-Frank Act. The report is the next step in the long debate over whether the fiduciary standard should apply to all who provide investment and financial advice to individual investors. The SEC was charged with conducting this study under Dodd-Frank, reporting to Congress on its findings and recommending whether to extend the fiduciary standard to all who provide advice.
In this, the first of a three-part report, we timeline how extending the fiduciary standard to all advice givers has developed.
Extending the standard beyond RIAs could signal a seismic shift in how advice is provided to investors, changing the way brokers and investment advisors conduct their businesses, and what protections the SEC is willing to institute for investors. Not since the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 has there been more potential for re-drawing the rules that govern conduct of brokers and investment advisors toward customers and clients.
Although investment advisors have had a fiduciary duty to clients since the ‘40 Act, the ‘34 Act, which governs purchases and sales of securities through brokers, mandated a suitability or commercial, fair-dealing standard. Both Acts became law in a very different era: No advice was provided by brokers; banks were separate from brokers and insurers were a wholly different kind of entity. Most investors in stocks or bonds were wealthy.
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Now, responsibility for one’s own retirement cuts across nearly all income strata in the United States and rests with many workers who were thrust into investing not because they have spare dollars to play with, but because they must make investment choices to fund their own retirement, college and other savings. Gone are the 5% or higher guaranteed bank savings accounts. The financial product array is so complex and extensive, and advice is so critically important to investors, that it is a totally different situation today than when those Acts became law.
To top it off, since the elimination of Glass-Steagall, banks, insurers and brokers have merged, and the functions of brokers and investment advisors often look identical—as do titles—leaving investors understandably confused about the type of relationship they have with their financial professional (Broker? Investment advisor? Trustee? Fiduciary? Salesperson? How is an investor to know, when nearly everyone’s business card carries a financial advisor or similarly vague—if important sounding—title?), how that individual is paid, and what other conflicts may exist. This all set the stage for the changes being contemplated at the SEC right now.
A Winding Road
The road to this point has been a long one. As a member of The Committee for the Fiduciary Standard, it has been a privilege to participate in meetings in Washington with regulators and legislators and their staffs. The Committee was organized in 2009 to advocate, on behalf of investors, for extension of the fiduciary standard to all who provide investment or financial advice to investors.
While preserving the confidentiality of private meetings, and without speaking for the Committee, I can report on the process I’ve observed by which the SEC has arrived at its conclusions, and some of the topics that were discussed in scores of meetings with regulators, lawmakers and other interested groups.
The Committee has met with SEC Chairman Mary Schapiro and each of the SEC Commissioners. We held meetings with Chairman Rick Ketchum and the executive team at FINRA, and senior staff at the Treasury and Labor (DOL) departments. We met with House finance and Senate banking committee members’ staffs, and leaders from SIFMA and the Financial Services Institute (FSI), and other groups.
The Committee’s founding members, most of whom are still actively involved, came together because we thought that in the aftermath of the financial crisis, there might be a way to advocate for reforms that we thought would be beneficial to investors. We were aware that, according to the SEC’s Rand Report and the Tully Report, most investors believe that the advice they get is in their best interests and that many think they pay nothing for the advice they receive.
We understood as well that in financial services and investing now there is a vast difference between the special expertise required of a financial professional and that of an individual investor—much like the difference in knowledge between a surgeon and a patient. The very nature of that uneven level of knowledge is the foundation of the fiduciary relationship—as Boston University Law Professor and expert on securities and fiduciary law, Tamar Frankel, puts it, “when you entrust your money or property to another” because of their special knowledge, that is a fiduciary relationship.
SEC Leaders’ Evolution on Extending the Fiduciary Standard
Schapiro has been discussing the SEC’s original mandate of investor protection, and the need to put investors first, for some time. For those who think that because Schapiro was CEO of FINRA before becoming chair of the SEC that she would not be interested in extending a fiduciary standard to brokers, remember that Schapiro was an SEC commissioner from 1988 to 1994, and acting SEC chairman in 1993—all before going to FINRA.
In the cover story for Investment Advisor in May 2007, when Schapiro was CEO of FINRA, she spoke about looking at the industry “from the perspective of the investor.” Schapiro added, “The challenge is going to be developing products that are very sound—I’m not talking about taking the risk out of investing—we’ll never do that nor should we even attempt to do that, but tapping into these changing demographics with products that are really in the investors’ best interests and ensuring that they are sold appropriately to people.”
In a March 11, 2009 interview for Wealth Manager, when asked if the financial crisis could be the catalyst for a fiduciary standard of care for all advisors, as the new SEC chair, Schapiro said, “I think it’s entirely possible. I’ve said for a long time that it’s really a flaw in our system that investors get different standards of care and different standards of regulatory protection depending on whether they’re going to an investment advisor, a registered rep., an insurance agent, or an unregulated advisor of some sort. And it’s not fair for us to leave it to investors to figure out what protections they’re entitled to depending on which regulatory regime just happens to capture the person they’re dealing with.”
Schapiro also said, in a speech on April 27, 2009: “An SEC with an agenda that puts investors first—not just through an aggressive enforcement program—though that is essential—but also through effective rulemaking, market structure changes and creative use of the bully pulpit—can be a powerful force for good in our financial society.”