Regarding the AdvisorOne blog entry of Sept. 26, 2012 entitled, “HighTower Advisors: The New Face of Fiduciary?,” I agree with author Knut Rostad’s premise and conclusion. However, I would take issue with the opening statement that avoiding or managing conflicts of interest is, arguably, “[t]he centerpiece of a fiduciary’s responsibility and the glue in an advisor/client relationship of trust and confidence.” While one might accept this as true, one cannot “surmise [it] from the investment professionals who advised Congress as it crafted the Advisers Act of 1940, or the Supreme Court 1963 Capital Gains Research decision or, to fast forward, clear guidance that is offered by the SEC today.”
The Capital Gains case continues to have a profound influence on the law governing investment advisors nearly a half-century after the Court’s decision. The case often is cited for the proposition that Congress established a federal fiduciary duty for advisors when it passed the Investment Advisers Act in 1940. A careful reading of the Act and its legislative history, however, demonstrates that although Congress recognized certain advisors to be fiduciaries, Congress did not create or impose a fiduciary duty on advisors. Moreover, the Capital Gains case itself did not state that the Advisers Act created a fiduciary duty. Rather, the federal fiduciary duty was a creation of subsequent Supreme Court decisions, such as Santa Fe Industries v. Green and Transamerica Mortgage Advisers v. Lewis, which stated, in reliance on Capital Gains, that the Advisers Act created a federal fiduciary obligation.
After Santa Fe and Transamerica, the law governing advisers has developed against a backdrop of a federal duty, which has had important implications for advisors. The duty has expanded liability for advisors beyond liability for fraud, which is the prohibition adopted by Congress in the Advisers Act, and the duty has introduced an element of vagueness into the law governing advisors with respect to both the source and the content of the duty imposed.
Having said that, I wholeheartedly agree that there is no such thing as “zero” conflicts of interest. There will always be occasions where conflicts arise, such as the case where the advisor honestly believes that a particular mutual fund is the best choice for his client even though the advisor will be paid more than if another recommendation. In the context of CFP professionals, there is no distinction made between “technical conflicts” (whatever those may be) and outright conflicts.
However, not all conflicts are created equally. Advisors do not have a duty to disclose all current conflicts or future potential conflicts except when the conflicts are material, which may form the basis for Elliot Weisbluth’s characterization of conflicts (see the HighTower Advisors’ CEO’s answer on the issue in this video). The basic definition of a Conflict of Interest for the purposes of CFP Professionals is as follows, “A conflict of interest exists when a CFP Board designee’s financial, business, property and/or personal interests, relationships or circumstances reasonably may impair his/her ability to offer objective advice, recommendations or services.” Section 2 of the Rules of Conduct, “Information Disclosed to Prospective Clients and Clients” goes on to narrow what must be disclosed, to wit:
2.1 A certificant shall not communicate, directly or indirectly, to clients or prospective clients any false or misleading information directly or indirectly related to the certificant’s professional qualifications or services. A certificant shall not mislead any parties about the potential benefits of the certificant’s service. A certificant shall not fail to disclose or otherwise omit facts where that disclosure is necessary to avoid misleading clients.
2.2 A certificant shall disclose to a prospective client or client the following information:
a. An accurate and understandable description of the compensation arrangements being offered. This description must include:
i. Information related to costs and compensation to the certificant and/or the certificant’s employer, and
ii. Terms under which the certificant and/or the certificant’s employer may receive any other sources of compensation, and if so, what the sources of these payments are and on what they are based.
b. A general summary of likely conflicts of interest between the client and the certificant, the certificant’s employer or any affiliates or third parties, including, but not limited to, information about any familial, contractual or agency relationship of the certificant or the certificant’s employer that has a potential to materially affect the relationship.
c. Any information about the certificant or the certificant’s employer that could reasonably be expected to materially affect the client’s decision to engage the certificant that the client might reasonably want to know in establishing the scope and nature of the relationship, including but not limited to information about the certificant’s areas of expertise.
In other words, not just any information, but material information must be disclosed. It would be misleading under our rules for a CFP Professional to state that he/she has “zero” conflicts of interest because non-material conflicts arise frequently enough in an advisor/client relationship such that they must be distinguished from material conflicts.
The Supreme Court has, on numerous occasions, reaffirmed the traditional test of Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), that the materiality requirement under Section 10(b) of the Exchange Act is satisfied when there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as being important to his or her investment decision (including a decision to retain the security or not).” Thus, materiality depends on the facts and is to be determined on a case-by-case basis (pp. 238-241. Basic v Levinson, et al.)