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Don’t extend RIA fiduciary standard to broker-dealers

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Establishing a harmonized fiduciary standard for registered investment advisors and broker-dealers, the focus of a current SEC study, sounds fine in theory. All other considerations aside, who could argue with mandating a single standard of care for all investment advisors, irrespective of their professional status?

The problem lies in “all other considerations.” RIAs and broker-dealers operate according to different models, one of which (the former’s) lends itself well to a fiduciary standard. That of the latter would be upended by having to jettison the current suitability standard governing broker-dealers, requiring their FINRA-registered reps to comply with new regulatory requirements for which they’re ill-suited.

One reason: A fiduciary standard would be problematic for reps, most especially career agents, who source product primarily (if not exclusively) from a single carrier. That makes demonstrating that they’re acting in the client’s best interest—a requirement of a fiduciary standard—more difficult. Add to this the fact many reps derive compensation only from commissioned-based sales and the challenge becomes all the greater.

Moving to a harmonized standard would ultimately expose B-Ds and their reps to increased legal liability, driving up rates for errors and omissions insurance and, thus, the cost of doing business. The result would be an exodus of registered reps from the field—leaving an even greater share of an already underserved middle market without a financial service professional to help them with basic planning needs.

The deadline approaches

On July 5, the Securities and Exchange Commission will have completed a 120-day review of responses to request for comment, pursuant to Congress’ authorizing (but not requiring) the SEC to impose a harmonized fiduciary under the Dodd-Frank Act of 2011. This review may have to factor in a proposed Congressional amendment to Section 913 of the Dodd-Frank Act of 2010. Before proposing a revised fiduciary standard, the SEC would be required under the legislation to demonstrate that existing dual standards are economically harmful to investors. The SEC would also be mandated to coordinate with other federal agencies, among them the Department of Labor, which is drafting its own fiduciary standard for retirement plans subject to ERISA law. One fear of advisors: that the new DOL standard would eliminate commission-based compensation, forcing registered reps to move to a fee-only model.

That would be disastrous. For evidence of this, consider the experiences of advisors overseas. As I reported in an exclusive from the Million Dollar Round Table’s annual meeting in Anaheim, Calif., last year, the U.K. is witnessing a significant exodus of agents — estimates put the figure at 50,000-plus — as a result of legislation that went into effect on January 1 of this year.

Dubbed the Retail Distribution Review, the legislation imposes new educational requirements on advisors. The law also affects commissions: Advisors will only be able to accept fee-based compensation on new business. In respect to existing business, clients must be given the opportunity to discontinue renewal commissions if they believe they’re not receiving adequate advice or service.

Adrian Baker, a senior partner at St. James Places, Bristol, England, said during a roundtable discussion I co-moderated at MDRT that the legislation would likely have a “massive effect” on their income, as clients cash out policies and buy new ones so they can turn off renewal commissions.

In New Zealand, too, about one-third of advisors left the business after the full implementation of the Financial Services Act of 2008, which mandated that investment advisors meet educational requirements of a revised version of the National Certificate in Financial Services —unless they satisfy recognized alternative qualifications or designations — to become an Authorized Financial Adviser.

The same downsizing of the advisory field force could happen here, an outcome that could be as bad for the high net worth as for the middle class. Ken Ehinger, the new Regulatory Reform Committee Chair at the Association for Advanced Life Underwriting, warned as much when I interviewed him at the AALU’s annual meeting in Washington, D.C. in late April.

If the cost of regulatory compliance and E&O coverage were to rise as a result of extending the RIA fiduciary standard to broker-dealers then, said  Ehinger, a likely outcome would a significant reduction in the number life insurance professionals who sell variable annuities, variable life and variable universal life products — the last widely used by the affluent for both tax avoidance and investment purposes.

To be sure, many reps who elect to drop their FINRA registration to escape SEC regulation under a revised fiduciary standard would likely keep their insurance licenses. But they would shift their focus to non-variable products, including indexed life products and annuities, accelerating a product migration that has been that has been underway in recent years.

A better way

Rather than forcing reps to abide by a new standard that is of questionable value from a consumer protection standpoint, a better option, as Ehinger indicated, would be to enhance disclosure requirements for reps, both in respect to their role as financial professionals and the method by which they receive compensation. Consumers will then be less vulnerable to financial abuses — precisely the objective that Congress and the SEC are aiming to achieve.


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