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Debunk Redux: Fiduciary Was Good for Brokers the First Time, Too

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My last blog, about the FP Coalition’s excellent comment letter to the SEC, focused on data from an Aite Group survey sponsored by the FPA. As a follow-up, I’d like to highlight some supporting real-world data that the Coalition included about what actually happened to brokerage accounts in the aftermath of the FPA’s 2007 victory in its 2004 lawsuit against the SEC (which challenged the so-called “Merrill Rule”).

This history is as revealing about the brokerage industry as it is about the effects of a fiduciary standard. 

As you might remember, in perhaps its shining moment, the FPA challenged the SEC’s application of the so-called “broker-exemption” to the ’40 Act to fee-based brokerage managed asset accounts (which rendered them “non-fiduciary”) and won in federal court.

It was a landmark decision that resulted in the restructuring of a significant portion of broker-dealers’ business into “nondiscretionary advisory accounts” to which a fiduciary standard applied.

Here’s what the brokerage industry said about the decision and its effects (taken from the Coalition Letter): 

  • “During the time the SEC was seeking comment on the fee-based brokerage rule, some representatives of the broker-dealer industry argued that the result of the SEC failing finally to adopt the rule: would likely work to the disadvantage of customers, who, as a result, could face increased costs or who could lose their chosen forms of brokerage accounts…” 
  •  “During the pendency of the FPA’s suit against the fee-based brokerage rule, the same broker-dealer industry representatives argued that: The forced closure of this brokerage pricing avenue would be a major loss of client choice and a significant diminution in both pricing and account management flexibility that clients have come to expect and enjoy.”
  • Following the Court’s ruling, “the Chairman emeritus of one of the largest U.S. broker-dealers argued: ‘The decision by the U.S. Court of Appeals earlier this year…… if allowed to stand without remedy, would be an incredible public disservice, resulting in fewer choices, higher costs and greater obstacles for individual investors in managing their finances.’” 

Sound familiar?

To those who are following along, this is exactly—almost verbatim—what the securities industry is arguing today about the application of a fiduciary standard under Dodd-Frank to retail brokers. But this time, it truly is different: as the Financial Planning Coalition points out, we have a record of what actually happened after the FPA ruling went into effect, and it paints a very different picture from the industry’s dire predictions. 

As the Coalition notes, according to Boston-based Ceruli Associates, “…even after the broad market declines of 2008, the client assets in non-discretionary advisory accounts rose by almost 75% from approximately $329.6 billion at the end of the conversion process in 2007 to $574 billion in Q3 2012. Meanwhile, the level of fees charged to customers for this service model at the major national firms has stayed flat or decreased since 2007.” 

Further, according to Cerulli data, from 2007 through 2011, the number of FINRA registered reps “dropped by nearly 26,000. In the same time frame, the number of investment adviser reps grew by more than 6,000, and the number of dual registered representatives grew by almost 5,000, with the dual registrants showing the highest annual growth rate.”

At the same time, assets “held by clients” of registered reps dropped slightly, while the client assets of RIA reps grew more than 8% a year, and dually registered RRs saw client assets grow at nearly 16%. “If it were substantially more costly to provide investment advice under a fiduciary standard, or if customers did not perceive there to be benefits to a fiduciary standard,” noted the Coalition, “one would expect (at best) that the relative numbers of non-fiduciary and fiduciary professionals and their assets would have remained static.”

So, as it turned out, none of the industry’s dire predictions about the application of a fiduciary standard to client investment accounts came true, and in fact, the brokers who manage client assets in fiduciary accounts vastly outperformed their commission-taking colleagues. “Since 2007, those accounts have continued to multiply and grow in size without growing in cost or decreasing in flexibility,” concluded the Coalition. “The Commission should be similarly skeptical today of those who argue that a fiduciary standard of care would impose crushing costs or deprive customers of relevant choices.” 

What they said.