(In response to ThinkAdvisor’s interview with Ken Fisher that discussed in part the future of RIAs, Ron Rhoades posted comments on ThinkAdvisor that formed the basis of a full blog by Mr. Rhoades on the topic. Below is an edited version of his comments.–Ed.)
All the features of the potential fiduciary standard, including mandatory arbitration elimination, are likely to backfire and blow back — maybe fatally — on the naïve RIA world. BDs will likely subsume and exterminate the RIA world because the BDs would like to take it over: Money has been coming out of BDs and going into RIAs for 40 years. The RIA world has been growing rapidly at the expense of the BD world. And the BD world hates that.–Ken Fisher
So is Mr. Fisher correct?
If the SEC, acting pursuant to Sec. 913 of the Dodd Frank Act, imposes broad fiduciary standards upon broker-dealers (BDs) and their registered representatives (RRs) who provide “personalized investment advice,” is this the death knell for RIAs?
In a sense, probably…yes. In another sense… no.
Since the 1970s the SEC and FINRA have undertaken a series of wrong decisions which permitted brokers to transition from providing trade execution services to providing comprehensive financial and investment advice. I have written extensively on the decisions by FINRA and the SEC and I will not repeat that history here.
Yet, as will be seen, the SEC through its actions has diminished the fiduciary standard of conduct, and the BDs have already subsumed the reputation of all fiduciary advisors.
Whose “Best Interests” Are Being Looked After?
There is no question that BDs today are providing a large volume of personalized investment advice. And there is no question that the vast majority of consumers believe that they can “trust” their BDs and RRs to act in their best interests.
Yet despite assertions by BDs (and even by their industry lobbying organization, SIFMA, and by their membership “self-regulator,” FINRA) that they do in fact act “in their client’s best interests,” nearly any objective observer would dispute such a conclusion. It is clear that most BDs and their RRs continue to sell highly expensive investments, often choosing those products which pay them additional fees (through higher 12b-1 fees, payment for shelf space, receipt of soft dollar compensation and even payment for order flow, although this latter practice is de jure banned).
Indeed, BDs and RRs possess limited obligations to disclose the fees and costs of the products they sell. And their obligations to disclose and quantify their compensation are even more limited.
In essence, massive fraud occurs. While many BD firms and their RRs state that they act in their client’s best interests, the reality is that most act only in the self-interest of the BD firm and their RRs.
Contrasting Suitability and Fiduciary Standard of Care
The suitability standard is frequently applied to the provision of such advice, at least in many of the decisions of FINRA-approved arbitrators. This suitability standard relieves BDs and their RRs of the duty of care in recommending mutual funds and other pooled investment vehicles, a duty nearly all other service providers possess. Instead, the obligation of BDs and RRs under the very low suitability standard is, essentially, to not allow their clients to purchase products which are dynamite, i.e., “blowing up” each and every time. The weak suitability standard fails each and every day to protect consumer interests.
In contrast, the fiduciary standard requires extensive due diligence of the firm and individual providing personalized investment advice. While a prudent investment portfolio is not required to be employed for every client, there must be clear disclosure of the fact that a particular recommended portfolio is not prudent. Additionally, a full explanation of the risks, fees, and costs are required of the fiduciary advisor.
Disclosing Away Fiduciary Obligation: Permitted by the SEC and FINRA
In recent years we have seen the rise of the dual registrant, securities industry participants who are registered as both registered representatives and investment adviser representatives.
Under a strange and bewildering 2007 proposed regulation, the SEC permits BDs and their dual registrants to wear “two hats” at the same time, for the same client. This is permitted despite centuries of fiduciary law which indicate that the fiduciary obligation extends to the entirety of the relationship between advisor and fiduciary.
Moreover, the SEC also permitted, in that 2007 proposed regulation, dual registrants to “switch hats” seemingly at will. Of course, few clients understand such a change in role, and such a switch from a fiduciary role (in which trust can be placed in the fiduciary) to a non-fiduciary role (in which caveat emptor - buyer beware – is the mantra customers should observe) often occurs without the understanding and informed consent of the client.
The ill-founded 2007 proposed SEC regulation has found its way into a couple of reported court decisions. In essence, the SEC’s rules have influenced, adversely, the development of the federal common law in this area, and these rules and federal court decisions will likely filter down and diminish the fiduciary standard applied to relationships of trust and confidence when state common law is applied.