Fiduciary advocates renewed their call Tuesday for the Securities and Exchange Commission to act “expeditiously” to establish this year a uniform fiduciary standard of conduct consistent with Section 913 of the Dodd-Frank Act, which says the agency has the authority to write a fiduciary rule for brokers that’s “no less stringent” than the Investment Advisers Act rule.
In a joint letter to SEC Chairwoman Mary Jo White and the four SEC commissioners, the groups — which include AARP, the Certified Financial Planner Board of Standards, the Consumer Federation of America, the Financial Planning Association, Fund Democracy and the National Association of Personal Financial Advisors — provide what they say is “empirical evidence” from academic research, market analysis, and observation of industry practices that illustrates the harm to investors that results from allowing brokers to give advice to retail customers under a “suitability” standard.
“We strongly believe that in order to be meaningful and consistent with Section 913, a uniform fiduciary rule must include more than the current suitability standard supplemented by additional disclosure requirements,” wrote the groups, who dub themselves the “Friends of Fiduciary.”
Designed with a sales relationship in mind, the groups continued, “the suitability standard does not impose the same clear obligation that exists under a fiduciary standard, which requires the advisor to put the customer’s interest first.”
The groups go on to argue that the suitability standard “does not impose an obligation on brokers to appropriately manage conflicts of interest in order to ensure that they do not influence recommendations. These are among the standards that distinguish a suitability relationship from a fiduciary relationship.”
But Ira Hammerman, executive vice president and general counsel for the Securities Industry and Financial Markets Association, said in reaction to the groups’ letter that while SIFMA “fully supports the SEC moving forward with fiduciary rulemaking,” SIFMA ”strongly disagrees with any suggestion that customers of broker-dealers are suffering concrete harm in terms of higher costs or poorer performance.”
In fact, Hammerman continued, ”because broker-dealer customers pay commissions as opposed to asset management fees, they are often more economical than RIA accounts. As for account performance, I’m sure there are plenty of broker-dealer accounts that perform better than RIA accounts, and I’m sure there are examples of RIA accounts that do better than broker-dealer accounts.”
There is no justification, the groups say, “for applying different standards of care to financial professionals who are offering the same services to investors. Over the years, broker-dealers have not only identified themselves as financial advisors, but they have offered virtually identical services to investors in order to compete. The Commission has permitted, at least tacitly, this evolution by failing to apply the appropriate regulatory standard,” the groups say.
SEC Chairwoman White stated in late February that the agency would make a “threshold decision” this year on whether to move forward with a fiduciary rulemaking.
The letter then goes on to cite how investors are harmed by not requiring brokers to adhere to a fiduciary standard. “Investors suffer concrete harm — in the form of higher costs and poorer performance.” The letter notes that advice offered by a broker-dealer in a nonfiduciary capacity can significantly erode long-term investor returns: “As the Commission warned in a recent bulletin for investors, ‘over time, even ongoing fees that are small can have a big impact on your investment portfolio,’ reducing returns, shrinking a nest egg, and preventing investors from achieving financial goals.”
This impact, the groups say, was illustrated in an October Bloomberg Markets Magazine report on data filed with the SEC, which showed that “’89% of the $11.51 billion of gains in 63 managed-futures funds went to fees, commissions and expenses during the decade from Jan. 1, 2003 to Dec. 31, 2012.’”
The article stated that brokers, “’have an incentive to keep clients in managed-futures funds because they receive annual commissions of up to 4% of assets invested and investors pay as much as 9% in total fees each year.’”
The letter also cites research reviews performed by Michael Finke, professor and coordinator of the doctoral program in personal financial planning at Texas Tech University, of a number of academic studies related to the potential benefits to consumers of a fiduciary standard, including studies showing that less sophisticated and less wealthy investors are most likely to suffer harm from recommendations that are not based on their best interest.
For instance, a 2012 study found that commission-compensated insurance agents “will consistently recommend higher commission products to less sophisticated consumers, leading to welfare losses that are greatest among those who can least afford to sustain them,” the groups’ letter states.
Improving disclosures, the groups argue, will not “cure the significant harm that currently exists,” nor will better educating investors about the differences between brokers and advisors or relying on investors to choose the business model that is best for them. “It is in this context that the well-documented problem of investor confusion becomes relevant,” the groups state. “Numerous studies over the years have demonstrated that investors do not understand the differences between brokers and advisors, including the differences in the legal obligations to clients.”
Indeed, Finke told ThinkAdvisor that “increased disclosure is probably the worst thing that could happen. It may even be counterproductive.” Basically, he says, “conflict-of-interest disclosure may even create an environment where a client feels they either have to follow the advice or admit that they don’t trust the advisor. Since advisors are often acquaintances, this is very difficult to do.”