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Knut Calls Out the Brokerage Industry on Fiduciary Standard

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Last week, as part of the Institute for the Fiduciary Standard’s “Fiduciary September” program, president and founder Knut Rostad released a white paper titled “Key Principles for Fiduciary Best Practices and an Emerging Profession.” (See Industry Gears Up for Fiduciary September.)

In an interview, Rostad said this paper is intended to explain why a fiduciary standard for all financial advisors is more important than ever today, and to set the stage for the later release of a more detailed and comprehensive list of specific “best practices” that all fiduciary advisors should follow. 

To be honest, based on a prior “pre-release” conversation with Knut, I didn’t see the need for such a paper. It seems to me that when explained clearly to them, retail investors unanimously want their advisors to have a fiduciary duty to them: and the vast majority of them already think their advisor—whether a broker, insurance agent or RIA—already does in fact have such a duty. 

Yet, after reading Rostad’s well-researched and clearly articulated paper, I realize that it is a call to action for the independent advisory community, at a time when the “profession” of financial advice is at a crossroads. In the wake of the Dodd-Frank Section 913 mandate for a fiduciary standard of care for brokers, the securities industry is not only attempting to coopt the use of the term “fiduciary” without actually changing its business practices, it’s also trying to gain control of already fiduciary independent advisors. Knut does a nice job of elucidating the securities industry’s real position on fiduciary standards, and why, in response, it requires a true profession of financial advice.

Here’s how Rostad describes the current situation: “While character is the hallmark of a profession, caveat emptor…is the hallmark of brokerage sales practices. Explicitly, all brokers say they do right by their customers—and many brokers do operate at or near the fiduciary standard investors expect. Implicitly, however, a very different picture emerges as industry lobbyists vigorously defend and protect conflicted advice, opaque fees and expenses, and misleading or incomplete communications.” 

He goes on to cite the following examples, taken from a July 14, 2011 letter to the SEC, in which “SIFMA sets out its views as to what it believes [the] brokerage standard should comprise when brokers are supposed to ‘put investors’ interests first.’” In its letter, SIFMA:

  • “Advocates for brokers continuing to ‘offer products and services that are available today,’ essentially negating a ‘due care’ duty;”
  • “Chides the SEC for prioritizing avoidingas opposed to disclosingconflicts of interest;”
  • “Sets out weak disclosure protocols, which are more efficient for the broker-dealer but less effective for the investor;”
  • “Limits and confuses when [emphasis added] the SIFMA standard applies: such that during a single broker-customer discussion, a facts and circumstances exploration may be required to determine if the ‘SIFMA’ standard applies at all;”
  • “And permits the SIFMA standard to be restricted contractually.” [Meaning that under the SIFMA standard, the already weakened duty to put the clients’ interests first can be further eroded or eliminated in a brokerage agreement signed by the client.]

What’s more, as Knut points out, in the SIFMA position letter: “there is no mention of controlling investment expenses, prohibiting certain products or practices, strictly avoiding any conflicts, or requiring informed client written consent in any specific instance.”

He concludes this section of the paper by clearly making his case: “These brokerage sales practices can be harmful to investors, and the aggressive lobbying efforts to expand them underscore why the principles underlying fiduciary ‘Best Practices’ matter.”  

Rather then enumerating what those “Best Practices” might be, Rostad sets out three basic areas that they will have to address:

  1. Conflicts of Interest
    “Conflicts of interest have long been acknowledged as undermining independent and objective advice. The Investment Advisers Act of 1940 was literally conceived from the concerns of investors’ confusing advisors with product salespersons, who disguised themselves as legitimate advisory organizations.”
  2. Fees and Expenses, which should be both reasonable and transparent.
    “With fees and expenses, a fiduciary advisor’s conduct and practices should reflect certain principles, including investor knowledge of all fees and expenses. Prospective clients should be fully apprised of the total estimatedfees and expenses. And clients should be fully apprised of the total actualfees and expenses, and fees paid by any third party to the advisor.”
  3.  Clear, Complete, and Truthful Communication.
    “The worst shortfalls are… …instances where certain facts are omitted, and [therefore] an incomplete or inaccurate conclusion may be easily drawn.” Knut cites two examples: a Government Accountability Office research report which found numerous brokerage firms falsely advertising ‘free’ IRAs; and a NASAA report that found “widely varying and inconsistent disclosures of brokers’ fees and expenses.”

In addition to SIFMA’s own words, Rostad also cites Rutgers professor Arthur Laby to make his case: “Laby argues that the strongest rationale for holding brokers to the fiduciary standard is that brokerages have advertised ‘trusted advice’ services in explicit language and titles for decades, and have created ‘reasonable expectations’ that brokers are fiduciaries.”

Knut sums up his paper this way: “Fiduciary advisors need to recognize that they alone, among all industry participants, can reclaim their proud heritage, unabashedly embrace the ethical principles of fiduciary duties and restate in the public square in the clearest terms possible what it means to be a fiduciary adviser.”  

And then issues a call to action for independent advisors: “They alone can rededicate themselves to this mission, because they understand their true value to investors. They must lead a campaign to defend and protect this heritage – for today and to pass on to the next generation.”

It’s a powerful case that independent advisors are at crucial point in their 30+ year history. SIFMA and the brokerage industry has gone all-in against a true fiduciary standard and independent advisors. I believe retail investors would virtually unanimously back fiduciary advisors, if they understood the choice they were making. It’s up to the independent advisory community to get the word out.

See Knut Rostad’s latest blog for ThinkAdvisor, Fiduciary Advisors Are in Peril: How to Fight Back