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Regulation and Compliance > Federal Regulation > SEC

Deadlock: Why the SEC’s Stalled on a Fiduciary Standard for Brokers

By Bob Clark

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While the Department of Labor continues to wrestle with the securities industry over its proposed conflict of interest rule for retirement advisors, the SEC has yet to take any action on its now five-year-old Dodd-Frank mandate to create a fiduciary standard for brokers. Many observers, myself included, have begun to wonder whether the Commission will act on the issue at all. 

Recently, former SEC Chairman Arthur Levitt provided an authoritative insight into what the holdup is, in a speech to the Investment Adviser Association: “The commissioners at the SEC are so divided philosophically [on the fiduciary standard]…that I believe they will be locked in conflict on this issue for a long, long time.”

To better understand this divide at the SEC, Knut Rostad released a paper titled “Fiduciary Reference: An Analysis of Investment Fiduciary Issues” during the Institute for the Fiduciary Standard’s “Fiduciary September,” this year. In that paper, Rostad compares remarks made by SEC commissioners Luis Aguilar and Daniel Gallagher, who represent both ends of the fiduciary “philosophy” spectrum at the Commission.

Both men have also announced they will retire as soon as their replacements are chosen. (The Obama Administration has announced its candidates for those two spots on the Commission; see White House Nominates Peirce, Fairfax as New SEC Commissioners. The Senate must confirm the nominations.)

Their views capture the essence of the current debate at the highest level, demonstrating why compromise on a fiduciary standard for all advice givers probably won’t be quickly—or easily—reached.

“Commissioners Aguilar and Gallagher embody disparate visions within the SEC and the body politic,” wrote Rostad. “Their statements deserve careful attention. Fiduciary advocates’ proposals…reflect the meaning of relationships of trust and confidence. They are tethered by history and law and reason and common sense….  They presume, as in law and medicine, financial advice deserves fiduciary status, that fiduciary advice is good for investors and conflicted advice is not. Yet, in contrast, fiduciary opponents who advocate for the ‘caveat emptor’ principles implicit in their views labeled “choice,” cannot, in simple good faith, make these statements.”

For his part, Commissioner Aguilar takes a practical view: focusing on how best to ensure investor protections, which were expressed in an April 29, 2010 speech:

“Extending the fiduciary duty that underlies the investment adviser regulatory framework to broker-dealers who provide investment advice is the ultimate investor protection issue—because the harm to investors is real if broker-dealers giving advice are not held to the fiduciary standard and fail to put their client’s interests before their own. The fiduciary standard has served advisory clients well for many years and it should be the governing standard whenever investment advice is provided. If you are giving investment advice to an investor, regardless of the title on the business card, you should always be bound to do so in the best interests of the client. While the scope of service may vary between clients, the standards of loyalty and care in providing that service should not.”

Commissioner Gallagher, on the other hand, takes a more scholarly view, as we see in his keynote address to the National Society of Compliance Professionals, on Oct. 23, 2012:

“In order to address harmonizing our rules—imposing conduct requirements on brokers with our rules that do the same for investment advisers—we need to understand not just the present state of affairs, but also how things came to be the way they are—the evolution of law, regulation and market practices. It’s important to understand the reasons why Congress decided over 70 years ago to regulate investment advisers through the Investment Advisers Act of 1940, which was separate and distinct from the Securities Exchange Act of 1934 that established a regulatory framework for brokers and dealers…

“Aside from its registration provisions, the Advisers Act shared little in common with the regulatory regime then applicable to broker-dealers. Notably, Congress explicitly exempted from the Advisers Act brokers who provided investment advice that was merely incidental to brokerage transactions for which they received only brokerage commissions… …The convergence of the roles of brokers and investment advisers has led to calls for new efforts to harmonize the two regulatory regimes, as exemplified by the new mandates and regulatory authority set forth in Section 913 of Dodd-Frank. As we review today’s landscape and consider whether and to what degree to harmonize the broker-dealer and investment adviser regulatory regimes, however, we need to be cognizant not only of the very different histories of those regimes… …we should bring to bear our historical experience and approach the subject with a certain regulatory humility that places our efforts in the context of eight decades of securities regulation.”

Some readers may know that I’m a big fan of history: especially the importance of understanding how and why we got to where we are now. Yet you don’t have to study history very long to realize that failing to realize when things have changed is equally as bad a mistake as being historically ignorant.

As Commissioner Gallagher notes, it’s the “convergence of the roles of brokers and investment advisers that has led to calls for new efforts to harmonize the two regulatory regimes….” It’s also the convergence of these roles that has led to unprecedented confusion among retail investors.

We certainly need to recognize the importance of both the sales and advisory roles in financial services. But it’s equally important to recognize the harm to investors caused by the blurring of the lines between those roles. Investors need to be able to easily and clearly understand when they are being “advised,” and when they are being “sold.”

As Knut Rostad once told me: “Investors shouldn’t need a lawyer to understand what their broker is required to do for them.”

Perhaps the nominees for the SEC put up by President Obama, who signed the Dodd-Frank Act into law, will turn out to be fiduciary advocates who can break the stalemate that has prevented the SEC from fulfilling its Dodd Frank mandate.

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