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Industry Spotlight > Broker Dealers

Fiduciary Debate 2016: A Watershed Year

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A January paper released by the Institute for the Fiduciary Standard detailed regulatory and fiduciary issues on the table in 2016: the Department of Labor’s fiduciary rules for IRA advisors; the Securities and Exchange Commission’s fiduciary standard for brokers; the CFP Board’s announced review of its best interest standard for financial planners; and the Institute’s own “Best Practices for Fiduciary Financial Advisors” white paper.

In the paper, titled “Fiduciary Duties Advanced in 2015; 2016 Will Reveal How Much these Gains Are Secured — or Not,” Knut Rostad, president of the Institute, wrote that “a key issue in 2016 will be defining a best interest standard and the appropriate stringency of fiduciary duties.”

Whether or not you believe any of these initiatives will come to a conclusion in the coming year, there is at least the potential for significant gains — or further erosions — in investor protections. In his paper, Rostad put it this way: “The debate over if fiduciary duties should prevail is over. The battle over what fiduciary duties prevail rages on.”

Rostad added, “This battle will shape the future of advice, and its outcome is uncertain, despite […] the compelling case for ‘trusted advice’ found in history, law, research and common sense.”

Of course, it’s what industry advocates do say that concerns Rostad and many others. As usual, the powerful (and well-funded) brokerage industry has done a masterful job of getting its message across: in this case, persuading many members of Congress and the media of the lunacy of expanding fiduciary protections to the clients of retail brokers, both in the case of IRAs and in general.

Rostad makes a powerful case that these self-serving contentions are largely unfounded and, more importantly, provides intellectual ammunition for client-centered advisors and other fiduciary advocates to set the record straight — and, hopefully, to increase investor protections.

Rostad rightly refocuses the debate on investors’ best interests, a subject that is often lost in the flood of financial industry rhetoric. “Fiduciary status exists to mitigate the information asymmetry between providers and consumers of socially important services that entail a high level of complexity. The stringency of fiduciary duties increases with the risk these relationships present to investors,” he wrote.

He added that fiduciary relationships between consumers and professionals in law, medicine or finance “serve to protect consumers [who are] unable to protect themselves.” As such, fiduciaries’ services are “‘socially important,’” and “investors have a basis to entrust their fiduciary with power.”

To demonstrate the importance of fiduciary duties in personal finance, Rostad cited a 2008 RAND Corporation paper titled “Investor and Industry Perspectives on Investment Advisors and Broker-Dealers,” which found that nearly two out of three (63%) focus-group participants “believed that brokers are required by law to act in the client’s best interest.” What’s more, after having the differences explained to them, “investors are often unable to tell whether their own financial professional is a broker or an advisor.”

Given investors’ widespread lack of understanding about the differences between types of financial advisors, it’s not much of a surprise that the securities industry’s and the SEC’s preferred remedy of disclosure isn’t very effective. Rostad cited a 2012 SEC study conducted by branding agency Siegel and Gale on the effectiveness of client disclosures, which found that 56.9% of respondents who recalled receiving a conflicts of interest disclosure from their advisor said they fully understood the potential impact on their advisory relationship, and only 55.2% took any action.

He then details the attempts of the financial services industry to misdirect the current conversation away from investors’ best interests. “Industry advocates, of course, do offer arguments to oppose fiduciary duties for brokers rendering advice,” he wrote, noting their central argument is an economic one, as “increased costs will force broker-dealers to abandon smaller accounts.”

However, Rostad said those economic arguments “have been roundly refuted [while] industry advocates do not refute the case for fiduciary duties.”

One of the challenges to those economic arguments comes from Barbara Roper, director of investor protection for the Consumer Federation of America. In a comment letter submitted last year to the DOL on its conflict of interest rule, she cited numerous examples where brokerage fees exceed those of independent advisors:

“A 1% asset management fee directly charged by many fiduciary advisors is equivalent to the 1% 12b-1 fee indirectly charged by many brokers. In return, the broker’s customers get a one-time transactional recommendation with no ongoing duty of care, but they continue to pay the annual 1% fee for as long as they hold the investment. In contrast, the advisor’s customers get ongoing account management and, in many cases, comprehensive financial planning for the same 1% annual fee. […] If, as the evidence suggests is often the case, the broker also recommends funds with higher expenses, even after the cost of compensating the broker is subtracted, then the increased costs to the investor for non-fiduciary advice are that much higher.”

‘Lopsided’ Battle of Ideas

As for the securities industry’s attempts to steer the fiduciary conversation away from investors’ best interests, Rostad cited a March 2015 white paper by securities law firm Morgan, Lewis & Bockius, which he said provided a “broad-based defense of FINRA.” That paper “asserts that rules regarding conflicts of interest for brokers are similar to those for investment advisors,” Rostad wrote, and that the DOL’s conflict of interest rule is unnecessary. Curiously, though, departing FINRA Chairman Richard Ketchum has “expressed his view that brokers need to move toward a best interest standard,” according to Rostad.

Furthermore, the Morgan, Lewis & Bockius paper asserted that “‘broker-dealers […] are subject to extensive regulation.’” However, Rostad continued, “while this assertion may seem strong, Morgan Lewis offers no evidence countering [a Council of Economic Advisers report] that wide gaps exist in the present regulatory regime.”

Rostad also quoted Ketchum as saying: “‘If there’s an impression in America that undisclosed backdoor payments are the driver of what goes on in the securities industry, that impression is false.’ Again, though this assertion may seem to be a strong point, it is not,” he wrote. “Ketchum’s ‘denial’ statement is curious: It is very narrowly tailored and does not appear to address the central point.”

Morgan, Lewis & Bockius claimed that “‘many financial professionals do not receive any compensation from third-parties in connection with client dealings, and if they do, the third-party compensation may directly or indirectly offset or reduce the fees that clients may otherwise pay.’”

Rostad countered that claim, writing, “It does not refute the prevalence of practices that result in investors unknowingly paying fees, and it does not refute research suggesting many investors believe brokerage services and products are ‘free.’”

The biggest flaw in the Morgan, Lewis & Bockius paper, according to Rostad, and in the securities industry’s anti-best-interest-standard arguments, is that “it does not refute the historic or legal basis for fiduciary duties.” He added, “How very lopsided is the battle of ideas. It is not lopsided only because many arguments of industry advocates are founded on claims that have been well-refuted in comment letters and testimony. It is lopsided also because of the character and essential strength of the case for a trusted advice standard.”

Rostad concluded — and I agree — that the outcome of the fiduciary debate likely won’t be determined in Washington. While it looks like the DOL may prevail in passing its rule redefining fiduciary, opposition is still formidable (see Jamie Green’s Feb. 2 story, “How to Kill DOL’s Fiduciary Rule,” and Melanie Waddell’s Feb. 4 story, “Senator Enters Race to Kill DOL Fiduciary Rule”). If extending ERISA protections to IRAs is meeting such stiff resistance, it’s hard to have much optimism about increasing investor protections in far stronger spheres of industry influence such as the SEC and the CFP Board.

Accordingly, Rostad concludes that the fate of increased fiduciary protections for investors will depend on the actions of fiduciary advisors. “Advisors can make a difference,” he wrote. “They can demonstrate to skeptical investors how [client-centered] advisors merit trust and confidence, not just in words, but in deeds” by communicating plainly, clearly and truthfully, and by acting transparently and in their clients’ best interest.

“The best opportunity for prevailing” in the fiduciary debate, he wrote, “lies in engaging investors about what to expect from true” fiduciary advisors.

— Check out “House Speaker Ryan: DOL Fiduciary Rule Could Block 7 Million IRAs From Advice” on ThinkAdvisor.


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