Extending a fiduciary rule to brokers could actually weaken the fiduciary standard for advisors.
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Some years ago, an industry lobbyist at a luncheon preceded a presentation by an NASD (now FINRA) official by asking: "What is the difference between an investment advisor and a broker? Answer: A broker doesn't call you in the middle of dinner."
Advisors continue to make a point of staking out the differences between themselves and brokers, often on the ground that advisors are fiduciaries and brokers are not. However, if the SEC follows a staff recommendation to impose a fiduciary duty on brokers, advisors may lose an important weapon in their marketing arsenal.
The Fiduciary Brand
The fiduciary duty is not just a legal standard; it is also a valuable brand. The Investment Adviser Association, Financial Planning Association, CFP Board of Standards, and National Association of Personal Financial Advisors frequently go out of their way to distinguish investment advisors from brokers on the basis that advisors have a fiduciary duty to their clients and brokers do not. The IAA's Cutting Through the Confusion brochure, for example, specifically highlights the fiduciary status of advisor and non-fiduciary status of brokers.
Many of their members/certificants use the fiduciary standard as a marketing tool. The home page of the firm that I am associated with prominently announces "its strong fiduciary commitment to its clients" and includes a link to a page on Fiduciary Excellence, which leads to a document entitled Fiduciary Standards - The Foundation for Trust. Fiduciary Solutions' NAPFA profile page claims that "'fiduciary' encompasses the heart of the company's business philosophy." Connemara's home page boasts that it is "A Trusted Fiduciary" in 20-pt font.
The fiduciary branding strategy is often explicitly used to distinguish advisors from brokers. Mainstreet Financial Planning heads its home page with: "welcome to a firm that provides advice, not sales." "If you're looking for a financial advisor who will put your needs ahead of commissions," then visit Clarity Financial Planning's home page. Financial Strategies' home page begins by describing the difference between brokers and advisors as follows: the broker "owes his loyalty to the firm, not the client." This pitch echoes NAPFA's position that brokers "are required by federal law to act in the best interest of their employer, not in the best interest of their clients."
NAPFA takes the fiduciary brand to new levels. Its members must sign a Fiduciary Oath. Its Focus on Fiduciary page has links to: Definition of Fiduciary, Fiduciary Difference, Fiduciary Information, Fiduciary Questionnaire, Fiduciary Voice Podcast (with more than 40 individual episodes of the "Focus on the Fiduciary Show"), and three fiduciary-related videos. In case the message has not gotten through, one video bears the unsubtle title "Brokers vs. Advisers" and features an image of a fistful of dollars over the words: "People who look out for their commissions." That's not just marketing; that's bare knuckles marketing.
Fi360 has turned the fiduciary duty into a business model. The firm offers an Accredited Investment Fiduciary (AIF) certification to those who pass an examination on fiduciary practices, satisfy continuing education requirements and annually attest to a code of ethics. For aspiring high priests of the fiduciary church, there is the AIF Analyst (AIFA) designation, which authorizes holders to perform a CEFEX Fiduciary Certification.
Either investment advisors are fooling themselves or the marketing power of the fiduciary brand is real. Some segment of the market for investment advice values the fiduciary brand and may choose an advisor over a broker for that reason. Exclusive ownership of the fiduciary standard means more business for advisors, yet for some reason that is not entirely clear, they are eager to give away the fiduciary brand.
Please, Please Take My Fiduciary Brand . . .
The investment advisor community has spent the last few years lobbying to share their brand with brokers. During the legislative battle over the Dodd-Frank Act of 2010, advisors argued that all brokers who provide investment advice should be subject to the same fiduciary duty as advisors. Many brokers are subject to a fiduciary duty because they are also advisors under the Investment Advisers Act, but many are exempt from the Act. Although the broker community essentially acquiesced in the view that such exempt brokers should be subject to a fiduciary duty, the insurance lobby fought advisors and consumer advocates to a legislative stalemate. Congress passed the buck to the SEC by giving it the authority to impose a fiduciary duty on brokers, but not before conducting a study of the issue.
The SEC staff released its advisor/broker study in January and, consistent with SEC Chairman Mary Schapiro's oft-stated position, recommended applying the fiduciary duty to brokers who provide personalized, retail investment advice. On its face, the fiduciary duty would be the same one that applies to advisors under the Investment Advisers Act. The study's tea leaves seem to presage a general rule requiring that brokers act in the best interest of their clients. That rule would be followed by a series of specific conduct rules that, depending on your point of view, either implement the best interest standard or undermine it.
The SEC's two Republican Commissioners dissented from the study, in part because the staff had not conducted an:
Analysis of the investor returns (controlling for risk and investor characteristics such as age, income, and education) generated under the two existing regulatory regimes.
Because such an analysis is not even feasible, it appears that two votes may have already been cast against any future fiduciary rule proposals. Their thinking must be that Congress authorized the SEC to adopt fiduciary rules because it did not want fiduciary rules to be adopted.
Chairman Schapiro does not need the Republicans' votes, however, so the SEC stands poised to anoint brokers with the fiduciary brand, while advisors stand cheering on the sidelines. The fiduciary brand will no longer be their exclusive property. It will not serve to differentiate advisors' services from brokers' services because advisors will no longer be able to claim that brokers are not fiduciaries. The owner of advisors' fiduciary brand (the government) has given it to brokers. And advisors are celebrating.
. . . And Then Dilute It
Advisors are less likely to celebrate the likely dilution of the fiduciary brand. Chairman Schapiro has consistently stated that the fiduciary duty must reflect brokers' business practices, which means that, in some contexts, the fiduciary bar will be lowered for brokers. The SEC staff is likely to support that position. After all, this is the same SEC staff that until just a few years ago took the position that fewer brokers should be subject to the Advisers Act's fiduciary duty. In 1999, the SEC staff pushed through a proposal (known as the "Merrill Lynch Rule") that expanded the broker exemption from the Act to brokers who received asset-based advisory fees. The rule was summarily rejected by a federal court in 2007.
The just-released staff report continues to reflect the staff's longstanding view that broker regulation imposes a standard for investment advice that is as high or higher than the fiduciary duty. SEC Chairman Schapiro and even FINRA have come to accept that the fiduciary standard imposes a higher duty, but the SEC staff has not. For example, the staff erroneously claims that under current law brokers that receive revenue sharing payments "must disclose the revenue sharing arrangement to the customer" (at page 56). The staff cites a case to support its position, In re AIG Advisor Group, in which the revenue sharing disclosure claim was actually dismissed on the ground that it could not, as a matter of law, be brought under the antifraud provisions of the federal securities laws (as almost every court has found with respect to such claims).
At the same time that the staff claims that brokers are required to disclose revenue sharing, the SEC has a pending rule proposal that specifically rejects such a disclosure requirement. So does FINRA. Both of these proposals provide a concrete preview of how the fiduciary duty will be diluted. The SEC staff is almost certain to interpret the new fiduciary duty not to require the disclosure of revenue sharing payments that is required under longstanding fiduciary law. And as anyone with a working knowledge of agency bureaucracies knows, it is often the staff, not the boss, that calls the shots.
This dilution of the fiduciary duty is a necessary product of the laws of political forces. When a negotiation occurs between two opposing political forces, the outcome will almost never reflect that uncompromising victory of one over the other. And where one side--the brokerage industry--has undeniably greater political power than the other, that side is more likely to prevail.
Some dilution of the fiduciary standard is, politically speaking, inevitable. To believe that the forces for the fiduciary standard will prevail over the forces favoring its dilution is to deny the elemental forces of politics. In the current political climate, the question may not be whether fiduciary rules will transform the broker standard into a wholly fiduciary one, but whether any rules will be adopted that raise the broker standard at all. Perhaps advisors will keep the fiduciary brand for themselves after all, in spite of their best efforts to give it away.
The Fiduciary Future
It is more likely, however, that the SEC will adopt rules extending the fiduciary duty to brokers. One reason is that Chairman Schapiro is irretrievably, publicly committed to it, and she has the support of a majority of the Commission (although she may be reluctant, in the current political climate, to weather two dissenting Republican votes). Another reason is that FINRA wants badly to become the regulator for investment advisors. It is difficult to imagine that happening if a fiduciary duty is not applied to FINRA members who provide retail investment advice. Advisors probably will have to address the question of how they can continue to differentiate their services without exclusive ownership of the fiduciary brand.
One answer may be to take back the fiduciary duty. For example, the Dodd-Frank Act does not specifically authorize "fiduciary" rules, but rather rules that require that brokers act in the "best interest of the customer." Advisors failed to persuade Congress to adopt the common fiduciary formulation of "solely in the best interest." This is the kind of distinction that may provide the means by which advisors could seek to maintain exclusive rights to the true fiduciary brand. This would be difficult, however, because brokers will be able to claim that they are legal fiduciaries whose fiduciary duty derives from the same statute (the Advisers Act) as advisors' fiduciary duty.
Another strategy may be to identify specific practices that fiduciary brokers are permitted to engage in but that fiduciary advisors abjure. For example, advisors might take the position that real fiduciaries do not engage in principal trades or accept revenue sharing payments. NAPFA's rhetoric suggests a view that a true fiduciary cannot be paid commissions or any other product-connected compensation, a position echoed by the way in which "fiduciary" law is applied under the Employee Retirement Income Security Act. However, many advisors may be reluctant to change their business practices solely to recapture the fiduciary brand.
There may be other strategies that would preserve some or all of the fiduciary brand for exclusive use by investment advisors, but if the SEC adopts a fiduciary rule for brokers, some dilution of both the legal standard and the brand is inevitable. Fiduciary rulemaking may stand as a reminder to advisors of the adage: Be careful what you ask for.
Mercer Bullard is president and founder of Fund Democracy, a mutual fund shareholder advocacy organization, an associate professor of law at the University of Mississippi School of Law, a senior adviser for financial planning firm Plancorp Inc., and a former assistant chief counsel at the SEC. He has testified frequently before Congress on regulatory issues.
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