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The Great Compromise to the Fiduciary Debate

The best way to resolve the fiduciary dilemma lies in subjecting both RIAs and broker/dealers to the 'sole interest' fiduciary standard of care found in ERISA, argues W. Scott Simon of Prudent Investor Advisors.

W. Scott Simon, 04/05/2012

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award. 

As most advisors must know by now, the U.S. Department of Labor (DOL) has gone back to the drawing board in an attempt to craft a fiduciary standard of care that will encompass both registered investment advisors (RIAs)--who are already covered by the "best interest" fiduciary standard of care under the Investment Advisors Act of 1940 ('40 IAA)--and registered representatives and their broker/dealers (B/D)--who are covered by the (non-fiduciary) suitability standard of care under the Securities Exchange Act of 1934.

Those who demand a "level playing field" usually want B/Ds to be governed by the best interest fiduciary standard of the '40 IAA--which, as noted, governs RIAs. On the other side are those who believe that B/Ds need not be subjected to any fiduciary duty or, if they are, be subject to one, in my view, so eviscerated by exemptions such as the seller's exemption (found in the rule proposed by the DOL and since withdrawn but sure to resurface) as to make it unrecognizable as a fiduciary standard.

We can see that the ground over which this fight has taken place includes allowing B/Ds to either be left alone, as is, with their suitability standard or be subjected to a standard characterized by some as "fiduciary lite." But no one in this fight, including even the most rabid defenders of the status quo, has demanded that RIAs be brought under the suitability tent.

The Great Compromise: The Sole Interest Fiduciary Standard
I have long believed that the best way to resolve this fight lies in subjecting both RIAs and B/Ds to the "sole interest" fiduciary standard of care found in the Employee Retirement Income Security Act of 1974 (ERISA). In one fell swoop, ERISA's fiduciary standard--"the highest known to law" (Donovan v. Bierwirth, 680 F.2d 263, 272 (2d Cir. 1982))--would level that proverbial playing field for all concerned.

This compromise has the merit of disturbing both sides in this fight because it would change the existing standard of care under which each operates. For RIAs, they would be lifted from the best interest fiduciary standard of the '40 IAA to the sole interest fiduciary standard of ERISA. No longer would an RIA be allowed under the ERISA standard (unlike under the '40 IAA standard) to, for example, "double dip" by (1) receiving a fee on the advice it provides to its clients and also (2) earning commissions from the RIA's brokerage firm, bank, or custodial affiliate as a result of the trades it directs them to make to implement that advice.

For B/Ds, they would be lifted from the suitability standard all the way up to ERISA's "highest known to law" standard. This proposed compromise comports with what an official from the American Society of Pension Professionals & Actuaries (ASPPA) stated last year in commenting on the DOL's proposed rule to redefine fiduciary advice: "In our members' experience, these small-business owners are surprised when they find out the 'advice' they have received for their ERISA-covered 401(k) plan is not actually ERISA-covered investment advice." Further: "We urge the DOL to remove this confusion by clarifying the definition [of a fiduciary] so all parties--particularly plan sponsors--can be sure they are receiving the full protections under ERISA."

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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