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The Conundrum of Mary Jo White

If Wall Street were really interested in having a total commitment to the long-term interests of its clients, it would embrace a fiduciary standard, but it does just the opposite.

W. Scott Simon, 07/03/2014

Last week, I set out from California on a journey to the center of the (political) earth in Washington, D.C., to join up with a small band--we happy few--of colleagues to meet with Mary Jo White, chair of the SEC. The purpose of our expedition was to look her in the eye, so to speak, and set forth our views on the critical need for the SEC to issue rules requiring stockbrokers (that is, registered representatives of broker/dealer firms, or B/Ds) to adhere to the fiduciary standard of conduct set forth in the Investment Advisers Act of 1940, commonly known as the "40 Act." 

Some Background
To bring all up to date: the SEC and the U.S. Department of Labor since 2010 have been seeking to issue new rules that will redefine what it means to be a "fiduciary" under, respectively, the Employee Retirement Income Security Act of 1974, or ERISA, which oversees retirement plan accounts of plan participants, and the 40 Act (as amended by the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010, or Dodd-Frank bill), which oversees retail accounts of individual investors.

The Department of Labor issued its rule-making fiduciary redefinition in 2010 but was forced to withdraw it in the face of hostile fire from special interest groups representing big stockbrokerage firms, big insurance companies, big consulting firms, big mutual fund companies, and so on that do business in the retirement plan marketplace. Acceptance of such rules would upset the apple cart of their business models which are often rife with impenetrable conflicts of interest designed to maintain a structure of hidden (and therefore high) costs. (The Department of Labor has postponed issuance of its "Conflict of Interest Rule-Investment Advice" until at least January 2015 and perhaps even later.)

On the individual retail investor side, the SEC has stood by over the years and watched while these business models have grown Frankenstein-like features. Stockbrokers have morphed from order-takers (governed by the suitability standard of conduct under the Securities Exchange Act of 1934) into full-blown investment advisors that the SEC has allowed to avoid adhering to the fiduciary standard of conduct that registered investment advisory firms, or RIAs, must follow pursuant to the 40 Act. 

Chair White now has the ability to reverse a good deal of the harm that these B/Ds can do to individual retail investors. On one hand, that would be nothing short of revolutionary in the Washington political landscape: bucking the political pressure generated by the millions and millions of dollars that have been (and are currently being) thrown at House and Senate members by the aforementioned moneyed and well-organized crowd of special interest groups representing those who just don't want to be fiduciaries. 

On the other hand, perhaps not so revolutionary but merely a rather simple implementation of what is authorized (but not mandated) by Dodd-Frank: adoption of rules requiring stockbrokers, when providing "personalized investment advice" to individual retail investors, to adhere to a fiduciary standard of conduct "no less stringent" than the standard that must be followed by RIAs registered pursuant to the 40 Act. 

Fitting a Square Peg Into a Round Hole
The fundamental, underlying problem faced by chair White, of course, is reconciling the fiduciary standard of conduct that requires RIAs to put the "best interests" of their investor clients first with the fiduciary duty owed by stockbrokers as agents to the interests of their B/D principals. 

I've written about this conundrum before, but it wouldn't hurt to review the issues at hand here once again. In a nutshell, stockbrokers have a fiduciary duty to do what's in the best interests of their employer, but they don't have a fiduciary duty to do what's in the best interests of their investor clients. That's an inherent conflict of interest that no serious-minded person well-versed in these issues can "harmonize" in any way.  

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 Understandingis 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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