The Fiduciary Kerfuffle

Guest Contributor: Philip Lawton , Analyst, Aite Group

Taxes, entitlements, and the national debt limit are not the only controversial topics in Washington this summer. The Securities and Exchange Commission’s proposal to apply a uniform fiduciary standard to investment advisers and broker-dealers alike has created a ruckus in the retail investment industry. The Securities Industry and Financial Markets Association (SIFMA) and the National Association of Insurance and Financial Advisers (NAIFA) are lobbying vigorously against the SEC proposal.* What’s behind this brouhaha?  We are not qualified to offer legal advice, but here is a layman’s account.

As with so many other regulatory issues these days, the debate originated with the Dodd-Frank Act. Section 913 enjoined the SEC to study the effectiveness of existing legal and regulatory standards of care for brokers, dealers, investment advisers, and persons associated with them, and to determine whether there are “gaps, shortcomings, or overlaps” in the protection afforded retail customers by the existing standards. SEC staff duly issued a 208-page report to the U.S. Congress on January 21, 2011.

The SEC study considered, but rejected, eliminating the exclusion of broker-dealers from the Investment Advisers Act of 1940. Likewise, the SEC disallowed imposing the standard of care and other requirements of the Advisers Act on broker-dealers. Both of the rejected actions entailed making broker-dealers subject to the entire regulatory regime that applies to investment advisers.

Instead, the SEC proposed (in its “Study on Investment Advisers and Broker-Dealers,” pg. 109, emphasis added) what it calls the uniform fiduciary standard: “the standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.” The components of the uniform fiduciary standard are the duties of loyalty and care.

Well known to investment advisers, the duty of loyalty means that conflicts of interest must be eliminated or disclosed. The SEC study explicitly states that, in and of themselves, neither charging commissions for the sale of securities nor exclusively offering proprietary products violates the uniform fiduciary standard. Principal trading is a clear conflict of interest — there are risks that an investment adviser or broker-dealer might manipulate prices or dump unwanted securities into a client’s account — but the uniform fiduciary standard does not prohibit principal trading, nor does it necessarily impose on broker-dealers the same disclosure and consent requirements that apply to investment advisers. The study states that broker-dealers should, at a minimum, disclose their conflicts of interest related to principal transactions, and remain subject to existing obligations relating to suitability, best execution, and fair and reasonable pricing and compensation.

The SEC study acknowledges that the duty of care has different meanings in the regulatory domains of investment advisers and broker-dealers. For the former, under existing rules, the duty of care essentially means that investment recommendations should have a reasonable basis in research and analysis; for the latter, that they should be suitable** for the client. Guidance and/or rulemaking will be required to establish the minimum requirements of a standard of care under the uniform fiduciary standard.

Finally, taking their arguments at face value, SIFMA supports a uniform fiduciary standard for investment advisers and broker-dealers when they provide personalized investment advice. However, the organization believes that “appropriately robust and rigorous cost-benefit analyses are essential to inform and shape any SEC rulemakings, particularly those that call for the type of ‘sea change’ reform envisioned by Section 913 of the Dodd-Frank Act.”  NAIFA expresses concern “that the costs associated with the increased regulation and liability associated with a fiduciary standard could either drive our members out of the market or to an investment adviser model that primarily serves wealthier consumers.”

At once philosophical and consequential, the summertime debate over the uniform standard of care is unlikely to be resolved before snow flies. We will follow it with abiding interest. Please let us know what you think.

About Maureen Lowe

President and Founder of Financial Technologies Forum, LLC. Editor-In-Chief of FTF News. Entrepreneur, Jersey Girl that recently returned to Jersey, Loves to Bake, Married to a Kiwi, First Time Mom
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