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Obama administration, SEC, FINRA, FPA, fi360, U.S. Supreme Court and SIFMA raise fiduciary bar to different heights
January 21, 2011 — 4:24 AM UTC by Elizabeth MacBride
Brooke’s Note: The SEC finally issued its report late last night (Jan. 21) about whether a true fiduciary standard should apply to stock brokers. The answer: yes. Elizabeth will publish her analysis soon.
Editor’s note: RIABiz is republishing this story, written last spring, which includes many groups’ definitions of the fiduciary standard. The SEC is expected, on Friday, Jan. 21, to release a study on how it will apply the fiduciary standard to broker-dealers.
Added note: This story now has a worthy sequel based on the wave of expert comments appended to it.
The dictionary on my Mac says fiduciary means “involving trust.” From the Latin fidere, “to trust.”
If only the definitions in Washington, D.C., were so clear.
One of the questions facing the Congress and the Obama administration as they struggle to craft new regulations for the financial system is how to harmonize regulation of broker-dealers and investment advisors.
Broker-dealers currently operate under a lower no-penny-stocks-to-widows suitability standard – a difference that has driven some advisers crazy, because it means that broker-dealers have been able to advise their clients to buy investment vehicles that weren’t necessarily in their best interests. Advisers, on the other hand, have been held to a higher, though admittedly vague, fiduciary standard developed over the years through case law, which requires that investors’ interests be put first.
The Administration has proposed that the “standards of conduct for all brokers, dealers, and investment advisers, in providing investment advice about securities to retail customers or clients … shall be to act solely in the interest of the customer or client without regard to the financial or other interest of the broker, dealer or investment adviser providing the advice.”
But what might that be interpreted to mean, either on Capitol Hill as part of a larger package of legislation, or if left vague in the ultimate regulation, by companies and courts across the country?
The question now at hand is how detailed the description of the fiduciary standard ought to be, and what exactly, it ought to say.
During a summer of speeches, hearings and interviews, key players in the debate have given – either broadly or specifically – their ideas of what the fiduciary standard should look like.
U.S. Securities and Exchange Commission is most likely to end up with the responsibility of regulating financial advice, though through what mechanisms and subsidiary regulatory bodies is still an open question. On June 18, SEC Chairman Mary Schapiro gave a speech at the New York Financial Writers’ Association Annual Awards Dinner in which she laid out her view of a fiduciary standard:“I believe that, when investors receive similar services from similar financial service providers, they should be subject to the same standard of conduct — regardless of the label applied to that financial service provider. I therefore believe that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients.
The fiduciary duty means that the financial service provider must at all times act in the best interest of customers or clients. In addition, a fiduciary must avoid conflicts of interest that impair its capacity to act for the benefit of its customers or clients. And if such conflicts cannot be avoided, a fiduciary must provide full and fair disclosure of the conflicts and obtain informed consent to the conflict.
A fiduciary owes its customers and clients more than mere honesty and good faith alone. A fiduciary must put its clients’ and customers’ interests before its own, absent disclosure of, and consent to, conflicts of interest.
While I believe that a consistent fiduciary standard of conduct should be applied to all financial professionals providing personalized investment advice, I also understand that the fiduciary standard is not a panacea to deter all fraud against individual investors.”
FINRA, which currently regulates the practices of brokerage firms, works under the oversight of the SEC. It may end up with the job of regulator, still functioning under the SEC or conceivably under another agency. To give you a sense of the scope: it regulates 4,900 brokerage firms and 650,000 registered securities representatives. It doesn’t currently regulate the nation’s 11,300 investment advisors.
In a speech June 17 at the Exchequer Club in Washington, Chairman Rick Ketchum suggested that a standard should include the following principles:
• Every person who provides financial advice and sells a financial product is tested, qualified and licensed;
• Advertising for financial products and services is not misleading;
• Every product marketed to them is appropriate for recommendation to that investor;
• A full and comprehensive disclosure for the services and products being marketed that address, in plain English, the risks, including the worst-case risks, of the product; and
• Every person who is in the business of regularly providing financial advice is subject to a federally crafted fiduciary standard.”
Consumer Protection and Investment Advisor Groups
Seven groups – the Certified Financial Planner Board of Standards (CFP Board); the Consumer Federation of America (CFA); the Financial Planning Association (FPA); Fund Democracy, the Investment Adviser Association (IAA); the National Association of Personal Financial Advisors (NAPFA), and the North American Securities Administrators Association (NASAA) – banded together to back extending the current fiduciary standard to broker-dealers.
The current fiduciary standard stems from the Investment Advisors Act of 1940, which lays out in excruciating detail what an investment advisor is and does and how he or she is subject to regulation. It doesn’t outright include a definition of the fiduciary standard, but its provisions leave room for interpretation. And in the nearly 70 years since it was written, the Supreme Court and various state courts have interpreted the act, creating a body of case law that defines the current fiduciary standard.
Just try explaining that to a bevy of young staffers on Capitol Hill.
In 1963, the Supreme Court offered an interpretation in SEC v. Capital Gains Research Bureau Inc. I’ve taken this quote from the web site of fi360, a company that offers education and certification for advisers on fiduciary issues.
Here’s what the Supreme Court said:
“A fundamental purpose common to these statutes securities legislation enacted in the 1930sand1940] was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry…(as)investment advisers could not completely perform their basic function–furnishing to clients on a personal basis competent, unbiased and continuous advice regarding the sound management of their investments—unless all conflicts of interest between the investment counsel and the client were removed.”
Committee for the Fiduciary Standard
Speaking of fi360, its chief executive, Blaine Aikin, is a founding member of the Committee for the Fiduciary Standard. The Committee is promoting codifying the existing fiduciary standard. Anyone can join the committee through its linkedin site. The group’s steering committee has put forward five principles to be included in the fiduciary standard:
1. Put the client’s best interest first.
2. Act with prudence; that is, with the skill, care, diligence and good judgment of a professional.
3. Do not mislead clients; provide conspicuous, full and fair disclosure of all-important facts.
4. Avoid conflicts of interest.
5. Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.
The Securities Industry and Financial Markets Association has embraced the idea of a fiduciary standard, but is laying low – at least in public – on the specifics of what it should be. No doubt this lobbying powerhouse is crafting a careful position behind the scenes.
Its language so far does put it in opposition to the investment advisor groups advocating to extend the existing standard to broker-dealers, with one of the key differences being that SIFMA wants a federal standard rather than one that is applied differently in different states. SIFMA wants a new, “single maximum strength” standard, says spokesman Travis Larson.
If you know of other organizations that have taken a stand on the fiduciary standard, please let me know. I suspect there are many.
Editor’s note: Here’s a quick Wall Street Journal review of Elizabeth’s article.
Mentioned in this article:
Financial Planning Association
Top Executive: Lauren S. Schadle, CAE, Executive Director and CEO
National Association of Personal Finance Advisors
Top Executive: Ellen Turf
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