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Where the rewrite of financial regs stands relating to RIAs

The stakes are high and the outcome is still uncertain; here's what we know

Friday, September 30, 2011 – 3:07 PM by Alex Potts Guest Columnist
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Alex Potts: One thing is certain. This battle will continue at least through the end of this year.

Brooke’s Note: The back-and-forth of events relating to what standards we set for financial advice in this country and who polices them have gone on long enough to lull all but the most steadfast political junkie to sleep. Alex Potts reminds us in this recap that the stakes are as high as ever for RIAs and tells us that it’s not too late to make a difference in the outcome of the legislative process.

For the past few years, financial advisors have been anticipating — or in some cases, dreading — sweeping regulatory change from Congress and the Securities and Exchange Commission. And change is coming — it’s the one point upon which conservatives and liberals, regulators and legislators all agree.

From last year’s Dodd-Frank legislation to proposed SEC rule making to the new bill from House Financial Services Committee Chairman Spencer Bachus, R-Ala., which is being debated now, RIAs and brokers are bracing for the new regulations sure to come.

Areas of agreement

There is also agreement on what is driving this change.

If investors’ anger and voters’ rage at their losses from the Great Recession were not enough, Bernie Madoff’s $50 billion Ponzi scheme managed to shake investors’ confidence in financial advisors. The Barron’s cover story on Sept. 28, 2009 documented this atmosphere of distrust, which drove record numbers of investors to fire their financial advisors and try someone new — or go it alone.

That’s where the agreement ends and the division begins. Since the call for change began, the debate has fundamentally been between the following two perspectives:

  1. Applying the principles-based fiduciary standard governing registered investment advisors to anyone providing investment advice, which would be enforced by the SEC and state regulatory agencies.
  2. Creating a universal standard that “harmonizes” the differences between the fiduciary standard and the rules-based suitability standard that would be enforced by a self-regulatory organization such as the Financial Industry Regulatory Authority Inc., which currently regulates broker conduct.


While the debate has progressed over the past two years, the opposing approaches, and the organizations backing them, are still at loggerheads.

Those in favor of applying the principles-based fiduciary standard to anyone offering investment advice include the Financial Planning Association, The Committee for the Fiduciary Standard, the Investment Adviser Association and other organizations that represent RIAs.

They argue for applying the principles-based fiduciary standard embedded in the Investment Advisers Act of 1940, which provides a high degree of protection for investors without burdening individual RIAs with complex regulations and paperwork. Fiduciary-standard advocates also continue to support maintaining SEC oversight of RIAs managing assets above $110 million.

The groups in favor of “harmonizing” the fiduciary standard with the suitability standard include the Securities Industry and Financial Markets Association, the National Association of Insurance and Financial Advisors and the Insured Retirement Institute, among others.

Fewer options?

They claim that applying the fiduciary standard to commission-based brokers will eliminate investment options for all but affluent individual investors, arguing that fee-only RIAs tend to serve only the affluent. This group also argued that the SEC lacks the resources to police financial advisors, and proposed shifting that responsibility to a self-regulatory organization, such as FINRA. See: Debate continues: Fiduciary standard no panacea.

To understand these opposing perspectives, we need to take a step back to view the differences between how brokers have been regulated versus registered investment advisors.

For more than 70 years, RIAs have been held to a principles-based fiduciary standard defined by the Investment Advisers Act and later upheld in a 1963 Supreme Court decision, SEC v. Capital Gains Research Bureau. See: How 10 top groups define 'fiduciary’.

There are five core principles associated with the fiduciary standard as outlined by the Committee for the Fiduciary Standard:

  1. Put the client’s best interests 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

Is 'suitable’ suitable?

Brokers, on the other hand, are currently held to a “suitability” standard defined in the Securities Exchange Act of 1934. Instead of following the principle of putting clients’ interests first, the suitability standard is less strict. As long as a product is regulated and trades on an appropriate market, brokers can recommend investments that may pay higher broker commissions, have higher management fees or introduce higher investment risk, without disclosing any conflicts of interest. See: The suitability standard, defined.

For decades, these dueling regulatory standards coexisted, until the “Great Recession” rattled investors’ confidence and Bernie Madoff eroded their trust.

Therefore it’s no surprise that the push for new regulation places advocates for the fiduciary standard in opposition to those who would press for more relaxed guidelines — with both sides claiming to have investors’ best interests at heart.

The Dodd-Frank legislation passed last year did nothing to end this debate or clarify how financial advisors will be regulated. Instead, it mandated studies by the SEC on the fiduciary standard and whether or not an SRO should oversee financial advisors.


While the SEC issued a report in January that advocated applying the fiduciary standard to anyone providing investment advice, the rulemaking process has been delayed. See: One-man think tank: Four red flags in the SEC’s fiduciary report.

Some of the delay can be attributed to SEC members Kathleen Casey and Troy Paredes, who issued a dissenting opinion, questioning the recommendation to fundamentally change the rules.

In addition, Richard Ketchum, FINRA’s chief executive, testified in favor of the bill, and has already proclaimed that his organization is the ideal body to regulate RIAs and brokers.

While the Bachus bill does not explicitly mention the fiduciary standard, its intention to shift regulatory responsibility to an SRO does not bode well for fiduciary advocates.

High stakes

One thing is certain. This battle will continue at least through the end of this year. Considering the stakes involved, particularly for RIAs and investors, it makes sense to urge our politicians to protect the principles-based fiduciary standard, and apply the Hippocratic oath to proposed legislation that would govern how we regulate the financial services industry to protect investors … First, do no harm.

Alex Potts is president and chief executive of Loring Ward, a San Jose, Calif.-based firm that provides investment strategies and business development support for independent financial advisors.

Mentioned in this article:

Buckingham Strategic Partners
TAMP, Asset Manager for RIAs
Top Executive: Alex Potts

Jeff McClure

Jeff McClure

September 30, 2011 — 4:31 PM

It seems to me that there is a simple set of solutions here, based on what is happening in the real world.

First, eliminate the term “Financial Adviser.” I am not sure what that means, it is not in any way defined or regulated, and it confuses the issue. A person is either a broker, operating under the Suitability Standard or is an investment adviser and is bound by the Investment Advisers Act of 1940, i.e. is a fiduciary.

Second, give FINRA the authority and responsibility to regulate dually registered BD/RIA firms. My experience is that the vast, vast majority of firms and representatives of those firms that have added an RIA activity to their broker/dealer business have absolutely no intent of being held to a fiduciary standard. From their perspective being an “adviser” simply is a means of increasing revenues and achieving discretionary authority in customer accounts.

Third, get serious about regulation and inspection of the independent RIAs. My observations indicate that there are an abundance of supposedly registered investment advisers who have submitted a form ADV, but are anything but fiduciaries. I recently had an acquaintance from my Rotary Club who asked me to look into an “RIA” who was asking to speak to our club. A little research determined that the supposedly “federally registered investment adviser” was well over a year into the 120 day exemption from state registration and had actually submitted a new ADV this year claiming to have no money under management! The agency doing the advertising (owned by the “RIA”) was the claimed “federally registered” adviser but in fact was an unregistered DBA used as an advertising vehicle to sell annuities and life insurance as well as offering to manage and hold investments for members of the public.

I contacted the Texas Securities Commission and was told that as the person was registered with the SEC they would not look into it. I called the SEC and was told that since the 120 days had expired it was the state’s responsibility.

In short regulation and supervision of this person (who appears to actually be accumulating money without a custodian) is non-existent. It is a simple process to do an internet search for persons and firms claiming to be advisers except that the search turns up so many “advisers” who are unregistered that it becomes overwhelming. It is quite impressive to me that a person can submit an ADV to the SEC, claim to be an adviser and have absolutely no oversight if they state they have no money under management. It is no wonder that Madoff got away with it for so long.

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