How the SEC has pulled a vanishing act, looking the other way while brokers with flimsy pretenses hold themselves out as trusted advisors

Brooke’s Note: As you read this article, a sickening realization may come over you — that the SEC and all it stands for is withering away — not that it was ever a paragon of stewardship. The evidence, as Ron points out, is everywhere, not deep in Dodd-Frank or some other government tome. This article follows up, ironically perhaps, Ron’s ambitious series of stories mostly targeting the SEC’s would-be replacement for RIAs that concluded with What the 8 pillars of a FINRA-replacing entity for RIA oversight look like and how personal accountability is key. According to him, the SEC, by its inaction, has all but taken itself out of the game. Now, it’s time for the industry itself to step into the breach. Here’s what that would look like.

There was a time when the Securities and Exchange Commission cautioned that brokers who established relationships of trust with their clients, and who provided personalized investment advice, were fiduciaries with broad duties related to accountability and putting the client first.

Yet today, curiously, the federal regulator wonders if it should even impose any kind of fiduciary duties upon brokers who provide personalized investment advice. See: One-Man Think Tank: SEC courage likely to be tested in coming months.

There was a time that the SEC cautioned against the use of titles that denote relationships of trust and confidence.

Tomato, tom-ahto, broker, financial advisor

Yet today the SEC permits anyone to use the terms “investment manager” or “wealth manager” or “financial advisor” or “financial consultant,” without regard to the reasonable belief created in clients by the use of such titles that expertise and trust can be reposed.

There was a time when the SEC cautioned broker-dealer firms to be careful in their advertising, and to not imply a relationship of trust and confidence exist when, in fact, such does not. Yet today such advertisements are abundant.

There was a time when the SEC noted that principal trades by fiduciary were only to be a rare activity, undertaken only in markets where agency trades were not available. Yet today the SEC has permitted dual registrants to engage in principle trades on a wholesale basis, without proper inspection and oversight.

There was a time when core fiduciary duties could not be waived. Yet today, many major broker-dealer firms’ Form ADVs, Part 2A state, to the effect: “We are fiduciaries … but … and but … and but … and but.”

Be one with your 12(b)-1

Wall Street firms now often say, in essence: “We are fiduciaries … but we may also receive additional compensation via 12(b)-1 fees in addition to the investment advisory fees you, our client, pay. No, we do not credit such fees against your investment advisory fee.” See: 7 reasons why wirehouses shouldn’t milk the old business model.

And they also in essence often say: “We are fiduciaries … but we may also receive payment for shelf space and soft-dollar compensation. And although we are fiduciaries … we have no obligation to ensure that a tax-efficient strategy is utilized in your portfolio. We are fiduciaries … but we won’t even prepare an investment policy statement for you, nor will we design and implement a prudent investment strategy for you, nor even let you know when we are giving imprudent advice.”

And these “fiduciary” dual registrants also often, in essence, state: “Oh, yes. We can also wear two hats. And we can switch our hats at will, in the corner of our dimly lit offices, while you — the client — are unaware.”

There was a time when the SEC was respected. No more.

Government by the people, for the lobbyists

This is what happens when we leave the fiduciary standard in the hands of government. Under ongoing pressure from Wall Street’s banks and the insurance companies, it is abrogated, compromised and gutted. And then, what little that remains of fiduciary obligations is not enforced through diligent oversight.

The fiduciary battles continue in Washington, D.C., and will for some time. Pro-fiduciary advocates may, largely through the courage of Phyllis Borzi and her team at the Labor Department’s Employee Benefit Security Administration, prevail to apply fiduciary standards to all providers of advice to defined-contribution and individual retirement accounts. See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.

Yet, I possess little hope that the SEC will act in similar fashion, either to correctly research what the fiduciary standard is all about, nor whether they will they understand the reasons for its application to investment advisory and financial planning activities. The response of SEC staffers to each recitation of the long-understood requirements of the bona fide fiduciary standard will most certainly be: “Surely the fiduciary standard cannot mean that.”

The SEC takes no action now against the wholesale abrogation by Wall Street’s firms of their fiduciary obligations when providing personalized investment advice. Such nullification of core fiduciary duties occurs by these firms’ mere disclosure of multiple and often insidious conflicts (followed by uninformed consent of the client, not understood, and without intelligent, informed consent). Of course, no client would ever consent to be harmed — the fiduciary standard requires ongoing substantive fairness to the client, even when a conflict of interest is permitted to continue to exist. See: One-Man Think Tank: Inside the legal issues of the Goldman Sachs hearings.

There are major economic forces that have, and continue to, diminish the fiduciary standard of conduct. It has already been diminished. The true, bona fide fiduciary standard, well understood and based upon centuries of legal precedent, will continue to be eviscerated.

'Objectivity’ with a subjective slant

The word “objective” has lost its meaning. Many of these broker-dealer firms tout their objectivity, when no such real objectivity exists due to multiple and nefarious conflicts of interest. Is this fraud?

When the Securities Industry and Financial Markets Association stands up and says all of its members place the customer’s “best interests” above their own, is this fraud? Every other country that has adopted the common law of England as the basis for its jurisprudence understands that the term “acting in your best interests” is tantamount to the fiduciary duty of loyalty. When in the United States did we permit “best interests” to mean otherwise? When did we permit clients to be deceived so often, and to such detriment? See: After starring in New Yorker article, Mary Jo White holds SIFMA event spellbound and 'no-admit, no-deny’ is still in play.

When those who use titles that denote relationships of trust and confidence, and who provide advice under the aura of such representations, yet disavow or disclaim their core fiduciary obligations, is such not blatant fraud?

I am not optimistic about the future of the fiduciary standard. The fiduciary standard, as the SEC presently applies it, is no longer a high standard of conduct. It has become the basis for a new type of fraud. “Trust me” and “fiduciary we” and “best interests” are the expressions of this fraud, when in fact such trust is betrayed by the users of these terms over and over.

True professionals exist, but they are few and Wall Street’s influence is great

What can right this ship? What can undo these wrongs?

Only true professionals can defend the fiduciary standard — by organizing and forming professional societies dedicated to their members’ avoiding conflicts of interest rather than embracing them. That is, embracing all of the core fiduciary obligations, with no need to disclaim these duties away. See: FINRA’s scandalous litany of failures and its efforts to redefine the true fiduciary standard out of existence.

Yet, in my travels, I have seen only a few voluntary professional societies that have actually adopted such high ideals. And less than 1% of those who are involved in financial services are members of these societies. Outgunned and outmatched by millions and millions of dollars from lobbyist contributions and often-secretive dealings resulting in a revolving door between Wall Street, their lobbying firms and the SEC, these professional societies have no real chance to defend the fiduciary standard. Nor do professionals possess any hope that the fiduciary standard will be restored by the SEC to the pre-eminent standard of conduct it once was.

'Let it be known’: The marketplace solution

So what can we do? We must persevere — not in the halls of Washington, D.C., but rather in the realm of public opinion and consumer demand.

Let it be known, loudly and clearly, that financial services regulation is largely a sham. It provides the illusion of protection for those who receive investment and financial advice, when in reality such protections rarely exist. Rather than be the bulwark for the preservation and application of the bona fide fiduciary standard, the SEC has become complicit in its demise. See: An X-ray of one affluent, educated and sophisticated investor’s portfolio shows how it was chewed up by fees.

Let it be known that fraud is rampant and widespread.

Let it be known, loudly and clearly, that there are a trusted few who will act in the clients’ best interest, with no need to disclaim away their core fiduciary obligations.

Let it be known, loudly and clearly, that without a trusted advisor bound by bona fide fiduciary duties at all times, consumers in this complicated financial world — whether they be Mom and Pop and Aunt Bea from Main Street, the fiduciary plan sponsor or the fiduciary endowment or pension fund trustee — have little chance to be successful in attaining their financial goals.

Let it be known, by consumers and the media, loudly and clearly:

“WE NO LONGER WANT THE 'SOLUTIONS’ WHICH WALL STREET PUSHES.”

“WE DON’T WANT PRODUCTS BURDENED WITH EXCESSIVE FEES, FALSE PROMISES OF 'BEATING THE MARKET.’”

“WE DON’T DESIRE TO BE DECEIVED ANY LONGER. WE WILL ONLY ACCEPT BONA FIDE FIDUCIARIES, BOUND BY A WRITTEN OATH TO ACT ALL TIMES AS SUCH.”

“WE DON’T WANT TO HEAR WALL STREET’S LIES AND DECEPTIONS, MOTIVATED BY THEIR OWN SELF-INTEREST.”

The bona fide fiduciary’s oath

Hence, let it be known that only those few advisors who are willing to sign the following oath (designed in some detail, to avoid ambiguous interpretations and to prohibit the most severe conflicts of interest) actually deserve the trust of our fellow Americans:

“I AFFIRM TO YOU, MY CLIENT, THAT I AM A BONA FIDE FIDUCIARY INVESTMENT AND/OR FINANCIAL ADVISOR. I COMMIT AT ALL TIMES DURING ANY ASPECT OF OUR RELATIONSHIP TO THE FOLLOWING CORE FIDUCIARY OBLIGATIONS:

“I will always put your best interests first. I will not seek to remove my 'fiduciary hat.’ I will always be your trusted advisor during our trusted-advisor-client relationship. See: FINRA’s scandalous litany of failures and its efforts to redefine the true fiduciary standard out of existence.

“I will act with prudence; that is, with the skill, care, diligence,and good judgment of a professional. I will recommend to you only prudent investment strategies backed by solid evidence (through extensive back-testing or through academic research which has withstood the test of time); if an investment strategy is recommended to you that cannot be shown to be prudent, I will ensure that you are fully aware of the risks of such strategy. I will conduct extensive due diligence on both the investment strategies and investment products which I recommend to you. I will ensure that the total fees and costs you pay for the receipt of investment and financial advice and in relation to the implementation of any strategies will be fully disclosed (or at least estimated, when not quantitatively known). I will ensure that the total fees and costs you pay are reasonable.”

“I will not mislead you, and I will provide conspicuous, full and fair disclosure of all material facts. I will explain these facts to you. I assume the obligation to ensure your understanding of these important facts.

“I will avoid conflicts of interest. I will not suggest that I engage in a “principal trade” with you. I will never sell you a proprietary product of my firm, nor a product from any affiliated firm, nor a product from any firm in which I hold a material interest. I will never accept 12(b)-1 fees unless they are fully and completed credited by both me and my firm against the investment advisory fees that you pay to me. Neither I nor my firm will ever receive payment for shelf space or soft-dollar compensation or other forms of revenue-sharing payments. I will avoid all other forms of material third-party compensation to the extent that I can reasonably do so.

“I will fully disclose and fairly manage, in your favor, any unavoidable conflicts. I will ensure your complete understanding of these few and rare conflicts of interest, when they occur. I will seek out and obtain your intelligent, independent and informed consent to such unavoidable conflict of interest. Even then, I will recommend the best course of action for you, in adherence to my continuing obligation to act in your best interests and to ensure substantive fairness exists at all times.

“For my trusted advice and expertise as your financial guide and educator, I require only reasonable professional fees, fully disclosed and agreed-to in advance of any specific product recommendations.

“I AM, AND WILL ALWAYS BE, DURING ANY ASPECT OF OUR RELATIONSHIP, NOW AND IN THE FUTURE, YOUR BONA FIDE FIDUCIARY ADVISOR.”

'No one left to fleece’

There will be a time when the bona fide fiduciary standard will become commonplace in the service of individual consumers.

But this will not occur through government action (and inaction). Not through lobbying in the halls of Congress, nor in the conference rooms of government agencies. See: How 10 top groups define 'fiduciary’.

Rather, bona fide fiduciaries will apply it, as they prevail in the marketplace in the years to come.

Only then might the wolves of Wall Street emerge to “see the light” and be willing to adopt bona fide fiduciary obligations to their customers. Only when it becomes apparent, as their market share continues its slow erosion, that they have no other choice but to wear the white hat of the fiduciary. Ultimately they will have no one left to fleece. But that’s a long, long, long time off — years and years, if not decades.

Consumers: Protect thyself

In the meantime, consumers will need to be diligent. They will need to demand the fiduciary oath above. They will need to seek out those very few advisors — who perhaps number only a few thousand in the United States today — who will freely and voluntarily sign the oath set forth above.

Where might consumers find such bona fide fiduciaries — advisors you can truly trust? I would suggest that the members of three professional organizations would likely sign the fiduciary oath set forth above:

National Association of Personal Financial Advisors (www.napfa.org)

Each of these organizations possess, on their websites, “Find an Advisor” search tools for consumers to utilize to find trusted financial and investment advisors.

In conclusion

There was a time when the words “fiduciary” and “best interests” and “trust” and “integrity” meant something truly special in America. With the grit and perseverance of bona fide fiduciary advisors, their clients and the media, there will come another such time.