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New York Fiduciary Panel Yields Surprise Honesty While Drawing Lines in the Sand

February 15
02:38 2011

The New York Law School and The Committee for the Fiduciary Standard Webcast hosted a special panel discussion and webcast on February 10th, 2011 entitled “The SEC Study Regarding Obligations of Brokers, Dealers, and Investment 1331184_15097032_line_in_the_sand_stock_xchng_royalty_free_300Advisers: What Does it Mean for Investors, Firms, Brokers, And Advisers?” With a half dozen top name experts, the panel brought out some unexpectedly honest comments but also showed the beginnings of battle lines being drawn.

Keynote remarks were offered by Tom Bradley, President, TD Ameritrade Institutional, who admitted he was a last minute replacement for Arthur Leavitt. Bradley broke down the issue into three key topics: 1) Investor Protection; 2) The Uniform Fiduciary Standard; and 3) Oversight. He cites the explosive scandals associated with the internet bubble, mortgage debacle and Ponzi scheme as proof of the need for greater investor protection. Bradley attributes these crises to simple greed and suggests investor protection entails strengthening existing protection measures, maintaining choice and putting the investor first.

Regarding the Uniform Fiduciary Standard, Bradley says TD Ameritrade supports the standard, “but the key is when advice is provided to an individual investor.” He acknowledges “you want to be at least as stringent as the existing investment adviser standard, but you want to continue to give investors choices as in the broker model.” Unlike some of his peers, he doesn’t fear the fiduciary standard and he freely admits to choice means either you’re buying a fiduciary service or you’re not. “You need to separate the distribution and sales of securities from the actual advice.” Bradley bluntly hints the root of today’s problems started when stock brokers as broker/dealers began to provide services that looked more and more like a Registered Investment Adviser. He now believes “the second you cross the line of providing advice, you should be held to a fiduciary standard.” In other words, not more broker exemptions.

Finally, in terms of oversight, Bradley revealed that “over 50% of our advisers preferred we keep the SEC as the lead regulator.” He did say those currently under an SRO had no consensus – except they did not want FINRA. Bradley concluded the “financial services industry has a perception problem. No matter who is examining the advisers, we need to make the examinations better.”

James A. Fanto, Professor, Brooklyn Law School, took to the podium next and gave his interpretation of “Dodd-Frank’s Tall Order.” He first directly stated what he sees are the real conundrum: There is no question about investor confusion (he cited the Rand Study here) but regulatory resources are limited. These two together means increased costs we will likely drive product availability.

Fanto honestly admits it’s difficult to see any other outcome that preserves all business models and products that doesn’t rely on disclosure. He reminded the audience the SEC recognizes disclosure about conflicts could be lost in boilerplate and their “Plain English” solution is meant to address that. Even still, disclosure only provides a small accomplishment. Fanto says it may help at the margins, but reminds us psychologists tell us the retail investor is generally not a rational processor of information. “To be fair to the SEC,” says Fanto, “the Commission is limited by disclosure orientation of federal securities laws and by resource constraints.”

The law professor then turned sanguine. “From one perspective,” he says, “this is nothing more than a fight between brokers and advisers with the advisers saying, ‘Brokers, get out of our business. You’re sneaking in there and trying to get competitive advantage by using our name without our duties.” But instead of just a turf war, it really should be about putting client’s first. It’s about being a professional in a highly specialized world. And it’s not as if fiduciary rules are alien to B/Ds. Fanto feels the outcome of the SEC’s rule-making process should be a renewed focus on professional obligations. “The financial professional is there to provide services to clients, not to use them as profit centers,” says Fanto. Disclosure, he points out, is a perverse outcome, not a fiduciary outcome. Alas, Fanto laments, there is no language about renewed professionalism in the SEC report.

Fanto concludes with a warning. The reputation of finance and financial professionals is at the nadir. Matt Taibbi’s phrase in Griftopia calls financial professionals “grifters.” If all the fiduciary debate becomes is a turf war and a debate about disclosure, then it’s doomed to failure. Rather, it must be about reinvigorating the true concept of fiduciary duties.

Pouring cold water and the excitement of a possible uniform fiduciary standard, Michael Koffler, Partner, Sutherland Asbill & Brennan, is coldly realistic. He says we won’t be seeing an answer on the fiduciary standard for quite some time. Koffler points out the disclaimer language on the cover the SEC study. The first indication the process will go slow is the fact the study is just from the staff, not the “SEC.” The second matter that will slow it down is the fundamental disagreement between the dissenting commissioners. In reality, this is a political issue. The political element will not go away, if anything, it will get worse.

Robert L. D. Colby, Partner, Davis Polk & Wardwell, former SEC Deputy Director of Market Regulation, pointed out the issues we’re talking about are extremely important because people are saving for their retirement. This is at a time when financial investing has become much more difficult and complex. Inflation is the great thief of savings. Most people with savings – however large or small – have to secure financial advice. Having said that, Colby had a more upbeat tone than Koffler.

There are differences at the start between B/Ds and RIAs. “The report is in ‘staff speak’ and you need to decipher it,” says Colby. The “default” standard of the B/D should shift from one where they don’t have to put the client first to one where they do. When you talk about “Fiduciary Duty,” that is the starting point of the discussion. Colby says fiduciary duty can then be redefined by way of contract. “For example, a mutual fund company offered me a financial plan. They recommended replacing every fund I had with a fund that they manage. I thought this was odd, but then I read the fine print of the contract and it said they would provide advice only within the range of their own products. In another example, I used a B/D who did the exact same thing with the fee based RIA side of his business vs. the fee-based B/D side, with the former providing higher fees to the B/D.”

Colby likened the SEC Study as the first step in the 12 step program – it acknowledges we have a problem.

Thomas M. Selman, EVP, Regulatory Policy, FINRA, came to the paneled armed with a specific point of view. He said the US is the only country in the world where B/Ds and RIAs are regulated under a different set of laws and regulators. This wasn’t a serious problem for the first 50 years because there were clear differences between the two types of services. Today, about 88% of all investment advisers are associated with a B/D. The customer should not be required to figure out what type of protection they receive depending on whether they use a B/D or an RIA. From the customer standpoint, the protection should be similar. On the B/D side, there has to be clear statement of fiduciary standard. They’ve always had a fiduciary duty, but limited in scope. For example, on the RIA side, the RIA who charges an asset based fee will be responsible for monitoring that account on an ongoing basis. A B/D only has this duty through the execution of the trade. Similarly, on the RIA side, a financial planner charging a fixed fee to establish a plan does not have the duty to monitor that account on an ongoing basis.

This leaves one piece unanswered – who should conduct the oversight? Selman says RIAs are subject to an honor system, whereas B/Ds are subject to FINRA. He believes it’s “highly doubtful user fees will generate enough revenue to fund the amount of exams the SEC needs to do.”

Knut A. Rostad, Chairman, The Committee for the Fiduciary Standard, came full circle as the last speaker. He started by posing the question “Why does the fiduciary standard matter?” Rostad says it matters because we couldn’t explain what happened in September 2008. “Too many people had too many unanswered questions. We conclude there was a systematic breakdown… an erosion of standards of responsibility…” The fiduciary standard matters. It will say whether or not investors come back to trust the industry, believes Rostad. He cites a raise in investor trust from December 2008 to December 2010 from 11% to only 16% to show the issue of trust is huge and needs to be addressed.

Rostad disagreed with Colby on the difference between B/Ds and RIAs. He pointed out there is a difference of “kind” in that RIAs are legally required to put the client’s first while B/Ds do not.

He said the SEC should be applauded for endorsing a “uniform fiduciary standard no less stringent than that of RIAs.” Rostad also likes the idea that the SEC admits it would consider banning certain conflicts of interest. However, as it was pointed out, this is a staff study. He then went on to emphasize a couple of key issues in the study.

Rostad wonders what is it going to mean to be “business model neutral”? He sees this as going in two possible directions. Dodd-Frank said a commission-based product doesn’t in of itself violate a fiduciary standard. He questions how certain business models may not naturally put the client’s interest first and wonder how the SEC might reconcile this conflict with the duties of a fiduciary.

The second area Rostad focused on was the issue of conflicts-of-interest. How is the conflicts-of-interest issue viewed in the study vs. the RIA ACT of 1940 vs. the Supreme Court 1963 Opinion in SEC vs. Capital Gains Research? The Court said all conflicts-of-interest must be removed for RIAs. In the Study – and Rostad pointed out this isn’t “staff speak” – the Duty of Loyalty requires conflicts-of-interest be “eliminated” or “disclosed.” Further, the staff points out it’s the firm’s responsibility – not the client’s – to disclose the conflicts. This issue becomes important because it gets to the heart of “what is in the best interests” of the client. “Best interest does not mean disclosure,” contends Rostad. “If disclosure is permitted, then the fiduciary duty is removed from the firm and placed on the client. We need to hold firms accountable, and how we deal with disclosure will tell us whether or not we intend to hold them the accountable.”

Thus were lines drawn in the sand. We’re left to wonder if the tide of time will wash away those lines or merely wash away the sense of urgency for a uniform fiduciary standard.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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