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Exclusive Interview with fi360’s Duane Thompson: Dual Registration’s Impact on the Fiduciary Standard

April 24
00:34 2012

(This is the third installment of a three part series on Dual Registration)

We conclude our series on the impact of the Merrill Rule and dual registration on the fiduciary standard debate with our conversation with Duane Thompson, AIF, is a Senior Policy Analyst at fi360. Duane has more than 20 years of experience in federal and state business issues, having also served for 14 years as a managing director of the Financial Planning Association, the largest group in the country representing independent financial planners. During that time, he managed the Washington D.C. office of FPA with responsibility for all legislative and regulatory matters before Congress, the Securities and Exchange Commission, other federal agencies, and state governments. He was kind enough to participate in an extended discussion on our subject and allow us to share that talk with our readers. As you’ll see, Duane has a very thorough knowledge of the topic and his answers will prove most enlightening to those both new to the issue as well as those already immersed in the debate.

FN: What is fi360’s view on whether or not they believe the fiduciary standard would have been an issue if it wasn’t for the Merrill Rule and the growth of dual registration?
Thompson: The ‘What if’ question is always interesting but unanswerable. What would have happened at Waterloo if Blucher hadn’t marched to Wellington in time? In the context of the fiduciary debate, where would we be now if the Merrill Rule was still in place? At the time the DC court threw out the SEC rule, industry statistics showed assets in wrap fee programs declining while assets in fee-based brokerage programs increasing. This statistic suggests that growth in dual registration of securities brokers would have slowed over time, but probably not the debate over the appropriate standard.

Certainly, a loss in court wouldn’t have changed the views of many independent investment advisers and consumer groups that an unlevel playing field existed for investment advice. The question of whether they had the political muscle to do anything about it is a different matter. The lawsuit may have served as a catalyst in raising awareness to the point that Congress felt compelled to act. What we are witnessing today, assuming the SEC proposes a fiduciary standard, is a continuation of that debate, even if nearly everyone is embracing fiduciary conduct. The question now is will it be a strong or weak fiduciary standard?

FN: Why do you feel there has been such a dramatic increase in dual registration?
Thompson: Price compression on commissions in the ’90s really started the shift in the brokerage industry to asset management fees. The SEC’s requirement that brokerage firms offering wrap fee programs dually register as investment advisers served as the catalyst. On-line trades costing below $10 in the late ’90s no doubt increased the pressure on commission revenue. The FPA lawsuit that overturned the fee-based brokerage rule in the late 2000’s – some call it the Merrill Rule – forced many other registered reps to register as advisors so that now almost 9 out of 10 reps are dually registered.

FN: How does dual registration impact the fiduciary standard discussion? Would we be having this debate if we didn’t have the number of dual registrants we have?
Thompson: Dual registration affects the fiduciary debate since you often have the same firm or personal adviser subject to different standards. In addition, regulators have not policed the use of titles, increasing investor confusion over who acts in their best interest and who is a salesperson. What the number of dual registrants doesn’t take into account are the number of registered reps who are also insurance producers but do not hold all three licenses. Thus we are seeing many agents in the insurance industry face a potential fiduciary requirement for the first time.

FN: Why do brokers need to maintain dual registration?
Thompson: The broker-dealer exemption from the Investment Advisers Act is extremely limited, once ‘special compensation’ is received for investment advice (instead of a commission) that triggers the need for a broker to register as an adviser. There can be situations when a client obtains personalized advice from a broker, for which the broker must be registered, but also wants to maintain an active trading account without calling on the broker for advice. The trading account would typically only require the broker to be securities licensed. Providing personalized investment advice is a fiduciary function, non-discretionary trade execution is not.

FN: Since the Investment Adviser Act of 1940, RIAs have always been prohibited from transaction-based fees (like commissions). Why is this so?
Thompson: Dodd-Frank notes that receipt of commissions “in and of itself” is not a breach of fiduciary responsibility but, in practical terms, it is hard to avoid a fiduciary breach if compensation isn’t neutral. The conundrum is that commissions are, by definition, a form of incentive compensation but a sales incentive involves an inherent conflict of interest. Therefore, a fiduciary needs to find a way to eliminate the sales incentive that commissions are intended to provide. There are compensation leveling techniques to accomplish this but it is generally easier to simply charge an account level fee and avoid commissions altogether.

FN: Specifically, which brokerage transaction-based fees are more easily converted to asset-based fees and which one aren’t?
Thompson: A level fee for investment advice is the ideal situation, since it minimizes or avoids conflicts of interest. So the question becomes what commission-based activities are more conducive to a level fee engagement. In my opinion, if a commission-based broker is helping a middle-aged client implement a savings and investment plan for retirement, or managing the assets of a high net worth client, that kind of personal advisory activity would be more readily convertible to an asset management arrangement than a broker who is simply pushing an IPO to anyone and everyone. With regard to IPOs, the 1940 Act considers shares owned by a brokerage firm to be a ‘principal trade’ and the highest risk to clients. This restriction reflects to a certain extent the severe penalties under ERISA for self-dealing, in which the fiduciary benefits at the clear expense of the plan participants unless there is an established safe harbor.

FN: Thanks for sharing your thoughts, experience and wisdom on this matter. You’ve done an excellent job both explaining the history behind dual registration as well as why it’s an important concern today. If any readers were less than aware of the significance of this debate, they are most assuredly more enlightened as a result of your responses.

Readers interested in the first to parts of this series are invited to visit the following links:

Part I: Is Dual Registration the Cause of Opposition to the Fiduciary Standard?Part II: Will Broker Evolution Obviate the Fiduciary Standard Debate?

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


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