On July 21, 2010, President Obama signed into law H.R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Although the Dodd-Frank Act does not immediately impose a fiduciary standard of care on broker-dealers, it does give the SEC the authority to do so. Specifically, Section 913 requires the SEC to compare the effectiveness of investment advisor regulation to broker-dealer regulation and establish a standard that is at least as stringent as current investment advisor regulations. The result is due to Congress by Jan. 21, 2011.

The word "harmonization" appears in Section 913, and a "harmonized" standard is the term the industry is using. It is important to define a fiduciary standard that looks beyond the Investment Advisers Act of 1940 and is consistent with existing fiduciary acts, including ERISA (Employee Retirement Income Security Act of 1974); UMPERS (Uniform Management of Public Employee Retirement Systems Act); UPIA (Uniform Prudent Investor Act); and UPMIFA (Uniform Prudent Management of Institutional Funds Act).

We also need to recognize that the typical investment advisor is not focused on a single market segment. An advisor may provide personalized investment advice to retail clients (the focus of Section 913), but these same clients may also be small business owners sponsoring a retirement plan (plan sponsors are subject to ERISA); they may serve as trustee of a personal trust (subject, in most states, to UPIA); or they may sit on the investment committee of a foundation or endowment (subject, in some states, to UPMIFA).

Each of these roles will have slightly different fiduciary requirements. But the compounding effect of such differences can be devastating to an investment advisor attempting to build an effective and efficient practice; hence the need to advocate for a harmonized standard that can be applied to any client setting.

THE BASICS

A fiduciary makes a commitment to judge wisely and objectively, and to ensure that all processes and procedures are congruent with the goals and objectives of the client. The rewards for being a fiduciary are not always apparent and not always commensurate with the level of effort, process and risk undertaken. This is the very essence of stewardship. A fiduciary standard is a continuous process that requires ongoing discipline to do the right thing, at the right time. This is the very essence of a covenant.

A word that consistently appears in these definitions and in existing fiduciary legislation is "process." A fiduciary standard applies when an advisor provides a comprehensive and continuous investment or financial planning process.

We believe that a harmonized fiduciary standard should not apply to every registered rep, nor to every client engagement; it should depend on the facts and circumstances, and be based on the services offered. The simplest example? Any services that include comprehensive, ongoing investment advice should be considered a fiduciary engagement.

We further believe that registered reps should decide which standard they are going to provide and then be required to provide that standard to each and every client. This opinion is driven by operational necessity; compliance departments would find it impossible to supervise reps if they all had certain clients covered by a fiduciary standard and other clients by a suitability standard.

FOUR PILLARS

Ordinarily, Washington allows an industry affected by new legislation to contribute to the details of any standards that emerge. We suspect that will be the case with the Dodd-Frank Act. The Foundation for Fiduciary Studies has released the 2010 Fiduciary Standard to serve as an initial rallying point.

Any standards development organization (SDO), such as the foundation, is interested in both consensus and substantiation. The public and the industry want to see consensus, whereas regulators and the courts are more concerned about substantiation. If the operative words are consensus and substantiation, the procedural words are what we refer to as the four pillars: principles, process, prudence and consistency.

Principles: Generally speaking, fiduciary standards are defined in terms of principles (as opposed to rules). There is relatively little specific law that governs the conduct of fiduciaries. Instead, fiduciary standards are based on several simple principles supplemented by industry best practices, regulatory opinion letters and case law.

There is a lot of speculation about FINRA's involvement with a harmonized fiduciary standard; that's understandable given its oversight of broker-dealers. However, if FINRA is going to be involved, there needs to be agreement on one rule: There will be no rules! Rules diminish principles. It's been demonstrated repeatedly that rules-based governance is inferior to principles-based governance. Need proof? Congress is governed by a code of conduct (rules), not a code of ethics (principles).