In mid-January, the SEC released its "Study on Investment Advisers and Broker-Dealers" to Congress. Analyzing the study provides an insightful look into how the SEC views the "harmonization" of two different regulatory structures.

When you finish the dissection process, the SEC's view is really not that complicated. The report makes few references to consumer protection. Instead it lingers on concerns about placing undue regulatory burden on the brokerage business model, on whether this or that proposal would disrupt brokerage industry operations, whether imposing a fiduciary standard would cause brokerage firms to bear the burden of additional costs and how that burden might be alleviated.

In addition, the report repeats the SEC's long-standing interpretation of the Investment Advisers Act of 1940-that (I am quoting directly from the report here) "a registered representative of a broker-dealer is entitled to rely on the broker-dealer exclusion [from registering as an RIA] if he or she is providing invest- ment advisory services to a customer within the scope of his or her employment with the broker-dealer." In other words, if you work for a brokerage firm, no matter how you provide investment advice or how you are compensated, you don't have to register.

I found this assertion remarkable because this exact interpretation was struck down by the U.S. Court of Appeals for the District of Columbia in March of 2007. As you read through the report, you realize that if the SEC would simply accede to the Court's interpretation of the 1940 Act, and require RIA registration by brokers who hold themselves out to the public as providers of investment advice and portfolio management, then more than 50 pages of expensive regulatory recommendations could be eliminated.

TWO BURDENS

Instead, the SEC wants to borrow "the best" from both the broker-dealer and RIA regulatory structures, and herein lies the biggest problem with its recommendations. The logic seems to be: If the brokerage firms are going to be burdened with a fiduciary standard of some sort, then it's only fair to burden RIAs with a lot of sales-related compliance that the brokerage firms currently have to deal with.

If the goal was to punish both business models equally for past misdeeds, then there might be some logic to this line of thinking. But it makes absolutely no sense if the SEC's focus is truly on consumer protection. By splitting the baby, the SEC plans to require "disclosures" of conflicts of interest, rather than banishing them altogether, and to engage in "rulemaking" that would specify a uniform fiduciary standard of conduct-replacing principles with rules wherever possible. It is the equivalent of spinning gold into straw.

If the SEC is totally focused on consumer protection (unfortunately, the report makes it abundantly clear that it is not), then the goal should be to do exactly the opposite: to replace rules with principles wherever possible. If we impose a fiduciary standard on retail brokers who provide advice, we can safely set aside most if not all of the regulatory rules-based baggage they currently operate under, and make the world much safer for their customers.

BROKER MISDEEDS

That assertion should not go unchallenged, so let's explore it for a moment. As advisors, we know (or should know) when we're violating basic principles of fairness and loyalty to our customers. Brokers know this too. When some wirehouse brokers talk, jokingly, about "putting lipstick on the pig," they know that they're slyly deceiving their customers. FINRA rules allow this behavior, but a fiduciary standard would not.

You've probably heard brokers tell an old joke about how the ideal investment product would benefit the customer, the broker and the brokerage firm, all at the same time. The punch line: "Well, two out of three ain't bad." Here again, we see with remarkable clarity that brokers know they aren't watching out for the best interests of their customers. They can follow the strict letter of FINRA's rules and engage in this behavior all day long. But if they must live up to a fiduciary standard, suddenly they have to face up to the reality behind the joke and change their behavior.

It is perfectly legal, under FINRA's rule-based consumer protections, to create packages of loans of dubious origin backed by borrowers whose resources and credentials are virtually unknown and largely uninvestigated, and make selling these questionable securities the most profitable division of your brokerage firm. Such behavior wouldn't pass the most rudimentary fiduciary smell test, and I think everybody-brokerage executives, brokers, regulators, RIAs and consumers-know this. Applying fiduciary principles is not rocket science.