During the third week of January, the financial advisor community found itself with some required reading-two regulatory agencies released three long-awaited studies required by the Dodd-Frank Act. The GAO authored the first, on regulating financial planners; the SEC prepared the second, on the oversight of investment advisors, specifically whether a self-regulatory organization (SRO) is warranted; and the third, also penned by the SEC, was on the appropriate standard of care for investment advisors and broker-dealers.
The third study is garnering the most attention and will have the most impact on the industry. In that study, the SEC recommended that investment advisors and broker-dealers be held to a uniform fiduciary standard of conduct. The SEC will also look to "harmonize" investment advisor and broker-dealer regulations associated with the uniform standard.
DODD-FRANK STIPULATES . . .
Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) required the SEC to evaluate, among other things:
* The effectiveness of existing legal or regulatory standards for providing investment advice;
* Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards;
* Whether retail customers understand the differences in the standards of care that apply to investment advisors and broker-dealers;
* The regulatory, examination and enforcement resources to uphold standards of care;
* The potential impact on retail customers on their access to products and services offered by broker-dealers; and
* The potential additional costs to retail customers if there were changes in regulatory requirements.
Two key tenets guided the SEC's evaluation which, in turn, shaped the agency's final recommendations:
* "The regulatory regime that governs the provision of investment advice to retail investors is essential to assuring the integrity of that advice and to matching legal obligations with the expectations and needs of investors."
* "Investors have a reasonable expectation that the advice that they are receiving is in their best interest. They should not have to parse through legal distinctions [emphasis added by author] to determine whether the advice they receive was provided in accordance with their expectations."
As required by the Act, the study included a comprehensive review and analysis of the differences between the standards of conduct for an RIA and a broker-dealer. The study included input from more than 3,500 letters received by the SEC, and from meetings with numerous representatives from the financial services industry, state regulators, professional associations and SROs.
ONE STANDARD OF CONDUCT
Based on its comprehensive review, the SEC concluded that both investment advisors and broker-dealers should be held to a uniform fiduciary standard of conduct. Specifically: "The standard of conduct for all brokers, dealers and investment advisors, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer or investment advisor providing the advice."
The SEC identified several benefits associated with a uniform fiduciary standard of conduct. It will:
* Heighten investor awareness and consumer protection;
* Accommodate different business models and fee structures;
* Preserve investor choice, without decreasing the investor's access to existing products or services; and
* Require that investors receive investment advice that is given in their best interest, under a uniform standard, regardless of the regulatory label of the professional providing the advice.
The SEC's next step (purportedly to take place over the next six months) is to engage in rulemaking to address the two primary components of the uniform fiduciary standard of conduct. They are the duty of loyalty and the duty of care.
In the duty of loyalty, the SEC will decide if rulemaking should prohibit certain conflicts, require firms to mitigate conflicts through specific action or impose specific disclosure and consent requirements. In the duty of care, the SEC will consider specifying minimum baseline standards of professionalism.
HARMONIZED REGULATION
In addition, the SEC will look to "harmonize" investment advisor and broker-dealer regulations associated with the uniform standard. [It's important to note how the SEC uses certain terminology: The term "universal" is associated with the standard of care; and the term "harmonized" is associated with the regulations.] The harmonization of regulations will include such subjects as:
* Advertising and communications;
* Use of finders and solicitors;
* Supervision;
* Licensing and registration;
* Continuing education;
* Books and records;
* Principal trading;
* Code of ethics [which actually is a code of conduct because it is based on rules, not principles]; and
* Policies and procedures manuals.
SOME TWEAKS
So has the SEC gotten it right? There are a few caveats. First, the SEC has said that the uniform fiduciary standard of care will apply when the investment advisor or broker-dealer is providing "personalized investment advice." I think the definition may be too broad. The SEC should consider tightening the definition to read, "comprehensive and continuous investment advice."
Such a change would be consistent with the SEC's definition of assets under management: "'Assets under management' is defined as the securities of portfolios for which the advisor provides continuous and regular supervision or management services."
Furthermore, "comprehensive and continuous" parallels the language used by the CFP Board and FPA to define when a fiduciary standard is applicable to financial planners. CFP Board, Rules of Conduct 1.4, says, "A certificant shall at all times place the interest of the client ahead of his or her own. When the certificant provides financial planning, the certificant owes the client the duty of care of a fiduciary as defined by CFP Board."
The study also acknowledges the potential negative impact a uniform standard could have on many broker-dealer business models, and the SEC stated it will attempt to mitigate the impact through rulemaking. I believe the easiest solution is to adopt the "comprehensive and continuous" language proposed above. Most of the concerns raised by broker-dealers were related to the execution of trades and the selling of financial products, which would fall outside the scope of the proposed "comprehensive and continuous" language.
Finally, although there are two references to the ERISA fiduciary standard, the study did not take into account that investment advisors and broker-dealers also may be subject to fiduciary standards when advising personal trusts, foundations and endowments. If we are to define truly uniform standards and promulgate harmonized regulations, then the standards and regulations should apply to any client engagement, not just retail clients.
Overall, I believe the SEC got it right. The study also provides a measured response to broker-dealer concerns. Like any Washington study, there will be compromises, and no clear winners nor losers, with one major exception-investors. A uniform fiduciary standard of conduct, coupled with harmonized regulations, should dramatically improve the process for investors.
Donald B. Trone is CEO and founder of Strategic Ethos and founder of the Foundation for Fiduciary Studies.
