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.



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.



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.

Congress enacted the Dodd-Frank legislation in part because the public was outraged at how brokerage firms brought the global economic system to the brink of collapse. Dodd-Frank then asked the SEC to look specifically at whether the fiduciary standard (already imposed on RIAs) might be applied to brokerage firms in order to prevent the brokerage industry from giving us a repeat performance. The answer is obvious: Yes, this would be a great solution, a great way to protect consumer investors and the economic system from toxic products sold at a profit to unsuspecting buyers.

But this is far from the answer that the SEC provides. Instead, the Commission's "gold into straw" approach gives Congress a blueprint for cheapening the fiduciary standard for the convenience of the very corporations that helped trigger the mess to begin with, and in the process (by reducing the fiduciary concept to rulemaking and compliance), cheapening it for all other providers of investment advice.



On top of that, the SEC would impose on RIAs a lot of compliance activities designed to prevent churning and the sales of inappropriate investments and other activities that are already forbidden, much more efficiently and comprehensively, by the fiduciary standard in place. These new activities won't make fiduciary RIAs any more responsible for their clients' welfare than they already are. The only thing the additional paperwork would accomplish is to make it harder for independent fiduciary RIAs to manage a complex business, which makes them less competitive with the brokerage office up the street.

There's more to the study, of course, including a remarkable amount of concern by the SEC staff about preserving the brokerage industry's proprietary trading activities. What public purpose does it serve to have large brokerage firms competing with their customers for investment returns, recommending to customers what the firm wants to unload out of its portfolio and offering to buy cheaply from customers those investments its analysts believe are poised to go up in value?

And in one of the appendices, not long after the SEC has stated that it would need more resources to implement a variety of regulatory changes, we see that its RIA examination staff of 460 conducted 1,083 examinations of RIA offices in 2010. That comes to about 2.3 a year per staff member. Given that an extraordinary SEC examination might last two weeks, and most last less than five days, would it be possible for the agency to boost its productivity just a bit? If those staffers each conducted 10 a year (surely not an insurmountable number), then the SEC would put all RIA firms still within its regulatory ambit under a two-year examination cycle-with existing resources.

We should probably be outraged at the tone and recommendations of this report. But as I read through the SEC's recommendations, I'm mostly disappointed.

I want to live in a world where government regulators are focused 100% on making sure that the investment advice consumers receive is fair, well-informed and beneficial to their financial health. I want to live in a world where nobody would even think that it's right and fair to package and sell toxic investments until the global economy chokes into a near-death experience, where nobody puts lipstick on the pig.

The SEC's report tells me that we are a million miles away from that happy world. I guess I could live with that. Harder to swallow is that the SEC wants to move us even further.


Bob Veres is editor of Inside Information (, which helps advisors become more effective, efficient and successful by identifying best practices in practice management and client services.

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access