An appeals court ruling that vacated the fiduciary rule was tragic for investors and prompted Wall Street trade groups to double down on calls for harmonizing regulatory standards.

Those opposed to the Department of Labor's regulation would prefer to see the SEC create a unified best interest standard for financial advisors and brokers (note, it's not a fiduciary standard). And SEC Chairman Jay Clayton said on Monday the court decision doesn’t affect his thinking about moving ahead on a rule. “The sooner the better,” he added.

However, the 5th U.S. Circuit Court of Appeals' reasoning for vacating the rule does matter, and it suggests the industry move in an entirely different direction. Rather than unite brokers and advisors under one all-encompassing standard, it may be time to differentiate them again. After all, the appeals court ruling restates the basic rationale of the Investment Advisers Act of 1940 — the need to distinguish and separate product sales from advice.

In writing for the majority in the 2-1 ruling, Judge Edith Jones focused on the definition of “advice" and recounted established legal precedent. The judge cited the scope of fiduciary responsibility under the Employee Retirement Income Security Act of 1974. A fiduciary "renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or any property of such plan.” The key here is compensation for advice.

The judge said that the Labor Department redefined this provision in crafting its fiduciary rule, claiming that the agency's definition of who a fiduciary is can include individual sales transactions. This, she said, is a far broader definition than Congress intended and is not permitted.

It is the difference between rendering investment advice for a fee and getting compensation from “any advice” associated with a sales transaction that matters. The judge said Congress was well aware of this distinction and, purposely did not include any advice.

The judge further drew out this distinction by highlighting what she said was the SEC’s basic concept “tying investment advice for a fee to ongoing relationships between adviser and client.” These relationships in the SEC's view, the judge notes, cultivates intimacy between advisor and client.

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In contrast, brokers who give incidental advice are not fiduciaries unless they've come to occupy a position of trust with their customers, the judge says.

The appeals court decision sets out a compelling rationale for why demarcation is the best way forward. Distilled, it is this: Incidental advice is not and cannot be real advice because of their opposing functions.

In a sales capacity, a broker-dealer represents issuers, whereas investment advisors represent clients. A broker-dealer — who is contractually obliged to the issuer and paid by the issuer, contingent upon completing sales to distribute products — sells products. He or she may not consider, much less appreciate, how or why guidance tied to a product recommendation is not real advice.

The cultures and languages of sales versus advice are too different to be joined by legal writing that, among other things, serves to cloak the very differences the appeals court decision explains are so important.

The judge argues for the logic and reasonableness in demarcation. Her ruling also argues for the central importance of reforming job titles, reinforcing a clear line between brokers and advisors.

Finally, it argues that it's time for these two groups to go their separate ways.

Knut Rostad

Knut Rostad

Knut Rostad is president of the Institute for the Fiduciary Standard