Executive Summary
In the next key step of the progression towards a uniform fiduciary standard for all brokers and investment advisers in the delivery of personalized investment advice, the SEC has issued a request for data and information to conduct a cost-benefit analysis on the potential consequences of implementing such a rule. The analysis is expected to include not only an evaluation of the potential benefits to the consumer, and costs to the industry (which become indirect costs to consumers as well), but also the prospect costs and benefits of various approaches to harmonize regulation and oversight between the rules-based broker-dealer system and the principles-based fiduciary RIA approach.
What the outcome of the cost-benefit analyses will be, though, is still anyone's guess. While fiduciary advocates tend to emphasize the weaker advice and conflicts of interest inherent in the broker suitability framework, it's less clear how to precisely quantify the financial impact of such conflicts, and the exact amount that consumers could benefit from a fiduciary standard. Yet the reality seems to be that demonstrating a cost-benefit analysis that favors consumers may be crucial if fiduciary rulemaking is to move forward.
On the other hand, a strong cost-benefit analysis may show surprising results as well - for instance, is it really true that the fiduciary model is more costly, or could it actually be less costly to administer as so many gray ambiguous areas that result in consumer complaints would simply be outright disallowed? If the fiduciary model is more costly, why are so many brokers breaking away to start independent RIAs that appear to be more profitable, not less? Why is it that the volume of complaints appears to be greater against suitability-based brokers than fiduciary-based investment advisers if fiduciary is really a "higher cost" model? Could the truth really be that a higher standard that eliminates ambiguity may actually result in lower costs to consumers?
Ultimately, the comment period will remain open for four months, so expect to hear a lot more about this issue as various organizations submit their own cost-benefit studies. And if you're interested, you can submit your own comments as well through the SEC's website.
SEC Release No. 34-69013, File No. 4-606, issued on March 1st, represents the SEC's formal request for data and other information relating to the potential implementation of a uniform fiduciary standard for brokers and investment advisers, pursuant to Section 913 of Dodd-Frank. Although Dodd-Frank originally just mandated a study on the potential benefits of a uniform fiduciary standard, the results of the study issued in January 2011 recommended that the SEC move forward with a uniform fiduciary standard. However, the SEC has made little progress since then, both due to intensive fighting from lobbyists, what appears to be a general uncertainty about how best to proceed given the wide ramifications, and a trepidation from the SEC that any rule it issues will be challenged in court and struck down anyway. The latter has been especially problematic given the SEC's string of recent court losses, including most significantly in July 2011 on the so-called "proxy access rule" which would have made it easier for shareholders to nominate company directors - the key issue in the case was the court's determination that the SEC's cost-benefit analysis was weak, and even since that turning point the SEC has been wary to issue new rules without such a study.
Of course, the difficulty in this context, especially for those who advocate on behalf of a stronger fiduciary standard, is that it's far easier to quantify the potential costs of fiduciary than the benefits. The SEC's request tries to set a framework for such an analysis, to at least help to ensure that various studies which are submitted - and which may show contrasting results - are at least done in a relatively consistent manner so that they can be compared. Nonetheless, the challenges are significant in trying to figure out what might have happened or how investors might have done if brokers or investment advisers were subject to a different standard than they are. In other words, it's one thing to state that brokers have certain conflicts of interest under a suitability standard, but another to actually quantify exactly how much more money investors in the aggregate might have had were such conflicts not present, and especially given that any/all advisors still expect to get paid something for their work. The matter is even more complicated if the alternative for investors was simply to end out in "better" investments; how exactly does one rigorously quantify the amount of additional return for investors who get "less conflicted" investment solutions? In addition, the reality is that some aspects of benefit for the consumer really are adverse "costs" to the industry; for instance, if a uniform fiduciary standard does generally result in lower costs for consumers, it does mean the potential loss of revenue for the industry at large, and therefore some amount of advisor attrition that would have to be replaced to maintain consumer access to advice.
On the other hand, perhaps a thorough cost-benefit analysis will challenge or undermine some of the criticisms that have been put forth about the potential industry problems of a uniform fiduciary standard. For instance, the implication from the broker-dealer community all along has been that a fiduciary standard would be more expensive to administer, which in turn would be reflected in higher costs for advisors to do business, which would lead to higher minimums to work with advisors, and in turn could result in less consumer access to financial advice in the first place (and potentially put some advisors out of business). Yet this concern seems in stark contrast to the trend of breakaway brokers and the dramatic growth in recent years of the RIA channel; if fiduciary is so much more expensive, why are more and more advisors adopting its standard in such high numbers? Is it possible that perhaps the higher standard of RIAs simply makes so many questionable activities outright illegal that the challenges of compliance are actually easier and less costly to implement, and that advisors have been gravitating to the RIA model because it is more profitable and represents a lower cost way to deliver advice to consumers?
Similarly, when we look to the volume of consumer complaints, the frequency of litigation (or arbitration), and the damages awarded, it's not clear at all that being subject to a fiduciary liability results in a more costly model. Perhaps a part of the cost-benefit analyses submitted will look at why it is that there appear to be more complaints against brokers than against investment advisers, even though the latter are subject to a higher standard? Unfortunately, this data - especially with respect to which leads to not just more complaints but greater monetary damages that have to be paid to consumers - will be distorted by the limited information available from the brokerage channel due to its history of using opaque arbitration and industry-friendly arbitration panels that may mitigate the damages awarded to consumers. Nonetheless, the implication remains that perhaps having a lower, more controversial standard with more grey areas may actually be the more costly way to deliver advice to consumers, and that a clearer fiduciary standard can reduce both the cost and the amount of harm inflicted on the public - especially when paired together with an increase in investment adviser examinations as mandated under Section 914 of Dodd-Frank to reduce any incidences of fraud or theft of client assets.
Another challenge is that even with a more uniform standard between investment advisers and brokers, there is a significant difference in how rules are administered across the channels, given the largely rules-based structure for brokers and the principles-based approach under the Investment Advisers Act of 1940. As a result, another aspect of both the cost-benefit and potential rulemaking is the "harmonization" of regulatory oversight between the two groups, which many fiduciary advocates and RIAs fear will result in a more costly rules-based compliance structure similar to what FINRA applies to broker-dealers; on the other hand, some have suggested that the principles-based regulation of RIAs is too loose and that a greater rules-based process is necessary for both consumer protection and to ensure that large organizations can properly oversee their broker-advisers if there is a uniform fiduciary standard. In any event, the reality seems that any analysis of the costs and benefits of a uniform fiduciary standard will also include costs and benefits of how best to regulate such a standard across both channels in a consistent manner; the recommendation of the Section 913 SEC study was that harmonization should occur where "harmonization appears likely to enhance meaningful investor protection, taking into account the best elements of each regime."
Ultimately, it's still possible that no rulemaking will happen at all in the end; Dodd-Frank still only mandated the issue be studied, not that a rule move forward, especially if the findings of a cost-benefit analysis suggest that the costs simply aren't worth the benefits implied by the SEC's 2011 study. Nonetheless, the SEC's progression forward on rulemaking suggests that a uniform fiduciary standard is still on the table. However, the outcome of cost-benefit analyses may still have significant sway in determining whether/which version of a standard is adopted, and how regulations are harmonized to oversee it. Expect to see SIFMA, the Financial Services Institute, the Institute for the Fiduciary Standard, the Financial Planning Coalition, and other organizations weigh in over the next four months (the comment period is open for 120 days).
Those interested in submitting comment or feedback on the request for information can do so using the SEC's Internet comment form, or send an email to [email protected] (and include File Number 4-606 in the subject line).
Michael,
I wonder if the E & O carriers might be a good source of data. Which business model do they view as the higher risk? How is that reflected in premiums?