Executive Summary
With 2015 shaping up to be a potentially significant year for fiduciary regulation, recent comments by SEC chairwoman Mary Jo White suggests the SEC will soon begin to consider how to draft rules that could subject broker-dealers to a similar fiduciary standard as the one that applies to investment advisers. Most likely, this would occur by creating a “uniform fiduciary standard” that would apply equally to both groups, given that the lines between the two types of “financial advisors” have blurred to the point that consumers no longer understand the differences.
Yet the reality is that when advisors and salespeople are clearly labeled as such, consumers actually can understand the difference. We intuitively understand that the advice of a doctor or lawyer is different than the fashion “advice” of the salesperson in a clothing store or the nutritional "advice" of the person behind the counter in a butcher shop. And in fact, subjecting salespeople to an advice standard can create more problems than it solves, whether it’s making butchers become Registered Dieticians, or turning brokers into fiduciaries while they are supposed to still fulfill their actual role as brokers.
Accordingly, perhaps the better solution to the blurring of the distinction between investment advisers and brokers is not to subject them all to a single uniform fiduciary standard as "financial advisors", but instead to simply re-assert the dividing line between them. Let advisors be [investment] advisers (subject to the fiduciary rule that already exists), brokers be the salespeople they legally are, and rather than mixing the two let each hold out as such to the public - where brokerage salespeople are called brokers and investment advisers are called financial advisers - so consumers understand the true choice being presented to them. In other words, consumers don't deserve a choice between fiduciary and suitability; they deserve a choice between advisers and salespeople.
And notably, the rules already exist to create such a separation, under the Investment Advisers Act of 1940. Which means if the SEC merely enforced the existing rules as written, where any advice that is beyond being “solely incidental” to brokerage services would require investment adviser registration anyway, we could resolve today’s consumer confusion about financial advisors… without writing any new laws at all!
Confusing Advisor Titles And A Potential Uniform Fiduciary Standard
The Investment Advisers Act of 1940 (“the ’40 Act”) was intended to make a distinction between investment advisers who provided (ongoing) investment advice, and broker-dealers that were in the business of selling securities. Under the legislation, those who were in the business of providing investment advice for compensation were investment advisers, and registered representatives of broker-dealers were only exempt from registering as an investment adviser if any advice they provided was solely incidental to their business as a broker (or dealer) and they received no special (i.e., separate) compensation that could be construed as paying for advice services.
Because the two - investment advisers and brokers - were delivering substantively different services, they were also accountable to different (legal) standards. Investment advisers under Section 206 of the ’40 Act were expected not to engage in any acts that could be construed as fraudulent, deceptive, or manipulative – a provision that was ultimately interpreted by the Supreme Court in the case of SEC v. Capital Gains Research Bureau, Inc., to confer a fiduciary duty on such advisers. Alternatively, brokers were held to a simpler suitability standard - a rule designed to regulate salespeople by aiming to limit the sales of unsuitable products.
In the decades, since, though, the dividing lines of practice between registered representatives of broker-dealers and investment advisers has blurred, as brokers increasingly used a consultative (advice-oriented) selling process, and eventually began to fully adopt the comprehensive financial planning process and hold themselves out accordingly as financial advisors. The end result is that while several decades ago, a stockbroker would literally have “stockbroker” on their business card (and likewise an insurance agent would actually be an “insurance agent”), in today’s environment virtually all such advisors hold themselves out to the public the same way, with titles like “financial advisor”, “financial consultant”, “wealth manager”, or outright “financial planner”, regardless of their actual legal and job function.
This blending of the business models, and associated titles, was affirmed by a 2008 RAND study commissioned by the SEC, which indeed found that in the current environment, “investors typically fail to distinguish broker-dealers and investment advisers along the lines that federal regulations define,” and as a result consumers were generally unaware that “advisors” with similar-sounding titles could be subject to substantively different standards regarding the advice they provided and the solutions they recommended.
Accordingly, Section 913 of Dodd-Frank authorized the SEC to further study and consider whether to implement a “uniform fiduciary standard” for all investment advisers and broker-dealers, to eliminate the "gap" in regulatory standards given the substantive similarities of the advice services now being offered by investment advisers and brokers.
Separate Legal Standards For Advisors And Salespeople
The essence of the difference in regulatory standards between investment advisers and broker-dealers is that investment advisers are in the business of advice, and broker-dealers are in the business of selling products. Clearly, those who offer advice should have to act in the best interest of the person receiving advice – otherwise it’s not really advice!? – while those who are in the business of selling products and expected to try to sell their products and have a recognized conflict of interest around any “advice” they give regarding their products (but are generally still expected not to sell something that is just completely inappropriate).
Notably, though, while much has been studied and written about consumer confusion regarding the differences between “fiduciary” and “suitability” standards, when consumers understand the context of the service – advice versus sales – the difference is actually readily apparent. Trusted professionals who give advice, like doctors, attorneys, and accountants, are expected to give us “real” advice to benefit us. And everyone understands that when the sales rep in the clothing store says “that dress/suit really looks good on you” that their “advice” may be colored by the desire to complete a sale. Likewise for the car salesman who says “this is the best car for you” or the waitperson who says “this [more expensive] bottle of wine would really complement your meal better.” Of course, salespeople who really do give good guidance often produce the best (sales) results in the long run, but we all understand that any “advice” they offer should be taken with a grain of salt and is different than consulting a professional advisor.
Notably, even in situations where there is an overlap in the related products – for instance, both my butcher and my nutritionist may give me guidance on what to eat – there is little confusion about the nature of the “advice” from each. The nutritionist is expected to give me advice about what to eat in the interests of improving my health. And we recognize that butcher at least might be recommending the virtues of a particular cut of red meat because he/she happens to be in the business of selling meat.
The Problem With A Uniform Fiduciary Standard Under Dodd-Frank
The fundamental problem of a uniform fiduciary standard can be explained by extending the preceding example. Imagine, for a moment, that butcher shops began to rebrand themselves as “diet centers”, where the butcher was called the “lead dietician” but really only ever recommended the meat for sale in the butcher shop… and suddenly, there was concern that consumers were “trusting” the advice of their butchers too much, and buying (and eating) more red meat than was healthy, failing to recognize that the butcher’s “advice” was really just about selling the meat in his shop (his products) and not necessarily the same as the advice of a bona fide nutritionist.
Accordingly, a “uniform advice standard” is proposed that would require all butchers to become fiduciary diet advisors, go through the educational process to become a Registered Dietician, and that butchers could only offer advice about what to eat after going through a comprehensive analysis of the individual’s health, diet, and family history, to ensure the advice was in the best interests of the buyer.
Now imagine the outcome of this approach. A Registered Dietician is required to complete a bachelor’s degree, so any butcher who didn’t go to college would no longer be allowed to sell meat; in addition, all butchers would also have to complete a national examination, and go through a process of supervised practice to earn their dietician status. It’s not hard to imagine that imposing such requirements would reduce the number of butchers and butcher shops.
In addition, imagine the process of going in to purchase a cut of meat. Even if you know what you want, it’s no longer acceptable to just go up to the counter, chit-chat with the butcher about what’s fresh, and order a piece of meat; now it’s necessary to go through an entire intake and analysis process so the butcher can first conduct his dietician duties and evaluate your health, diet, and family history. You may know what you want to buy, but the butcher can’t sell it to you without going through the process. What should be a 1-minute transaction is now a 30-minute ordeal, with lines out the door, and most people unable to access a butcher in a timely manner even if they wanted (especially since, as previously noted, there will now be fewer of them). And of course, if the butcher has to take 30X as long for each sale of meat, you can imagine the drastic increase in what the butcher will have to charge to purchase a cut.
In a similar manner, organizations like SIFMA lobbying against the uniform fiduciary standard have made the case that a fiduciary standard for brokers could similarly limit consumer access to financial services products, drive up the costs for advisors to deliver services (because they would potentially have to spend more time gathering information from and analyzing each client before making a recommendation), while simultaneously reducing the number of advisors (as not all may be ready/willing to step up to the fiduciary obligation and the competency requirements it may entail). People who simply want to buy a financial services product would have more difficulty doing so, just as those shopping for meat from the butchers with dietician requirements.
To ‘resolve’ this challenge, SIFMA’s proposed (but flawed) solution has been to rewrite the fiduciary standard if a new uniform one is imposed on all investment advisers and broker-dealers, adjusting the new rules in a manner that can reduce the adverse impact to existing business models so consumers don’t lose access to purchasing financial services products and retain a choice of what type of provider to work with. Yet fiduciary advocates have raised a valid concern that rewriting the fiduciary rules could ultimately undermine the fiduciary standard as it exists today under the Investment Advisers Act; unifying through a “new” standard will inevitably end out being a lower standard, as the current fiduciary framework is watered down to the lowest common denominator (undermining the true consumer protections of a fiduciary in the process).
No Uniform Fiduciary Standard, Just Re-Separate Advisors And Salespeople?
While the example above illustrates the fundamental challenge of extending a (uniform) fiduciary standard meant for advisors to the context of product sales, it also indirectly illustrates the solution – which is not to subject butchers and Registered Dieticians to a uniform standard, but simply to limit the butcher from holding out to the public as the lead dietician of a diet center when in fact it’s simply a butcher in a butcher shop!
In other words, both advisors and salespeople serve an important function in society – sometimes, we really do just want to buy a cut of meat and need someone to take our order – and the solution when the distinction gets fuzzy between advisors and salespeople is not to subject them all to a uniform (lowest common denominator) standard, it’s simply to reassert the dividing line between advisors and salespeople so consumers understand the context of the services they are receiving, and let them choose!
Accordingly, the real solution for today’s confusing advisory landscape for consumers is not to require that brokers be subject to a (uniform) fiduciary standard for advisors, but simply for brokers to be required to hold out as brokers and not advisors in the first place. And just as brokers already must acknowledge to clients that they are not tax advisors and should see their accountant for tax advice, they should also be required to disclose that they are not financial advisors and should see a true financial advisor for such advice. In point of fact, New York City Comptroller Scott Stringer has just recently proposed that brokers should be required to disclose to consumers that they are not fiduciaries, though ultimately Stringer misses the point; the real disclosure is not just that the broker isn't acting as a legal fiduciary, but that the broker isn't acting in the capacity of being a financial advisor in the first place, since any advice is still solely incidental to their brokerage services!
Alternatively, if the broker really does continue to act as an advisor and holds out to the public as one, then the broker should be required to register as an [investment] adviser because that is the expectation being created for the consumer! And this is a significant problem in today's environment; as a recent report from the Public Investors Arbitration Bar Association (PIABA) noted, 9 of the largest major brokerage firms are advertising to the public with messages implying they give personalized financial advice as fiduciaries and not clearly communicating that they are primarily in the business of brokerage services.
In point of fact, this delineating between brokers and investment advisers is actually what the Investment Advisers Act of 1940 already requires – brokers whose advice is anything more than “solely incidental” to their brokerage services must register as an investment adviser, and be subject to the fiduciary standard anyway. Which means the real problem is not that brokers aren’t subject to the fiduciary standard, per se, but more simply that brokers are holding out as though they will give personalized investment advice and act like [investment] advisers without being held accountable by the SEC to register as such.
Notably, this also means the “solution” for today's consumer confusion is actually much simpler than rewriting the fiduciary standard into a new uniform one that can apply to both investment advisers and broker dealers and risks being undermined. It’s just a matter of actually enforcing the ’40 Act, as written, including the definitions of “solely incidental” that were a part the final 2005 “Certain Broker-Dealers Deemed Not To Be Investment Advisers” rule which actually stated that delivering financial planning or holding out as a financial planner would trigger the requirement to register as an investment adviser. Were such rules to be re-applied today, all CFP certificants would be forced to become RIA fiduciaries under the Investment Adviser Act of 1940 simply by virtue of holding out as giving personalized financial planning advice!
The bottom line, though, is simply this: the idea of a uniform fiduciary standard is flawed, because it seeks to apply an advice standard for two fundamentally different roles – investment advisers who are compensated for providing investment advice, and brokers who are compensated for the sale and distribution of securities products. The solution is not to resolve consumer confusion between the two by trying to subject them all to a uniform fiduciary standard, while rewriting the fiduciary rules to somehow “preserve choice” for consumers about a range of advisor business models. Instead, the reality is that both advisors and salespeople perform separate and different important services for consumers, and the real choice for consumers should be whether they want to work with an advisor or salesperson in the first place! Accordingly, perhaps it’s simply time for the SEC to enforce the “solely incidental” rule as it is written, and eliminate the consumer confusion by requiring brokers and advisors to be regulated based on how they hold themselves out to the public in the first place, so consumers can clearly understand the choice with which they are presented!
