Broker/dealer trade group SIFMA fired off the latest round in the ongoing tangle over the fiduciary standard Thursday. The group sent a letter to the SEC that recommends creating for broker/dealers a modified version of the fiduciary standard that currently governs investment advisers. The new standard would accommodate the broker/dealer business model, SIFMA said, and how and when it applied would be determined by individual client contracts.
The fiduciary standard is a hot button issue for broker/dealers, investment advisers and investor protection and consumer groups. The standard, which requires that an advisor put the interest of his clients first, currently applies only to investment advisers under the Investment Adviser’s Act of 1940.
“There are those out there who continued to argue for the Adviser’s Act to be applied to the b/d community and that that should be the fix here, the solution,” said Ira Hammerman, SIFMA general counsel. “We strenuously reject that. We spent a lot of time in our letter explaining why the overlay of the investment adviser act to broker/dealers is not possible and is not what Congress meant to do,” he said. Indeed, in the letter, SIFMA lays out how case law and precedent would conflict with the exceptions Congress made for broker/dealer-specific activities in Dodd-Frank. “We’re not talking about preserving the status quo,” said Hammerman.
Barbara Roper, director of protection for the Consumer Federation of America, said she was encouraged by much of the content of SIFMA’s letter. “Ira and I used to have knock-down drag-out debates about whether the uniform standard should be fiduciary or suitability,” said Roper. “It would have been very easy for them in this political environment to get on board with those who are telling the SEC to slow down, or back off, or think small, so it’s a very positive thing for them to be out there with this message that they want the SEC to move forward,” she said.
Some of the details of the SIFMA proposal worry her, however—in particular making fiduciary duty subject to client contracts, and the degree to which SIFMA wants everything nailed down in rules. “The fiduciary duty does not permit the investor to sign away through a contract their fiduciary protection in a situation where it would otherwise apply,” she said. And, “We want the [fiduciary] principle to extend even where there is no violation of the rules.” Rules can always be gotten around.
David Tittsworth, executive director of the Investment Advisers Association, took a harder line. The fiduciary standard as defined by the Investment Advisers Act should not be modified at all to fit the broker/dealer business model, he said.
“SIFMA has argued for years that they oppose being subjected to the fiduciary duty under the Investment Advisers Act,” said Tittsworth. “Their latest letter does not offer any new evidence of why the well-established Advisers Act fiduciary duty will destroy their retail business model,” he said.
“In fact, for institutional clients, SIFMA argues that the Advisers Act fiduciary duty should not be modified at all,” Tittsworth continued. “But it does not explain why institutional clients, including mutual funds or pension funds that are managed for the benefit of retail individuals, should have a different fiduciary standard.”
SEC Mandate
Under Dodd-Frank regulatory reform, the SEC is authorized to extend the fiduciary standard to broker/dealers and their advisors “when providing personalized investment advice” to retail customers. Actual rulemaking isn’t expected to begin until the fourth quarter, but in January, the SEC released a study that recommended a strict version of that fiduciary standard be applied to broker/dealers.
Like Dodd-Frank, that study made clear that practicing certain broker/dealer activities, like charging commissions or selling proprietary products, would not in themselves constitute violation of the fiduciary standard. But it also emphasized a need to prohibit certain conflicts of interest (without defining which ones), rather than just disclose them to investors. The study seemed to suggest that such conflicts would be identified with the SEC’s help, over time, through interpretive guidance, rulemakings, enforcement actions and no-action letters. The report also emphasized the need, on the other hand, for new plain English and point-of-sale disclosures.
SIFMA was worried, it says in its letter to the SEC. “The Study raised the serious concern among our member firms that the SEC may be contemplating an ‘overlay’ on broker/dealers of the existing Advisers Act standard,” Ira Hammerman wrote in the letter. Such an overlay would “negatively impact choice, product access and affordability of customer services,” he writes. And it would be difficult for the broker/dealer model from commercial, legal and supervisory perspectives, he adds.
A New Standard
SIFMA’s proposed modified standard would accommodate certain business activities that are unique and fundamental to the brokerage model, like principal trading, IPO underwriting and fixed-income trading, Hammerman said. It would also govern the relationship between an advisor and client only after a written contract were drawn up between them. (It wouldn’t govern introductory discussions about the nature of the relationship.) And that contract would specify which activities are covered by the fiduciary standard, and which are not.
Let’s say, for example, that an investor held a huge concentrated position, in say, Apple stock—that it accounted for 30 percent of his portfolio. And let’s say the investor opted not to take his financial advisor’s advice to diversify out of that concentrated position. Then it might be written into the contract that the concentrated stock portion of his portfolio would not be subject to a fiduciary relationship, Hammerman explained in an interview with Registered Rep. Because otherwise, the advisor and the broker/dealer would be opened up to endless lawsuits, he said.
Roper objected that the fiduciary standard governs not the outcome, but the advice. “The fiduciary standard doesn’t say that the investor has to do what the advisor recommends,” she said. “It just says when the advisor offers advice, he has to adhere to the fiduciary standard.” In the case of the concentrated position, the advisor would just need to document the advice he offered about diversifying.
Meanwhile, SIFMA’s letter also posits that such a contract could specify that application of the fiduciary standard would be limited to “assets over which the broker/dealer has been given discretionary authority,” for example. That doesn’t follow the principles of the fiduciary standard, Roper said.
SEC Next Steps
SIFMA asks in its letter that the SEC’s rulemaking encompass the following steps:
1. Enunciate the core principles of the uniform fiduciary standard of conduct.
2. Articulate the scope of obligations under the uniform fiduciary standard of conduct.
3. Define “personalized investment advice.”
4. Provide clear guidance regarding disclosure that would satisfy the uniform fiduciary standard of conduct.
5. Preserve principal transactions.
It also lays out a suggested definition of personalized investment advice. What should qualify: communications to a specific customer recommending that the customer purchase or sell one or more securities; communications about securities to one or more targeted customers encouraging the particular customers to purchase or sell a security; technology that analyzes a customer’s financial or online activity and sends specific investment suggestions that the customer buy or sell a security; and discretionary decisions regarding securities bought, sold, or exchanged by the person or firm exercising investment discretion.
There is a much longer list of things that should not be considered personalized investment advice. A couple of things on the list: taking and executing unsolicited customer orders; market making, absent efforts to recommend the traded securities; underwriting, absent efforts to recommend the underwritten security; needs analysis (e.g. meetings to determine customers’ current and any new investment objectives and financial needs); seminar content that is not specific to a customer.
Finally, the study recommends the SEC provide clear guidance on what kinds of disclosures would work, and suggests a “layered approach,” with some disclosures at the point of sale and others on the Internet. “Detail can overwhelm key facts,” writes Hammerman in the letter. It also requests guidance on when written client consent would be required.
