Fiduciary Standard and Selective Amnesia at the SEC

I just finished reading Knut Rostad’s insightful post on regarding the ongoing debate over a uniform fiduciary standard for both stockbrokers and investment advisers. For those unfamiliar with Knut, he is the President of The Institute for the Fiduciary Standard. He has been championing the need for a uniform fiduciary standard that would require that both stockbrokers and investment advisers would be required to always put a customer’s interests first. Currently, stockbrokers are allowed to put their own financial interests ahead of those of their customers.

Knut’s post discussed the financial services industry’s ongoing campaign of misinformation regarding both the need and impact of a uniform fiduciary standard. The industry claims there is no need for such a standard, that everything is fine. The industry claims that such a standard would cause harmful cost increases for the industry and would reduce the number of stockbrokers who would provide advice to the public.

The annual number of court actions and arbitration cases clearly shows that things are not fine. The SEC has reported that their request for information regarding the increased costs that would be associated with such a standard produced little response. This should not be surprising, as the claim has no merit. Most broker-dealers have proprietary investment adviser firms or they allow their brokers to maintain independent advisory firms. Therefore, they are already required to review trades by brokers under the fiduciary standard’s “best interests” criteria pursuant to either the Investment Advisers Act of 1940 or NASD Notice to Member 94-44. Consequently, there should be little or no additional costs to broker-dealers under a uniform fiduciary standard.

The industry’s claim of reduced financial advisers to serve the public is pure speculation. As a trial attorney, courts do not allow purely speculative to be considered. As a former compliance director, I seriously doubt that brokers are going to walk away from any sort of compensation, at least honest brokers. As for those brokers who would not be willing to provide investment advice to the public under a “customer’s best interests first” standard, they should not be providing advice in the first place. If the SEC stays true to its stated mission statement of protecting the public, then the emphasis should be on quality of advice, not quantity.

Another article regarding the debate over a uniform fiduciary standard involved comments attributed to SEC Commissioner Daniel Gallagher. Commissioner Gallagher reportedly stated that he was unconvinced of the need for such a standard. Commissioner Gallagher reportedly based his statements on a lack of evidence regarding abusive practices by the brokerage industry. Commissioner Gallagher reportedly stated his opinion that the brokerage industry was being unfairly targeted, that “advisors are always seen as pure and brokers are seen as miscreants.”

I’m not sure where Commissioner Gallagher is getting his information, but again, as both a former RIA Compliance Director at one of the nation’s largest indie broker-dealers and a securities attorney, the simple truth is as with most industries, there are honest and dishonest in both the financial service and investment advisory industries. Furthermore, Commissioner  Gallagher’s call for additional information is troubling, as he need do nothing more than visit the SEC’s enforcement division and Finra’s enforcement division to uncover whatever evidence he needs.

However, I do not believe Commissioner Gallagher or, for that matter, Chairwoman White or any of the other SEC commissioners, need any additional information of the history of abusive practices within the financial services industry. I do, however, believe that they should take a refresher course in the stated mission and purpose of the SEC.

While the SEC’s home page proudly proclaims to be “The Investor’s Advocate,” recent history would seem to indicate that the SEC has become more “The Investment Industry’s Advocate,” at least with regard to protecting investors. In 2004, the SEC enacted a controversial exemption allowing broker-dealers to effectively act as investment advisors without registering as required by law. The exemption would have allowed broker-dealers to act as investment advisers without requiring them to comply with the “best interests of the customer,” or fiduciary, standard. Fortunately, the Financial Planning Association successfully sued the SEC, with the federal courts revoking the exemption and ordering the SEC to enforce the law as written.

With the current debate over a uniform “best interests” fiduciary standard, perhaps Madame Chairwoman and the commissioners should review the commission’s home page.

The main purpose of the Securities Act of 1933 and the Securities and Exchange Act of 1934 can be reduced to two common-sense notions, [one of which is that] people who sell and trade securities-brokers, dealers, and exchanges must treat investors fairly and honestly, putting investors’ interests first.” (emphasis added.)

Commissioner Gallagher’s statements notwithstanding, the obvious disregard for both the commission’s stated purpose and mission is even more puzzling given the fact that Finra, the entity primarily responsible for overseeing broker-dealers, clearly stated in Notice 12-25 that broker-dealers and their representatives must always act in the “best interests” of their customers. Consequently, a uniform fiduciary standard would simply reinforce Finra’s position. Finra’s position also either weakens the industry’s ‘increased costs” and “reduced advisors” claims or indicates that such claims are an admission that broker-dealers and their representatives have not been in compliance with Finra’s regulations.

Commissioner Gallagher is correct when he references the problem with dishonest brokers and investment advisers. Enacting a uniform fiduciary standard is not going to stop such activity. However, a uniform fiduciary standard will avoid the confusion investors face over what duty, if any, is owed them. A universal fiduciary standard will make it easier for regulators and investors to successfully address the unethical and dishonest brokers and advisers. As Dr. Martin Luther King, Jr. pointed out,

[m]orality cannot be legislated but behavior can be regulated. Judicial decrees may not change the heart, but they can restrain the heartless.

Despite Commissioner Gallagher’s selective amnesia, the financial service’s abusive practices and the resulting need for a uniform fiduciary standard to better protect investors are well-documented. Commissioner Gallagher’s position is inconsistent with the common-sense positions set out on the commission’s home page. Common-sense says that having two standards for groups providing the same services is ludicrous. Common-sense indicates that adopting a uniform fiduciary standard is both fundamentally fair for investors and, in truth, imposes no hardship on broker-dealers and their representatives other than having to treat investors fairly, as guaranteed by securities laws.

In Knut’s post, he references a statement by Scott Curtis, Raymond James’ President, to the effect that a uniform fiduciary standard would not be healthy for the brokerage industry. However Chairwoman White and the other commissioners should remember the mandate announced in 1949 in the decision in Norris v. Hirshberg v. SEC, namely that the federal securities laws were meant to protect the public, not broker-dealers.

Common-sense dictates that the SEC adopt a uniform fiduciary standard in furtherance of its purpose, protecting the public. Here’s hoping the SEC listens to the wise words of former Supreme Court Justice William O. Douglas-“common-sense often makes good law.”

About jwatkins

I am a securities and ERISA attorney. I am a CFP Board Emeritus™ and an Accredited Wealth Management Advisor™. I am a 1977 graduate of Georgia State University and a 1981 graduate of the University of Notre Dame Law School. I am the author of "CommonSense InvestSense: The Power of the Informed Investor" and " The 401(k)/403(b) Investment Manual: What Plan Sponsors and Plan Participants REALLY Need To Know. " As a former compliance director, I have extensive experience in evaluating the legal prudence of various types of investments, including mutual funds and annuities. My goal is to combine my legal and compliance experience in order to help educate investors and investment fiduciaries on sound, proven investment strategies that will help them protect their financial security and/or avoid unnecessary fiduciary liability exposure.
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