Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
This is the story of the implications of fiduciary best interest dying at the SEC.
In June, it will be five years since the SEC’s Reg BI premiered. The rule was supposed to require brokers to provide a higher standard of care for clients.
It has not.
No surprise here. Reg BI was sold on the fallacy that it is based on fiduciary principles and offered a best-interest standard. In fact, Reg BI was built on brokerage sales principles and swept away the meaning of fiduciary best-interest principles.
The surprise is the reach of Reg BI. Reg BI’s impact is not limited to a brokers’ customers. Reg BI undermines the values, beliefs and practices anchoring the principles that fiduciaries live by.
Fiduciary principles provide the basis for minimizing conflicts and costs and requiring high technical and professional competence. They are vital but are dying at the SEC.
Independent RIA leaders must act to preserve and protect fiduciary principles.
Introduction
Since 2009, the SEC has diminished what “fiduciary” and “best interest” mean, while wrongly calling Reg BI, which is a broker suitability standard, a “best interest” standard. Consider two principles that anchored fiduciary for decades – but have now been scrapped.
The first principle is that conflicts of interest are inherently harmful and must be avoided if possible. How harmful? A senior SEC regulator (noted below) called conflicts a “mortal threat.” This steadfast principle is gone. Instead, conflicts are now deemed inevitable, unavoidable and acceptable. Conflicts are okay today.
The second principle is that advice and sales must be separated in regulation. This principle was the main rationale for the 40 Act, but it was swept away by Reg BI. The elimination of these two principles paint a very different picture of fiduciary best interest at the SEC.
History, law and common sense: Brokers and advisers are as different as sales and advice
Securities attorney Michael Koffler wrote in 2009, “Broker-dealers act for their own account or as agents of the issuer, principal under-writer, syndicate members or wholesaler . . . and are contractually obligated . . . to distribute the very securities that they provide advice and recommendations on to investors.”
For a more detailed discussion of changing standards see this white paper.
The difference: Brokers represent issuers or other parties, while advisers represent clients. Brokers are compensated by others to sell and distribute products; advisers are compensated by clients to advise them as fiduciaries.
This is why broker-dealer conflicts so clearly undermine objective advice, as the Supreme Court noted. This is why an SEC senior regulator called conflicts a “virus” that are a “mortal threat to the [advisor] body.”
Consider these fundamental beliefs held by the SEC:
Advisors are as conflicted as brokers
Forget decades of precedent and law, today the SEC claims brokers and advisors have similar conflicts. The SEC’s bottom line for advisors is simple: “Stop adjusting your halo! You are as conflicted as brokers.” the SEC has ignored legal precedent and asserted a new definition of conflicts. Today, conflicts of interest include transparent fees paid by clients.
The SEC’s Reg BI release in 2019 explained why conflicts should not be eliminated. “We did not mandate the absolute elimination” of any “particular conflicts” as “[w]e were concerned that the absolute elimination of specified conflicts could mean a broker-dealer may not receive compensation for its services.”
Brokers and advisors are much alike.
What does this mean? Think, “Advisors sell like brokers and brokers advise like advisors.”
Despite legal differences, the SEC has talked about brokers and advisor similarities since 2009. Then SEC Chair Schapiro claimed brokers and advisers are “Merging to the point of, in some cases, relative indistinguishability. This is certainly evident from the retail investor’s perspective.”
By 2014, the new thinking at the SEC seemed set. At a TD Ameritrade Conference, SEC Commissioner Pivovar told the audience: There is just a 2-3% difference between the suitability standard and what a new standard from Dodd-Frank legislation would mean.
Brokers and advisors meet the same standard
Reg BI was criticized at the outset for failing to do enough to raise standards. The Consumer Federation and PIABA said so. Reg BI has been shown to fail to according to research by NASAA, the state securities regulators, in 2023. A key finding is revealing:
Implementation continues; yet, “Firms are still relying heavily on suitability policies and strategies that predated Reg BI. Efforts to address the standard of care concepts established by Reg BI remain perfunctory.”
The SEC’s CRS requires language that states brokers and advisors are held to the same standard:
When we provide you with a recommendation as your broker-dealer or act as your investment adviser, we have to act in your best interest and not put our interest ahead of yours. At the same time, the way we make money creates some conflicts with your interests...
In 2022 the SEC warned RIAs against disclosing their fiduciary status, because doing so may be “extraneous” or “misleading.”
… The staff cautions against an investment adviser using the terms “fiduciary” or “fiduciary duty” where doing so would be extraneous or unresponsive to the particular item or would involve, or suggest, exaggerated or unsubstantiated claims, and any use of the terms must be accurate and not misleading. …
Embellishing factual statements about the capacity or services of an investment professional or firm with phrases such as “an investment adviser who is held to the fiduciary standard,” is likely to be inappropriate. Similarly, the staff cautions against describing the fiduciary duty as a “higher standard” or the “highest standard. … (Posted March 30, 2022)
Conclusion
Financial regulation is a team effort. State securities administrators (NASAA) and the DOL have vital roles and a keen appreciation that conflicts are inherently harmful to investors. Yet, the SEC is the main regulator for advisors and brokers and deserves special attention.
The SEC’s 15-year role in preparing for, enacting and implementing Reg BI has been transformative. Here is the track record:
- Legal and business differences that separate advisors and brokers’ purposes and practices have been swept aside and ignored. In required language in the CRS, the SEC stated broker-dealers and investment advisors meet the same standard.
- The scope, scale, magnitude and complexity of conflicts that opaquely incentivize the conduct of brokers-dealers and their reps have been ignored.
- The meaning of “conflicts of interest” has changed. Today it includes client-paid fees. This new definition defies common sense. It ridicules the case for “fee-only” compensation.
- Research in 2023 showed Reg BI has not changed BD suitability practices much at all.
- The SEC has warned advisors against using fiduciary in their CRS disclosure because mention of the word can be “extraneous” or “misleading.”
Many RIAs believe that Reg BI doesn’t matter much. They say, “Sure, it doesn’t raise broker standards and it heaps mounds of disclosure on investors that are not understood. My clients and prospects understand what we do.”
This is fair but incomplete. There is much more to the Reg BI story.
Reg BI has fundamentally changed how many investment advisors and brokers think about fiduciary best interest and about the meaning of conflicts, sales and advice.
Reg BI questions the values, beliefs and practices that make the fiduciary best interest standard common sense. It rejects what the law, precedent and common sense tell us.
This story must be told. The implications of what Reg BI means to planners and advisors – independent and dually registered – and consumers must be heard. We need to understand implications of ignoring fiduciary law, principles and practices – and effectively saying brokerage sales practices are in the customer’s “best interest.”
Two years ago, the SEC warned advisers against disclosing their fiduciary status on CRS. Legally, this is inexplicable. Leaders in the independent RIA advice profession have a vested interest in protecting and preserving fiduciary best interest principles – with or without the SEC.
Knut A. Rostad, MBA, is the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard through research, education and advocacy.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our videos.
More Fiduciary Rules Topics >
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.