As the Obama administration prepares for its next four-years, this much is clear: The fiduciary standard is worse off today, as compared to four years ago, in its position in federal rulemaking and the public square. Fiduciary proponents need to regroup and rethink how to best move forward and prevent a repeat.
Under an Administration that takes pride in curbing Wall Street excesses, it is particularly disheartening that the position of the fiduciary standard in regulatory rulemaking is weaker and the position of fiduciary skeptics and opponents is stronger as compared to four years ago. Rulemaking at the Department of Labor and the SEC stalled under opposition; the outlook in each agency is uncertain. Statements about the fiduciary standard from skeptics or opponents were, generally, either unsubstantiated or dubious on their face, or just plainly inaccurate – but they carried the day in Washington.
This outcome was not preordained. Recall four years ago. Lehman Brothers folded in mid September, unemployment rolls increased by 603,000 in October to 10.1 million. On election day, Barack Obama swept into office, carrying heavy Democratic majorities in both houses of Congress (257-178 in the House, 59-41 in the Senate). After the 2008 election, Democrats held greater sway in Washington than at any other time since Lyndon Johnson swamped Barry Goldwater in 1964.
Early signals indicated that the Obama Administration intended to prioritize advancing fiduciary duties in financial reform. The Department of Treasury’s June 17, 2009 paper, “Financial Regulatory Reform,” recommended establishing “a fiduciary duty for broker-dealers offering investment advice and harmonize the regulation of investment advisers and broker-dealers.” The next day newly appointed Securities and Exchange Commission Chairman, Mary Schapiro, came out foursquare advocating the necessity for and virtues of the fiduciary standard for all those rendering “personalized investment advice about securities.”
Skeptics and opponents coalesced around certain arguments to, at minimum, stall rulemaking. It is important to recall these argument because they matter. Some opponents expressed support for disclosures and a commercial standard. This tactic was evident in a DOL public hearing, March 1 and 2, 2011. Here, fiduciary advice under ERISA, it is argued, should be treated in law no differently than a commercial sales transaction. This implicitly means the client experience and expectation discussing retirement planning with a fiduciary should be no different from any other sales situation, like the department store experience and expectation when buying that perfect sofa and love seat.
Skeptics and opponents of the fiduciary standard often express concerns of costs, and question whether the benefits exceed the alleged costs they associate with the fiduciary standard. The SEC Staff Study in January 2011 fastidiously evaluated comment letters. On the issue of cost concerns, the Staff Study makes a key point that is often forgotten. It is this: “None of the commenters provided any quantification of such anticipated costs” (emphasis added). So, while many commenters expressed cost concerns, no commenters expressed cost figures, or even, it appears, a ballpark cost estimate.
The Securities Industry and Financial Markets Association (SIFMA) wrote to the SEC on July 14, 2011, a 24-page, “Framework for Rulemaking.” Here, SIFMA’s leading priorities are made clear: Access to and choice among a wide range of products and services is paramount; as is being “business model neutral.” When conflicts of interest exist, “broker-dealers and investment advisers should be able to provide disclosures to customers in a pragmatic way.” The letter is striking in its candid expression of priorities that are essentially unrelated to fiduciary principles.
What is notable, actually glaring, is what SIFMA excludes. SIFMA’s letter is absent statements reflecting on the importance of long-established principles in fiduciary law, principles that have been cited by Supreme Court jurists. No where do we find explicit mention or reference to the vital importance of principles of loyalty, due care, and good faith, or ways to avoid or mitigate conflicts.
What is also noteworthy is SIFMA’s rationale to justify a broker-dealer standard is weaker than the 40 Act. This rationale is the foundation of it framework, and it is flawed. SIFMA incorrectly reasons that as Dodd Frank does not require the SEC to impose the Investment Advisers Act of 1940 on broker-dealers, SIFMA’s standard may be weaker than the 40 Act. This is in error.
Dodd Frank requires the SEC apply a standard on broker dealers that is “no less stringent” than the Investment Advisers Act of 1940. “No less stringent” permits the standard to be dissimilar to the 40 Act. Yet, it also means what the words plainly say, and the words say “no less stringent.” This is to mean, at the minimum, equivalent.
SIFMA states init supports “the establishment of a uniform fiduciary standard.” Is this a fair statement? Is it an unsubstantiated or dubious claim? SIFMA’s own explanations reveal a standard that is, in vital respects, a commercial sales and not the fiduciary standard. It is a standard not remotely “equivalent” to the 40 Act, as required by Dodd Frank.
Despite the historic political realignment and the financial crisis of four years ago, and despite the gallant efforts of many dedicated regulators and fiduciary advocates, the fiduciary standard is weaker today within federal regulatory rulemaking and the public square, and fiduciary skeptics and opponents are stronger. The fiduciary standard is weaker because the repeated dubious claims and inaccurate statements took hold in many quarters. While massive lobbying from insurance companies and broker-dealers took its toll, that’s not the whole story.
Dubious claims took hold largely because they were not effectively rebutted. So they drove much of the discussion. They drove the discussion far away from the relevant legislative and regulatory history, the law, reams of credible independent research, and the vital role of the fiduciary standard and culture in inspiring investor trust. They drove, instead, towards an alternate reality where the commercial sales standard is better for investors than the fiduciary standard; imagined additional costs just appear; contrived scenarios of empty shelves at the financial supermarket loom large; disruptions in the capital markets and untold investor harms are manifest. Dubious claims finally morphed into images of investors stranded, abandoned by brokers not able to afford to put the best interest of their clients first.
What can be done? Four steps could help ameliorate this situation. The steps are: Redirect the discussion; reset the issue and broaden access; rebut dubious claims; and urge the profession to lead the defense of the fiduciary standard.
Redirect the Discussion. Advocating that brokers rendering investment advice meet the fiduciary standard steers attention to how brokers conduct themselves. Attention to their “suitability” standard, their businesses, their services, and their best interests. This focus on brokers, by itself, offers little insight into the public policy discussion of society’s interest in the fiduciary standard.
Society’s interest in a robust fiduciary standard that undergirds a financial system that embodies integrity and accountability and merits investors’ trust is nothing if not profound. The discussion of the fiduciary standard should start by reminding policy makers of why this is so — why the fiduciary standard exists and matters. It must focus on how applying the fiduciary standard to brokers reinforces a trustworthy financial system, which in turn is essential to a market economy, especially one that has created more wealth for more individuals than any in world history. To do so we need to step back from the narrower conversation comparing standards of conduct and different business models and their impact on private interests, and instead take a broader view that focuses on the principles and values underlying our financial and economic system. A view that focuses on the public interest.
Reset the issue and broaden access. Advocacy against “suitable” investment advice inherently discourages wide participation. (One, unfamiliar with the nuanced differences in play, may well ask, “What, again, is wrong with being suitable?”) It has become largely an insiders issue, with low levels of engagement outside the industry and predictable lines separating key groups. Republican and business groups are generally on one side, and Democrats and “consumer” groups are generally on the other side.
This alignment of interests can fundamentally change by resetting the issue. Instead of an argument between fiduciary and suitability that very few understand well, fiduciary proponents can reset the issue between fiduciary conduct that inspires investor trust, as opposed to conduct that is questionable, unreasonable or unethical and fails to put investors interests first.
This is an issue that, it appears, many people understand and care about. Signs are ubiquitous. One area where signs offer a glimpse of the potential opportunity in resetting the issue is the number of well known conservative scholars, pundits and activists who have written about or spoken about different examples of bad behavior on Wall Street, and / or offered remedies which include more regulation in the form of breaking up the big banks. These expressions may simply coincide with opinion research which suggests grassroots conservatives are not enamored by Wall Street. Or they might suggest something far larger about the political landscape regarding Wall Street.
Rebut dubious claims. While new research and analysis will add to the discussion moving forward, the dubious claims and inaccurate statements currently on the record need to be addressed. Rebutting characterizations, facts, logic or legal reasoning that are weak or faulty is important. Not doing so would be a mistake and have consequences. One of the consequences would be a continued movement towards acceptance of the false and harmful notion that requiring a fiduciary standard of conduct in investment advice is bad for investors, and conflicted advice is good for investors.
Urge the profession to lead. Tough and smart regulation is necessary to maintain the integrity of the fiduciary standard. However, regulation, in and of itself, is insufficient to building a profession with the highest standard practices. More needs to be done. The profession needs to do more to lead the defense of the fiduciary standard by exercising the leverage and using the tools that it alone possesses.
Fiduciary proponents should regroup and rethink how to best move forward in light of the past four years. Though outgunned in pure lobbying firepower, fiduciary proponents have important assets and allies, not least of which is a better idea and an administration committed to reform. We can regain lost ground and positively effect the landscape, lay the groundwork for future rulemaking, and expand the coalition of groups who understand why the fiduciary standard is profoundly important to the country. In so doing, we can move towards ensuring that all investment advice is fiduciary advice.
Knut A. Rostad is president of the Institute for the Fiduciary Standard. Mr. Rostad will release a paper on this topic next month.
