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Mr. Chairman, “Rebuild the 40 Act Wall”
On July 25, 2018
By Knut A. Rostad
Originally posted on Advisor Perspectives, July 23, 2018
“Those who fail to learn from history are doomed to repeat it.”
RIAs must heed Churchill’s forewarning. The SEC’s proposed standards for brokers and advisors will erase the major rationale for the Advisers Act of 1940 – to differentiate advisors and brokers in regulation.
This is why RIAs need to remind the SEC how brokers and advisers differ. Just like butchers and dieticians or car dealers and Consumer Reports, advisers and brokers fill different roles in the same space.
Congratulations to SEC Chairman Jay Clayton for proposing these rules. They’re welcome. But as various commissioners suggested, they can be much improved.
The proposed rules were long in coming. On June 18, 2009, one day after the Treasury Department recommended that brokers’ personalized advice be held to the fiduciary standard, then SEC Chair, Mary Schapiro, embraced it.
Chair Schapiro said brokers and advisors becoming indistinguishable. This view has leaked into the standards and asserted in statements from former SEC Commissioner Paredes and SEC staffers Bob Plaze and David Blass. In 2014, Blass said, “I don’t think that the advisor fiduciary duty is higher than suitability.”
In 2015, in a Wall Street Journal interview, SEC Chair Mary Jo White reiterated this sentiment when she noted that brokers and advisors exhibit“essentially identical conduct.”
This is not right and investors know it. According to Financial Advisor magazine, Brian Smith (a retired Navy officer and AARP member) attended the recent investor roundtable in Washington and heard the SEC staff’s explanations. He was not pleased.
Smith wrote, “There was significant concern over the SEC saying brokers were acting in a customers’ best interest as opposed to an advisor acting as a fiduciary…. This is very confusing and misleading …. Saying someone is acting in your best interest when they may well be acting in their own best interest is just misleading.”
Officer Smith’s comments hit the mark. After all, legal, contractual, business and cultural differences divide brokers and advisors. Brokers who represent manufacturers are not the same as fiduciaries representing investors.
These differences are longstanding and hardly controversial. Investment counselors who helped craft the Advisers Act of 1940 knew it. They thought investors would confuse real advisors from salesmen who pretended to be advisors. One report at the time called brokers “tipsters and touts.”That’s why they built a wall to separate advisors and brokers.
The recent 5th Circuit Court decision to vacate the DOL Conflict of Interest Rule was widely supported by brokerage firms. The decision also echoed those sentiments in the contrast between fiduciary advice in an intimate relationship and incidental advice “merely as an incident to their broker-dealer activities.”
These differences are also natural, like two versus three. Our RIA Campaign for Investors highlights relationships of two versus three. Advisors are fiduciaries to clients and must be loyal at all times – no hidden partners. That’s two. Brokers are paid commissions to make sales to distribute issuers’ securities to investors. That’s three.
These are fundamental differences that are material to investors. To gloss over them is indefensible – a major lapse that begs to be corrected. I urge the SEC commissioners andChairman Clayton to listen to Officer Smith. Review the wisdom in the 40 Act. Restate how relationships of two and three differ. Reread Daniel Henninger’s 2012 article, No Guardrails, Again – with damaged investors in mind.
Mr. Chairman, rebuild the 40 Act wall.
This is not about being “conflict free.” There’s no such thing. There are no purely impartial “Mary Poppins” advisors – and advisors say so. This is about understanding the essential destruction that material conflicts will do wreak on competent and objective advice. It’s massive and well-documented in academic research.
Yet avoiding conflicts eludes brokers. I challenge any reader of this article to cite an example where broker-dealers urged brokers to avoid conflicts over disclosing conflicts. In fact, SIFMA has scolded the SEC for even suggesting avoiding conflicts may be a better choice.
The best advisors work very hard to avoid conflicts. They do because they know history and human nature. They do because they get what Carlo V. di Florio, then SEC OCIE director, meant in 2012 when he said, “Conflicts can be thought of as the viruses that threaten the organization’s wellbeing … and if not eliminated or neutralized, even the simplest virus is a mortal threat to the body.”
The Institute for the Fiduciary Standard
Welcome to the Institute for the Fiduciary Standard!The Institute is a nonprofit formed in 2011 to benefit investors and society through its research, education and advocacy of the fiduciary standard's importance to investors, our capital markets and economy. Six key fiduciary duties embody the fundamental elements of an investment fiduciary’s responsibility. Read More
Why an InstituteThe rationale for an Institute for the Fiduciary Standard is straightforward: The fiduciary standard is important, representing ideas central to our form of government and free market economy; it is under significant pressures from market forces that could sharply limit its reach; no other entity is solely focused on preserving and promoting the fiduciary standard. More...
The 6 Core Fiduciary Duties
- ‣ Serve the client’s best interest
- ‣ Act in utmost good faith
- ‣ Act prudently -- with the care, skill and judgment of a professional
- ‣ Avoid conflicts of interest
- ‣ Disclose all material facts
- ‣ Control investment expenses
Best Practices Board
- Christopher Cannon, CFA
- William C. Prewitt, M.S., CFP
- Stephen D. Johnson, CFP©
- Knut A. Rostad, MBA
- General Counsel to the Best Practices Board: Daniel Bernstein
- Clark M. Blackman II, CFA, CFP, CPA/PFS