This article originally appeared on Advisor Perspectives.
An historic realignment of fiduciary advice has snuffed out 40 Act principles. The SEC, the coming DOL Rule, and CFP Board standards have rejected them. The realignment reveals a path of destruction – to the law, language and logic.
Where do we go from here?
Start with a plan. A sober view of strengths and weaknesses (assets, liabilities). Set goals. Think outside the box.
This year, 2020, will fill the history books with events that stand out over the prior century. The federal regulation of fiduciary advice belongs with this history.
Fiduciary advice may seem to pale in comparison. It shouldn’t. Think October 1929.
After a decade of intense BD industry lobbying, in the past 16 months we have witnessed an historic realignment of advice regulation. The advice standards of the Advisers Act of 1940 are gone. The SEC, the coming DOL Rule, and new CFP Board standards reject them.
The heart of the 40 Act – the need to separate advice from sales and eliminate conflicts – has been ripped from the law. As I wrote last month in AP, this once vital law is essentially the investors’ civil rights legislation of 1940.
The CFP Board publicly rejects 40 Act principles. It champions business-model neutrality and interprets its neutrality to mean fee and commission compensation have no bearing on fiduciary fidelity.
This realignment is not just a clear defeat for fiduciary advice regulation. It is more. The decade of lobbying and advocacy has seriously wounded the three pillars on which investor trust of the capital markets relies – law, logic and language.
‘Where do we go from here’? Where is fiduciary advice in 2020? In 2009, the Obama administration challenged the SEC to establish, “a fiduciary duty for broker-dealers offering investment advice and (to harmonize) the regulation of investment advisers and broker-dealers.”
In 2020 the state of fiduciary advice is far worse than in 2009
New regulations not only essentially overturn 40 Act legal precedent; they also defy common sense and redefine simple language.
New ideas replace 40 Act ideas and now dominate thinking about investor protection. Chief among them is “choice”. Choice is championed as if it were the underpinning of fiduciary law. As a “cover” for conflicts, it is actually the opposite.
Other spurious ideas permeate key assumptions and arguments. They include: conflicts benefit investors, brokers and advisers are basically the same, and disclosure is an investor protection cure-all answer. Each is central to the realignment and demonstrably false.
These faulty ideas in federal rules and standards prevail despite fiduciary advocates’ aggressive rebuttals based on research, precedent, evidence and logic. Consumer Federation’s Barbara Roper and finance professor and fiduciary advocate Ron Rhoades have together authored the equivalent of the Federalist Papers for fiduciary advice. It’s hard to see where much if any of their arguments are reflected in the new standards.
Language has also taken a beating. Gone are basic meanings of words – “Best interest,” “required mitigation,” and “fee disclosure.” As used by the SEC, they don’t mean what the words say they mean. The best interest definition is left open; required mitigation does not mean mitigation is required; fee disclosure does not mean actual fees are disclosed.
Enter the ”Goldman Rule.” On June 21, 2012, U.S. District Judge Paul A. Crotty upheld a securities class action against Goldman Sachs. Crotty opined that Goldman cannot argue its public statements of “honesty,” “integrity” and “fair dealing” were simply “puffery,” and therefore not actionable. In a footnote, “Goldman’s arguments in this respect are Orwellian, …. Words such as ‘honesty,’ ‘integrity,’ and ‘fair dealing’ apparently do not mean what they say; … are mere shibboleths. If Goldman’s claim of ‘honesty’ and ‘integrity’ are simply puffery, the world of finance may be in more trouble than we recognize.”
The cost of Orwellian arguments
If Judge Crotty is correct, his statement should cause great concern. The cost of Orwellian arguments is high. A price is hard to calculate, but as Supreme Court Justice Potter Stewart said of pornography, “I know it when we see it.”
Disclosure has always been the center of SEC rules. It is now at the center of advice.
The results of testing disclosures matters. The SEC Investor Advocate / Rand 2018 study (OIAD) tested how well investors, “understand the retail market for investor advice.” The research included testing a handout that sought to explain the role of BDs and IAs.
What does the handout say on the different roles of brokers and advisers? A broker: “ . . . charges a fee or commission for buying or selling securities for investors.” An adviser, “Is in the business of giving advice about securities to clients.” About both advisers and brokers, “A financial professional can be both a broker and an investment adviser.”
On monitoring accounts, “The broker does not typically monitor … your account:” . . . “The adviser typically monitors your account.”
To its credit, OIAD acknowledged the handout failed and “more effective ways of communicating to investors the differences” are needed. One effective way? Start with material facts that matter to investors. For example:
The role, purpose and function of a broker-dealer is to represent the issuer or manufacturer to distribute products to its customers, while the role, purpose and function of an adviser is to represent the client as a fiduciary.
Disclosure that is purposely vague and omits material facts should not be likened to disclosure designed to be effective.
Instead, as seen in the required language of Form CRS, we have in part:
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.
The Kleimann Communications Group for AARP in 2018 sought to assess investor understanding of the proposed CRS form.
On mitigating conflicts, Kleimann reports, “Few participants knew what the word ‘mitigate’ meant and thus were confused about how exactly Broker-Dealer accounts would handle a conflict of interest…Because the obligation to ‘mitigate’ conflicts is not clearly defined in the proposed standard, subject matter experts were unable to come up with the language to clarify this requirement” (emphasis added).
The Kleimann report highlights the dilemma of crafting effective disclosure when key concepts are unclear or vary from widely accepted norms or common sense. The problem of unclear terms is discussed by Kleimann:
Ultimately, plain language and artful presentation cannot hide the fundamental lack of clarity around key ideas, such as best interest standard, consent, or mitigate. We, our subject matter experts, and our participants struggled with understanding and expressing these ideas cogently and explicitly. We recognize that clarification is no easy task. But, as always, clear writing is rooted in clear thinking. Without such efforts at a policy level, our results at a disclosure level will be modest.
Advocacy, language and disclosure are important. They reveal what has been done to overcome history, law and logic to realign fiduciary advice regulation. It has been no small task.
Where do we go from here? Start with a plan. Analyze strengths / weaknesses and assets / liabilities. Set goals. Think outside the box. Plot a course for the fiduciary movement.
Next month’s election will certainly effect priorities in a plan; it should not determine a plan. Where do we go from here? Elements of a plan should include the following:
- SEC and DOL. The two Democratic commissioners at the SEC avidly support fiduciary and real investor protection. Supporting immediate efforts to repair or repeal Reg BI is, of course, important. The election and next chair will determine what can be done. At the DOL the election will likewise determine the near term future of the coming rule.
- CFP Board. CFP Board has a great opportunity to re-engage 40 Act principles. The board should reinterpret “neutrality” and rebalance its promise to meet what it delivers.
- The states. Irrespective the election, the states, individually and through NASSA, will be important in interpreting and enforcing Reg BI and fiduciary duty in the states.
- Investor education. Investor education has been a tough slog to improve investor protection. With social media, millennials and digital marketing growing, new opportunities to help investors screen for real fiduciary advisors exist.
- The market. Corporate “self-regulation” (a misnomer) cannot substitute for federal or state regulation; in certain circumstances however, it can aid educational efforts.
- Adviser leaders. Individual advisers must speak out; their voices are needed.
Defending fiduciary advice is a long term venture. The past decade has been a low point. Make no mistake that the future of fiduciary is bright. History is on our side.