In 2012, an SEC director declared that conflicts kill objective investment advice. But this is no longer true, according to new guidance from the CFP Board.
The CFP Board offered its very different view in its publication, Guide to Managing Conflicts.
But it should be true. The Supreme Court explained in 1963 that avoiding conflicts is a pillar of sound investment advice, as originally articulated in the Investment Advisers Act of 1940. In a landmark case, Capital Gains Research Bureau, the Supreme Court held that the Advisers Act’s “fundamental purpose” was to “to eliminate conflicts between the investment adviser and clients.”
Are Conflicts a Killer?
Carlo V. di Florio, director of the SEC Office of Compliance Inspections and Examinations, spoke eloquently about conflicts:
. . . One can think of ethical concepts as the white blood cells that make an organization’s “immune system” – its compliance and risk management systems and culture – effective (and thus) conflicts of interest can be thought of as the viruses that threaten the organization’s wellbeing. As in the microbial world, these viruses come in a vast array of constantly mutating formats, and if not eliminated or neutralized, even the simplest virus is a mortal threat to the body.
For eons, a conflict of interest in advice could undermine objective professional advice in the best interest of the client. Brokerage selling agreements and commissions are classic examples. Conflicts are harmful and should be avoided or eliminated.
The importance of Capital Gains Research in the modern history of fiduciary advice is unquestioned – it is the Brown versus Board of Education for fiduciary advice. The court affirmed that “competent and unbiased” advice means removing conflicts and limiting adviser compensation to “direct charges to clients.” This is an unequivocal statement of how integral fee compensation is to fiduciary advice.
But the CFP Board Says Conflict Are Okay
The CFP Board offered some good points. CFPs must be aware of “material conflicts of interest” and that compensation methods matter. Further, it held that, “A material conflict of interest may be so great that it cannot be managed … and must be avoided.” But this key point deserves more than the scant attention (two sentences) that the CFP Board gave. CFPs need guidance to discern when a conflict is not manageable and must be avoided.
The CFP Board also claimed that conflicts may be managed through compensation models that de-emphasize flat, AUM or hourly fees. While that is a good point, the one sentence afforded to it does not suffice to explain what this means. Guidance is needed.
These positives were outweighed by the CFP Board fundamentally changing the operational meaning of conflicts. Forget di Florio’s eloquence and the need to eliminate or neutralize conflicts. Instead think of the need to accept, live with and manage conflicts however a CFP likes. CFPs can pick and choose how to manage conflicts, according to the CFP Board. Its watchword is flexibility.
The CFP Board’s redefinition of a conflict is seen in a number of ways. Here’s how.
A conflict is no longer mainly defined as it was by di Florio as a “virus” that’s a “mortal threat” that typically comes from third-party incentives, undermines objective advice and can be avoided.
The CFP Board rejected this view and instead redefined material conflicts broadly as coming from all compensation. This means if a firm has a pulse and accepts compensation, it has a material conflict. This is a stark change that has not been publicly defined, discussed and debated.
It should not stand.
Prioritizing avoiding conflicts in investment advice, per Capital Gains, was rejected casually, without comment on the burdens of “managing” conflicts.
Prioritizing differentiating conflicts based on their scale, scope, complexity and opacity was rejected or ignored. Take compensation complexities. Compare an investment advisor using two paragraphs to describe fee schedules to Ameriprise and the 17 pages that appeared in its December 2021 form ADV to explain how the firm and brokers are paid.
Lastly, prioritizing stating the purposes and differences between investment advisors and broker-dealers was rejected or ignored. The CFP Board followed Reg BI and treated IAs and BDs alike.
Former SEC Chair Mary L. Schapiro foresaw this in June 2009. She argued that broker-dealers and investment advisors should be regulated alike because they appear alike. She said they have “an apparent commonality of function.” That’s what I call the Shapiro doctrine of “apparent commonality.”
CFP Board: Advisers Are Conflicted All the Time
Conflicts used to be deemed pernicious incentives often coming from third parties. They had to be avoided, if possible. No more. Today, conflicts come from any compensation and can be “managed.” The CFP Board noted, “CFPs customarily receive compensation for their services.” But the CFP Board wrote that any compensation is now presumed a material conflict. AUM and hourly fee compensation were singled out as being “particularly acute” conflicts.
The CFP Board’s guidance applied the Schapiro doctrine and lumped brokers and advisors together. This change is foundational because now conflicts need not be avoided. Since they can’t be avoided, they must be managed. Yet, “manage” is not defined, so it means whatever a CFP chooses it to mean.
The CFP Board fundamentally redefined the meaning of conflicts of interest. In so doing, a pillar of the Investment Advisers Act and the meaning of advice and professionalism was disfigured. Now, conflicts are okay and any firm that has a pulse can infect clients with conflicts. This redefinition is a fundamental change that must be publicly vetted and discussed if it’s to be accepted. It cannot be merely proclaimed.