Article first published on AdvisorPerspectives

Sixty years ago this month, the United States Supreme Court affirmed that the Investment Advisers Act of 1940 obligated investment advisors to act as fiduciaries.

Last week, the Department of Labor heard testimony on its proposed Retirement Security Rule, which would extend the fiduciary requirement to broker dealers.

Many leading brokerage business and financial-services lobbyists strongly oppose the proposed rule. But their objections reflect basic misunderstandings of why fiduciary duties matter. Their basic premise is the rule is unnecessary. SIFMA’s December 12 testimony is representative.

The rule is needed to address conflicts of interest. Carlo V. di Florio, then director of the SEC Office of Compliance, Inspections and Examinations, spoke in 2012 of the “mortal threat” of conflicts of interest:

Conflicts of interest can be thought of as the viruses that threaten the organization’s wellbeing. As in the microbial world, these viruses . . . if not eliminated or neutralized, even the simplest virus is a mortal threat to the body.

Tamar Frankel, professor of law emerita, Boston University, has researched and written on fiduciary law for over 50 years. She was inspired to pursue this research after attending a conference in Israel and hearing a talk by Professor Louis Loss of Harvard Law School.

In 2011, BU brought together dozens of scholars to present papers for a conference, “The Role of Fiduciary Law and Trust in the twenty-first Century: A Conference inspired by the work of Tamar Frankel.”

Earlier this month, I spoke with Professor Frankel in her home about the state of fiduciary law in investment advice and wealth management. Heer are excerpts of our conversation:

What interested you most in fiduciary law?

The nature of fiduciary relationships and establishing trust between an expert and a customer. We cannot “follow” our own legal or medical advice. We need experts. For society to flourish, we need experts to be trustworthy and trusted. We must have reliance on and confidence in their advice and conduct.

Why?

Trusting is two-sided. The upside is trustworthy advice, but the downside is a reliance on experts that make clients or patients vulnerable to harm when an expert abuses their trust.

What do you mean?

A physician who performs surgery on a patient gains full control over the patient’s body and sometimes over the patient’s life. For example, in one case a physician used a patient’s unique cells to develop a new medicine. The physician asked the patient to make occasional visits for tests but did not tell him about the research. When the physician patented the medicine, the patient sued for ownership of the patent. The court held that the physician misappropriated the property of the patient in his body. Even though the patient was not harmed, and the physician patented his innovation, the physician had to share the financial fruits of his research with the patient. That is because the physician was a fiduciary, and got control over the patient’s body as a fiduciary. Moore v. Regents of the Univ. of Cal., 793 P.2d 479 (Cal. 1990).

What can be done to increase confidence and trust in finance?

To increase trust, we need to increase trustworthiness. The key is verification. Developing better ways for clients or patients to verify that the fiduciary puts the interests of the client or patient ahead of his own.

Fiduciary duties have diminished over recent years. Industry lobbyists have persuaded some regulators and many firms that conflicts of interest are no longer a virus that is a “mortal threat.” Conflicts of interest have been re-branded as something banal and harmless.

Industry lobbyists claim conflicts are ubiquitous, inevitable, and benign, and that BDs and independent IAs face similar conflicts. They claim a certain equity between BDs and IAs.

That is plainly wrong.

The purpose, business practices and cultures of insurance companies and BDs are built to distribute products. Independent advisors are built to render competent and objective advice – are starkly different from BDs.

The conflicts of interest facing independent advisors are far fewer, less complex, more transparent and better understood by retirement investors. This is what opponents of the DOL rule won’t acknowledge.

The Department of Labor’s proposed Retirement Security rule can be improved, no doubt.

But the DOL’s mission to reestablish a real fiduciary standard for retirement accounts should be applauded and supported and not opposed.

Article first published on AdvisorPerspectives