More On Legal & Compliancefrom The Advisor's Professional Library
- Scope of the Fiduciary Duty Owed by Investment Advisors A fiduciary obligation goes beyond the suitability standard typically owed by registered representatives of broker-dealer firms to clients. The relationship is built on the premise that the advisor will always do the right thing for the person or entity receiving advice.
- Best Practices for Working with Senior Investors Securities examiners deal harshly with RIAs that do not fulfill their fiduciary obligations toward senior investors, as the SEC and state securities regulators view older investors as particularly vulnerable and in need of protection.
(This article first appeared on WealthManagerWeb.com on May 20.)
Investor advocate Mercer Bullard is concerned about the impact of financial reforms that are intended to help investors. One reform in the Senate bill, which passed, 59-39, on Thursday, May 20, that had been debated the past week is an extension of the fiduciary standard of conduct to broker/dealers who provide advice to investors, requiring them to act as fiduciaries and, as such, to put investors' interests before their own. He shared some of his concerns with Wealth Manager Editor in Chief Kate McBride in an exclusive interview after he spoke at the fi360 conference in Orlando on May 7.
A University of Mississippi School of Law Associate Professor of Law, Bullard is a tireless pro-investor voice in letters to regulators and testimony on Capitol Hill. He is founder and president of Fund Democracy, a non-profit investor advocacy group for mutual fund investors.
Bullard was formerly an SEC assistant chief counsel, and securities lawyer at Washington, DC-based WilmerHale (formerly Wilmer, Cutler & Pickering). Currently, he is a member of the SEC's Investor Advisory Committee, formed last year as part of the SEC's investor protection mandate. The Committee's latest meeting was May 17 at the SEC's offices in Washington. Bullard is chair of a subcommittee of that SEC group, the Investor as Purchaser Subcommittee.
One of Bullard's worries is that the fiduciary standard will become diluted in the course of being applied to brokers--if the legislation passes. Bullard defines fiduciary duty as "a duty to act solely in the interest of the client." Broker/dealers are currently subject to the less-stringent "suitability" standard of conduct, requiring that their sales of investments be suitable to the investors' goals, but they are not required, in most cases, to act in their client's best interest. They can select the investment--say one of two stock funds--that pays them the most in commissions, or makes the firm the most money, even if that impacts the performance of that investment.
The higher "fiduciary standard" that investment advisors are held to under the Investment Advisors Act of 1940 requires, according to The Committee for the Fiduciary Standard, that they adhere to five core principles;
o Put the client's best interests first
o Act with prudence; that is, with the skill, care, diligence and good judgment of a professional
o Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts
o Avoid conflicts of interest
o Fully disclose and fairly manage, in the client's favor, any unavoidable conflicts
This editor is a member of the Committee for the Fiduciary Standard.
In addition, Bullard asks: Who will regulate everyone who would fall under the fiduciary standard of conduct? He cites a "gaping regulatory hole [and] absence of effective oversight," due to an "inadequate SEC inspection program" for investment advisors. He suggests a fee that is specially "earmarked" for investment advisor exams could help close the gap.
In part, the gap is due to inadequate funding for the SEC, which must turn over all the fees it currently receives to Congress, which then makes an appropriation of a portion of those fees back to the SEC. In recent years, the SEC has received an appropriation of about two/thirds of the funds it raises. That missing funding could go a long way toward more frequent investment advisor exams. Reforms legislation that the House passed in December contained a mandate to double SEC funding; that was also contained in the draft of pending Senate legislation on reforms.
FINRA--the Financial Industry Regulatory Authority--the self-regulator for brokers, is one possibility and certainly has made a play to be the regulator or RIA firms; many broker/dealers that FINRA regulates have RIA arms. But an effort to put that into an earlier version of the House legislation was defeated.
Since RIA firms with under $25 million in assets can be regulated by their state rather than register as RIAs with the SEC, one possibility is to raise that limit to $100 million for state regulation.
Fixing the retirement system
Bullard is also a proponent of fixing the retirement system, due to the "inadequacy of the 401-(k) as the sole retirement vehicle," In a joint letter from his Fund Democracy, The Consumer Federation of America, and Consumer action, to the Department of Labor, Bullard advocates provision of "standardized Simple Annuities," for retirement accounts; that the 401-(k) account choices, "reflect generally accepted investment theories;" and that they further, "reflect the needs of less sophisticated, low income plan participants are most susceptible to sales abuses, are at greater risk of committing planning errors, and are most vulnerable to losses that leave them unprepared for retirement."
The letter cautions on the use of variable annuities to fund 401-(k)s however, saying, "Variable annuities are more frequently the subject of abusive sales practice than any other investment. They impose higher fees and provide additional benefits of questionable value. We strongly encourage the Department to require heightened scrutiny by employers and/or product providers of variable annuity investment options."
Later, the letter notes that, "One analyst estimates that variable annuities transfer approximately $25.6 billion a year "of spendable investment returns" from vulnerable investors to the insurance industry and its sales force," [citing Scott Burns, in the blog "Variable Annuity Watch, 2008," on the AssetBuilder-Registered Investment Adviser Web site.] To be frank, we were stunned by the Department's request for comments on whether 404(c) regulations should "be amended to encourage use for these products..."
"If anything, the Department should take steps to discourage the rampant overuse of variable annuities."
Instead, Bullard suggests use of low cost, low fee "lifetime income annuities," or "fixed annuities." He also says Congress should "prohibit employer stock or limit it to 20%" in retirement accounts, acknowledging the number of employees burned by holding high allocations to employer stock if the company runs into problems.
The Goldman Sachs saga
When asked about his opinion on the SEC's fraud suit against Goldman Sachs, in which the firm allegedly didn't inform the buyers of a Goldman-created synthetic mortgage backed security, that a third party--hedge fund manager John Paulson, who allegedly planned to short the same security--helped select the underlying portfolio of mortgage securities. Did Goldman Sachs have a fiduciary duty to those clients? Were they operating under suitability? Well, even under suitability, Bullard says, "indirectly, suitability requires they disclose Paulson's role."
Comments? Please send them to firstname.lastname@example.org. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.