More On Legal & Compliancefrom The Advisor's Professional Library
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
David Tittsworth, executive director of the Investment Adviser Association, told Retirement Income Symposium (RIS) attendees in Boston on Monday that the SEC will probably issue its long-delayed ruling on whether it will extend a fiduciary responsibility in the first quarter of 2012.
At stake is the question of whether FINRA-regulated broker-dealers, now bound by a rules-based suitability standard that doesn’t require disclosure of conflicts of interest, should be governed by the same principles-based fiduciary duty as investment advisors.
In his presentation, “Fiduciary: The Issue That Keeps On Giving,” Tittsworth (left) walked the nearly 200 attendees of the RIS through a brief history of fiduciary duty from its origins in English common law, where a harsher sentence was given to culprits who used superior knowledge to take advantage of a helpless victim.
In the U.S., the long and winding road to a mandated standard of care began with the Investment Advisers Act of 1940, which he said imposed a “duty of care, loyalty, honesty and good faith” on investment advisors. In 1963, the Supreme Court ruled that the Act’s fiduciary duty requirements applied to all investment professionals unless advice was incidental to their primary business, and no “special compensation” (i.e., anything other than a commission) was received for advice.
Although this decision was affirmed in subsequent court decisions and SEC rulings, disputes have arisen in recent years, Tittsworth recalled:
- 1999: The SEC proposed the Merrill Lynch rule, making discretion over client assets (instead of form of compensation) essential in order for fiduciary responsibility to apply
- 2005: The SEC approved this ruling in a split decision
- 2007: The rule was invalidated by the District of Columbia Circuit Court following a lawsuit by the Financial Planning Assn. (FPA).
- 2008: The SEC hired the RAND Corp. to study the issue. Their key finding: investors were confused.
- 2009: In a Treasury Department “roadmap,” Treasury Secretary Tim Geithner recommended that broker-dealers who provide advice should meet the same fiduciary standard as registered investment advisors, upsetting B-Ds and insurance companies who saw his definition as too broad
- 2010: Dodd-Frank Section 913, a compromise, provided that when B-Ds provide personalized investment advice to a retail customer, they would be governed by the same standard as investment advisors
- 2011 (January): The SEC recommended a common standard for B-Ds and RIAs, touching off arguments that an adequate cost/benefit analysis had not been done
- 2011 (Sept. 14): At a hearing on Dodd-Frank Section 913, broker-dealer groups and insurance groups opposed extending the fiduciary standard to non-investment advisors
Now, Tittsworth said, members of Congress are urging the SEC to focus on some of the many other Dodd-Frank provisions that need to be implemented. At any rate, the ball is in the SEC’s court. Performing a cost/benefit analysis is likely to delay the final ruling, originally projected for year-end 2011, into the first quarter of 2012.
The IAA’s Position
The IAA, which represents investment advisory firms both large and small that collectively manage more that $10 trillion, has maintained four positions during this debacle:
- There is a fundamental difference between broker-dealers (“sell side”) and investment advisors (“buy side”).
- The fiduciary duty imposed by the Investment Advisers Act should not be watered down.
- Fiduciary responsibility should be extended to brokers and others who provide investment advice.
- Imposing the broker-dealer standard of care to investment advisors doesn’t make sense, especially since B-Ds are now moving into the IA space, not vice versa.
Enter the DOL
The Department of Labor got into the act in 2010, Tittsworth explained, with a proposal to broaden the definition of “fiduciary” to include professionals who provide nondiscretionary investment advice for a fee in retirement plans.
ERISA regulations from 1975 currently define fiduciaries as investment professionals who provide individual advice and have an ongoing relationship with clients who use this advice to make investment decisions. The DOL would like to broaden this definition so that fiduciary responsibility would apply to professionals who provide advice that “can be personalized” for clients and that “may be considered” in making investments.
Following pushback from industry sources who thought it was muscling in on the SEC’s turf, DOL beat a retreat. A “reproposal” is expected in early 2012.
Tittsworth closed his presentation with a quote attributed to Warren Buffett: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently”—a reminder that it’s character, not laws, that make people trustworthy.