fi360 Blog

fi360's Comments to the SEC on the fiduciary study

Yesterday, fi360 submitted our comments to the SEC on their study analyzing the effectiveness of existing regulatory standards for brokers, dealers, and investment advisers and identifying any gaps or overlap in regulation.

In short, we believe that too much confusion exists on the part of investors as to how financial service providers' functions differ and how these differences affect investor protection. Over time, the services provided by broker-dealers and investment advisers have come to more closely resemble each other in a way that wasn't envisioned when the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 were passed. This has made it necessary to introduce new regulations that clearly demarcate the roles of product providers versus advice providers.

Some of the specific recommendations for the SEC's study and eventual rulemaking that we suggest are:

• That Congress remove the exemption for incidental advice from the Advisers Act
• Create uniform disclosure requirements for brokers and advisers that emphasize avoiding and managing conflicts of interest, but that do not bog down the provision of investment advice
• Define "fiduciary," "best interests of the customer," and "personalized investment advice" in line with the Committee for the Fiduciary Standard's five core principles and existing SEC regulations

Our full comments can be downloaded here.

All comments submitted on this issue can be found on the SEC's website.

How to write an effective comment letter to the SEC

Have you submitted your comments to the SEC on its Study Regarding Investment Obligations of Brokers, Dealers, and Investment Advisers?  If not, I highly encourage you to take the time to get involved in the SEC's efforts to bring clarity to the regulation of investment professionals and provide greater protection to investors.  You must act fast as the deadline for comments is this Monday, August 30.

In writing and submitting comments, it's important to recognize the unique opportunity being provided to investment professionals and the investing public with this comment period.  First, it's an opportunity to provide input to the SEC that will be incorporated into its overall study and the final report that it must submit to Congress in January.  Second, it is also an opportunity to potentially shape future rulemaking by the SEC that will codify the existing fiduciary standard for investment advisers in SEC regulations and extend the same fiduciary duty to broker-dealers who provide investment advice.  With this in mind, I would advise those that would like to submit comments to take the time to consider the type of input that will both allow you to voice your opinion on the regulation of investment professionals, but also asssist the SEC in fulfilling its duties and exercising its authority under the Dodd-Frank Act.  

As a former SEC attorney, I speak from experience when I say that the most helpful comments are the ones that take the time to address issues and questions presented by the SEC, provide specific examples of how regulations play out in professional practice, cite to concrete numbers and statistics (and their source), and offer potential solutions on how to address a regulatory issue. 

Looking at the current request for comment, it's important to note that the SEC has been tasked with analyzing fourteen specific topics.  To the extent commenters take the time to comment on any or all of these areas, it will be extremely helpful to the SEC. In addition, SEC Chairman Schapiro stated in a speech in July that "Comments that recognize the primary and central importance of investor protection, but offer suggestions on implementing fair and flexible regulation, will help us craft rules that increase investor confidence while preserving brokers' ability to offer a full spectrum of services." Thus, the agency essentially has provided a roadmap to commenters on what information will be most useful.

In viewing comments that have already been submitted to the SEC, I would note that a form letter, referred to as Type A, submitted by over 200 insurance brokers provides a good example of a letter that could be useful to regulators.  While I don't necesarily agree with all of the viewpoints expressed in the letter and I also question the effectiveness of only submitting a form letter, the format of the letter itself is good because it addresses both issues raised by the study and addresses potential rulemaking.  The letter could be improved by including some of the examples and concrete number or statistics I mention above.  

Fi360 is diligently working on finalizing its comments for the SEC, and our hope is that other supporters of the fiduciary standard will take the time to submit comments as well and provide the SEC with the information and support it needs to effectively implement regulations that promote fiduciary principles.  

Yes, the fiduciary standard debate does matter

An interesting article came out yesterday that made the case that the fiduciary debate was basically meaningless because brokers can already be held to fiduciary standards through ERISA and various state laws. The author is of course correct as it applies to the cases and laws he cites. However, the article omits the gap around which the entire debate is centered. As Kristina explained to RegisteredRep yesterday, the big controversy and the target of the current reform efforts is about federal securities laws and the confusion among retail investors as to what standard of care they are receiving.

As the RAND Report on Investor and Industry Perspectives on Investment Advisers and Broker-Dealers illustrated, the services offered by brokers have come more and more to resemble those traditionally provided by investment advisers while both sets of professionals have continued to be regulated based on traditional definitions of their roles. More importantly, investors often can't tell the difference between the two. Brokers will often refer to themselves as "financial advisors" and investors typically assume a relationship of trust with investment professionals. Yet, the report reflects investors' doubt or surprise that a fiduciary standard doesn't necessarily apply. In addition, investment advisers and brokers themselves don't always know where the dividing line is between the recommendations and "incidental" advice that falls under the fair dealing (suitability) standard and individualized advice that falls under the fiduciary standard.

It's not hard to see why some would oppose a fiduciary standard to protect their interests or to find fault with the legislative and regulatory process. But it is much more difficult to believe that the pursuit of closing gaps and providing clarity and consistency in the interest of investor protection isn't a cause worth pursuing.

Senate-House conference committee fiduciary decision coming tomorrow

The process of reconciling the Senate and House versions of financial regulatory reform bills begins in earnest today, as the first provisions are up for consideration by the conference committee to decide what will be included in the final version of the combined bill. The agenda for today does not include the portion relevant to the fiduciary standard, though the Committee for the Fiduciary Standard is reporting on their LinkedIn page that the fiduciary discussion should occur tomorrow.

Some good resources for those of you following at home include the Senate Banking Committee's Key Issues page, which is updated with new materials as they develop, the Banking Committee's Newsroom, which is where the agenda for today was first printed, and the House Financial Services Committee's page dedicated to the conference, where they post all relevant materials. C-SPAN is also covering the conference live.

The fiduciary provision is contained in Title IX, subtitle A. So when that appears on the agenda for consideration by the committe, we will know exactly when that discussion is to take place.

UPDATE: The House Financial Services website now confirms that the Title IX, subtitle A (i.e., the fiduciary provision) is on the agenda for tomorrow. And, the House is proposing to replace the Senate provision to study the issue with their own provision to enact the fiduciary standard.

In the meantime, the Committee is calling on anyone who wants to see a fiduciary standard for all investment advice to call the offices of the conferees to express their support for the House provision for establishing the fiduciary duty, rather than the Senate's provision for an SEC study. Here is the complete text from the Committee's announcement:

Announcement from The Committee for the Fiduciary Standard

Last Call! Conference Committee Scheduled to Act on Fiduciary Provision on Wednesday.

The Conference Committee is scheduled to meet on Wednesday on the fiduciary provision. The Senators on the Conference Committee are the key votes.

Calls from constituents do matter. Please call your Senator and urge him or her to vote for the House provision establishing a fiduciary duty for brokers providing investment advice to retail investors, NOT for the Senate’s version which proposes a “study” of whether brokers should have to put client’s interests first.

Christopher J. Dodd Chairman (D-CT) - 202-224-7391
Tim Johnson (D-SD) - 202-224-5442
Jack Reed (D-RI) - 202-224-4642
Charles E. Schumer (D-NY) - 202-224-6542
Richard C. Shelby Ranking Member (R-AL) - 202-224-5744
Mike Crapo (R-ID) - 202-224-6142
Bob Corker (R-TN) - 202-224-3344
Blanche Lincoln (D-ARK) - 202-224-4843
Patrick Leahy (-VT) - 202-224-4242
Tom Harkin (D-Iowa) - 202-224-3254
Saxby Chambliss (R-TN) - 202-224-3521
Judd Gregg (R-NH) - 202-224-3324

Regards,
Knut

Knut A. Rostad
Chairman
The Committee for the Fiduciary Standard
www.thefiduciarystandard.org

A comparison of responses to the 2010 investment advice rule

The deadline for submitting comments to the DOL on the 2010 Investment Advice Rule was May 5th and sixty-eight comment letters were submitted by individuals or organizations.  The expectation is that the comments will be analyzed in short order and the final rule published later this year. To get an idea of how the final rule might go, we'll take a look at two of the comment letters submitted.

The American Benefits Council, the American Council of Life Insurers (ACLI), and the Investment Company Institute (ICI) submitted joint comments. Their comments recommended the following:

• State that historical performance is an appropriate factor to consider
• Refrain from defining generally accepted investment theories
• Refrain from favoring one investment style
• Clarify the fee leveling condition by stating that fees cannot vary, but remove the suggestion that the fiduciary adviser is not permitted to receive any compensation based on the investment chosen

In fi360's submitted comments, it's interesting to see how our thoughts compare with respect to the four overall recommendations submitted by the American Benefits Council, ACLI, and ICI.  Specifically, fi360 stated:

• A fund's past performance relative to the average for its asset class is an appropriate criterion for allocating assets to the fund; especially risk-adjusted returns.
• Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMH) should be specified as generally accepted investment theories.  Others may be permitted as well, but there is a need to be specific to (a) assure that the processes used to formulate the asset allocation and investment selection recommendations are reasonable and (b) make certification of the computer model practical.
• The model should not assign different levels of risk to passively versus actively managed investment options because this would be neither practical nor reliable.
• The fee neutral (leveling) requirements in the proposed rules will provide significant benefits to participants and beneficiaries.

For three of the four, the organizations are pretty much on the same page; a sampling of comments submitted by others indicate that most agree on these issues as well, although there are differing views on specifics related to the fee neutral approach.  Where we find differences is with respect to generally accepted investment theories.  The American Benefits Council, ACLI, and ICI favor letting the market determine how and what generally accepted investment theories are applied to computer models and fi360 called for more specific guidance.  Fi360 also stated that the fee neutral approach is preferred because the complications and possible manipulation related to the computer model with respect to managing conflicts of interest will make it much more difficult to implement and enforce.

Clearly there is interest in this final rule and most agree that implementation is necessary in order to give participants better access to professional investment advice.  We're hoping that we see the final rule very soon.

Help support the Akaka-Menendez amendment in Senate bill

After meeting with top Republicans and Democrats from Capitol Hill this week, President Barack Obama and Treasury Secretary Timothy Geithner expressed optimism about the prospects of a financial regulatory reform bill passing this year.  While Republicans have shown mixed support for proposed reforms, there still appears to be a willingness to work with Democrats to reach compromise on key provisions in the proposed Senate financial bill.   

Meanwhile, support for the fiduciary standard on Capitol Hill appears to be growing.  Senators Daniel Akaka (D - HI) and Robert Menendez (D - NJ) are considering offering an amendment to the Senate bill that would remove a provision that calls for a study of whether the fiduciary duty should be extended to broker-dealers.  The proposed study would be replaced with a provision that would authorize the SEC to adopt rules requiring broker-dealers who provide advice to comply with the fiduciary standard--an approach similar to that approved in the House financial bill.   The Senators, however, must first determine whether their colleagues will support their proposal because a vote against the amendment could jeopardize future efforts by the House to maintain their fiduciary provision in final legislation.

Another key issue also gained attention this week as Senator Charles Schumer (D - NY) teamed up with SEC Chairman Mary Schapiro and several former SEC Chairman to support self-funding for the Commission.  Self-funding would give the SEC greater control to budget and plan for the long-term.  In addition, self-funding would likely allow the SEC to retain its role as the sole regulator of investment advisers and improve its oversight and enforcement programs.

In order for these key provisions to be adopted along with comprehensive financial reform legislation, support and advocacy from professionals and investors alike will be critical.  To this end, industry groups, including the Committee for the Fiduciary Standard, have been encouraging professionals to support the fiduciary standard and SEC self-funding.  In particular, you can do your part by calling, e-mailing, or writing your Senators to voice your support for the proposed Akaka-Mendendez amendment and the existing provision that ensures SEC self-funding.   Here is an example of what you can write/say to your Senator: 

Dear Senator _______

I am an investment professional calling/writing from _____ (city) about the Senate's Restoring America's Financial Stability Act.  I urge you: (1) to support an amendment sponsored by Senators Akaka and Menendez that would require financial professionals who provide investment advice to comply with the well-established fiduciary standard; and (2) to keep the SEC self-funding provisions in the bill.

Fiduciary Standard.  The future well-being of the nation requires that all Americans increase their savings and make the best possible investment choices.  As investing has become more complicated, the role of financial professionals has become more vital.  Research by the Investment Company Institute found that 73% of investors consulted a professional financial advisor before investing in a mutual fund. Unfortunately, not all financial advisors are required to be fiduciaries, who, by law, must put the client’s best interests first. The key overriding mandates of the fiduciary standard are highlighted in the following five core principles:

• Put the client’s best interests first;  
• Act with prudence; that is, with the skill, care, diligence and good judgment of a professional;
• Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts;  
• Avoid conflicts of interest; and
• Fully disclose and fairly manage, in the client’s favor, any unavoidable conflicts

The Akaka-Menendez amendment would ensure that all investor's receiving investment advice would be protected under these fiduciary principles.

SEC Self-funding. The bill currently includes a provision that allows for an SEC self-funding mechanism. This is critical to allow the SEC sufficient funding so that it can plan for long term internal investments and better fulfill its investor protection mission. I support the SEC as the exclusive regulator of federally registered investment advisers, including providing the agency with the resources it needs to fulfill this role.

I appreciate your consideration of my concerns.

Respectfully,
(Name)
(City, State)

With financial regualtory reform legislation expected to be debated on the Senate floor as early as next week, you should call or write your Senator as soon as possible.  Moreover, please encourage your colleagues and associates to do the same as an united front is critical to the success of the fiduciary standard and to ensuring continuity in SEC oversight. 

Why Sen. Johnson's amendment is unnecessary and bad for investors

As has been widely reported this week, Senator Tim Johnson, has drafted an amendment that, if adopted, would put on hold the extension of fiduciary duty to brokers providing advice and instead require a study by the SEC of regulatory standards for brokers and advisers.  The amendment is the result of considerable lobbying done on the part of the insurance and brokerage industries.  However, consumer and advisory industry advocates for the fiduciary standard are concerned that Johnson's amendment is merely a stalling tactic. 

While it is true that harmonization of broker and adviser regulation and extending the existing fiduciary standard to brokers who provide advice will not be easy tasks, how a study would assist the process remains unclear.  A look at the amendment reveals that the SEC would be required to study "the effectiveness of existing legal or regulatory standards of care" and "whether there are legal or regulatory gaps or overlap" in those standards.  Such a request is puzzling, though, given that the SEC is the expert in legal and regulatory standards for brokers and advisers.  In fact, a recognition of existing gaps in regulation is what led the SEC to suggest to the Obama administration that harmonization and the fiduciary standard should be addressed in the plan the administration released last summer.

Johnson's amendment would require the SEC to consider several factors when conducting a study of broker and adviser standards of conduct.  In particular, the SEC would be required to consider how the protection under broker regulations compare to the protection under adviser regulations.  However, given that the RAND report, issued just two years ago, already addressed these different protections and investors perceptions of them, it's unclear what a new study would achieve.  Other factors the SEC would be required to consider are the impact and cost to entities and individuals of any changes in the standard of care for brokers and the impact on SEC resources.  However, as a result of significant administrative requirements, such impacts and costs would as a matter of necessity be quantified and considered in a rulemaking by the SEC.  Therefore, it's again unclear why a separate study is needed.

When considered as a whole, it is hard to understand how Johnson's proposal is anything but a delaying tactic given the SEC's significant amount of expertise in this area and the careful consideration the SEC would be required to undertake in any rulemaking it engages in to set conduct and other requirements for brokers and advisers.  In fact, it is puzzling why the information Congress would be asking for couldn't be provided through testimony or meetings with the SEC as well as in current legal and regulatory literature, rather than waiting for a report to be issued eighteen months after legislation is passed and delaying rulemaking for up to two years.   

The fiduciary debate is not new, and as recognized by the Committee for the Fiduciary Standard, the time for action is now. The Committee has asked its members to advocate against Johnson's amendment and has raised the following three key points for opposing the proposal:

1. All investors need protections afforded by the fiduciary standard, now.  As SEC Commissioner Walter has repeatedly pointed out, investors need to count on their adviser being held to the fiduciary standard and not worry about varying protections that different standards might provide.
2. The concerns expressed by lobby groups against the fiduciary standard are not generally held by brokers in the field.  According to a survey conducted by the Committee and SEI, a majority of brokers SUPPORT being held to the fiduciary standard.
3. Finally, most of the questions the proposal poses be addressed in the study are already answered or known in The Rand Report, other independent academic research, or through the SEC itself. The study is not needed.

Fi360 supports the advocacy efforts of the Committee and hopes that other supporters of the fiduciary standard will heed the Committee's call to action and contact Senator Johnson and his staff directly to voice their opposition to his amendment. 

Slow progress, but more support for a fiduciary standard

With political momentum shifting on the heels of Scott Brown's victory in Massachusetts last week, the future of financial regulatory reform and how quickly it can get done is becoming a bigger question mark with each passing day. While many hoped the Senate Banking Committee would be ready to tackle financial reform issues by late January or early February, recent reports indicate that it likely will be spring by the time the the committee has a bill ready. Committee Chair Christopher Dodd is still working through several issues with Committee Ranking Member Richard Shelby in hopes of gaining the bipartisan support that will be needed for financial reform to pass in the Senate.  However, reports from the Hill are that no final decisions have been reached on key provisions in a proposed Senate bill.  

Despite the slow progress in the Senate and increased lobbying by the insurance industry, remarks made by Goldman Sachs CEO Lloyd Blankfein and Bank of America's Sallie Krawcheck last week make it clear that support for applying a fiduciary standard to all professionals who provide investment advice is widespread.  What remains unclear, however, is whether these industry leaders support extending the existing fiduciary standard recognized by groups such as the IAA, Financial Planning Coalition, and the Committee for the Fiduciary Standard, or whether their views fall in line with SIFMA's call for a new federal fiduciary standard.  

And even if a new fiduciary standard is what is being referred to, it's still uncertain what SIFMA and its members think such a standard should look like or why such a new standard is needed.  Throughout the fiduciary debate, SIFMA and others have argued that fiduciary law lacks clarity due to the presence of state common law and a lack of understanding of when a fiduciary duty applies.  However, such arguments ignore the fact that requirements under the securities laws, including the Investment Advisers Act of 1940, are federal standards.  In fact, an outline on the SEC website describing regulation of investment advisers by the SEC explains that the fiduciary standard applied to investment advisers at the federal level does not rely on state law and is therefore a uniform standard (you'll find the explanation of fiduciary duty on pages 13-16 and the reference to the federal standard in footnote 80).  Even the Supreme Court has stated more than once that the anti-fraud provisions of the Investment Advisers Act establish "federal fiduciary standards" to govern the conduct of investment advisers.

Bottomline, the federal fiduciary standard is established and has been applied by federal courts and the SEC for years.  And though political momentum has shifted in Washington, it is still clear that the individuals in the investing public  are concerned about the economy, their financial futures, and their ability to rely on financial professionals.  It may take more time and compromise to make financial regulatory reform a reality, but both political and public pressure is mounting to make it happen and to ensure investor protection is a key part of reform.   

A Time for Advocacy

After finishing up hearings on financial regulatory reform earlier this month, the House Financial Services Committee began the task of marking up reform legislation this past week.  The Committee reached its first major milestone by passing legislation on over-the-counter derivatives and will continue to push forward on other pieces of legislation in hopes of a full House vote on a reform package in November. 

Fiduciary duties for investment professionals that provide advice continues to be a key piece of the proposed Investor Protection Act of 2009 , which will likely be considered in a mark-up session next week or the following week.  With this legislation looming, industry groups representing different views on the fiduciary standard have been increasingly promoting their advocacy efforts on Capitol Hill.  Just these past couple of weeks the Financial Planning Coalition launched a website, as did the Committee for the Fiduciary Standard, in order to promote fiduciary issues and keep the public abreast of their advocacy activities.  On the broker-dealer side, the new head of the SIFMA Washington office started his new post and will play a key role in the organization's lobbying efforts to promote "a harmonized fiduciary standard." Meanwhile, members of FSI spent a day meeting with Congressional members to promote "a universal standard of care" for investment professionals.  

In an effort to further promote the fiduciary standard, fi360 CEO, Blaine Aikin, urged our readers earlier this week to speak out on behalf of investors and the professionalization of investment advice by contacting legislators and regulators.  Now is a key time for clear and effective advocacy for the fiduciary standard as Congress is moving quickly to consider and implement financial regulatory reform, and key industry groups are jockeying for their views to be heard.   

If you would like to do more to promote the fiduciary standard and ensure that Congress "gets it right", you should contact your Senators and Congressional Representatives as soon as possible.  In addition, you should directly reach out to the Chairman Barney Frank and Ranking Member Spencer Bachus of the House Financial Services Committee and Chairman Christopher Dodd and Ranking Member Richard Shelby of the Senate Committee on Banking.  

Key points to emphasize to Congressional Leaders and your own Senators and Representatives include: 

• To the extent that investment professionals provide similar services, similar protection for investors' interests should also be provided; and in particular, broker-dealers who provide investment advice should be held to the same fiduciary standard of care as investment advisors. 

• As acknowledged by panelists testifying before on the House Financial Services Committee on October 6, 2009, the fiduciary standard is a more stringent and higher standard than the suitability standard that currently applies to brokers.  The fiduciary standard requires investors' interests to be put first and involves more than just checking to ensure that a single investment is appropriate for an investor. 

• Despite claims by SIFMA to the contrary, the principles upon which the fiduciary standard are based are clearly established in law.  (In fact, as Blaine's blog post from Wednesday explains, the Committee for the Fiduciary Standard has identified five core principles, which have been received positively by policymakers in Washington.) 

The message on the fiduciary standard needs to be made simple and clear to legislators who must largely look to regulators and the industry for guidance and education on these issues.  We will continue to keep you updated as regulatory reform continues to develop, and we hope that you will heed the call to action to promote a positive change in regulation on behalf of investors and the profession as a whole.

A true fiduciary standard can't compromise basic principles

In my most recent Fiduciary Corner column in Investment News, I wrote about The Committee for the Fiduciary Standard and the five fiduciary principles the Committee focuses upon. The five principles capture the essence of the fiduciary standard that is well established in law and regulation. They are paraphrased here:

1. Place investors best interests first (singular duty of loyalty to the investor)
2. Provide advice with the skill, care, diligence and judgment of a professional (duty of due care or the prudent expert standard)
3. Provide full and fair disclosure of all material facts (duty of utmost good faith)
4. Avoid conflicts of interest (because conflicts are situations that make fulfillment of the duty of loyalty less reliable)
5. Manage unavoidable conflicts in the best interest of the client (which is meant to assure that the objectivity of the advisor is not impaired)

Some financial service industry trade groups and a handful of transaction-oriented firms are advocating, either overtly or by lobbying legislators behind the scenes, to establish a “new fiduciary standard” that purportedly would draw from both the principles-based fiduciary standard and the lower rules-based fair dealing standard associated with traditional brokerage activities.

While these efforts are couched in terms of finding a workable compromise solution, they amount to a call to abandon the true fiduciary standard and christen the fair dealing standard as the “new fiduciary standard.”

Simply put, you can’t compromise principles and claim to adhere to them.  Consider what it would mean to compromise on the five fiduciary principles.

1. Compromising the singular duty of loyalty results in divided loyalties, which is at odds with the very definition of a fiduciary.
2. Compromising due care results in acceptance of less than a professional level of competence.
3. Compromising on full and fair disclosures results in the suppression of material information and a failure to provide the transparency crucial to relationships of trust.
4. Accepting conflicts of interest that can reasonably be avoided undermines the integrity of the duty of loyalty.
5. Permitting unavoidable conflicts to be merely disclosed rather than managed in the best interests of clients creates a “buyer beware” overtone to client interactions that is inconsistent with the entire concept of professional advice

In short, regulatory reform that compromises fiduciary principles is not reform at all; it is regulatory regression that would weaken investor protections and push the business of investment advice further from becoming a true profession. Moreover, the fiduciary standard stripped of its core principles bears no resemblance to the true standard whatsoever. Please speak out on behalf of investors and the professionalization of investment advice by contacting legislators and regulators, commenting on financial blogs like this one, and joining The Committee for the Fiduciary Standard (www.thefiduciarystandard.org).