fi360 Blog

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.

Would LeBron make a good fiduciary?

Last night, LeBron “King” James, the two-time league MVP and past NBA scoring champion, and arguably the most sought after free agent player in the league, made a decision on where he would play the next segment of his short, but superstar career.  The press coverage was astounding, reaching crescendo with his live announcement on ESPN entitled “Decision 2010.”  As I watched the broadcast, it occurred to me that LeBron may make a good fiduciary.

LeBron needed to decide where to continue his career.  As a free agent, the ball was largely in his court.  He set his priorities: winning an NBA championship was number one.  He and his trusted advisors defined a due diligence process to be used to help make the best decision for him to meet his objective.  The process consisted of quantitative and qualitative factors, to be sure.  He applied the process.  Meetings were held; presentations were given by the finalist candidates.  He took his time and considered all the facts and factors that would play into his decision.  He smartly consulted with his trusted advisors.  Finally, he made the decision that lined him up best to obtain his goal of winning an NBA championship. 

Whether or not he knows it, by setting his objective, doing his due diligence, following a process, and focusing on his goal, LeBron exhibited the skills of a good fiduciary.  For example:

He set priorities. The foremost of which was putting him in a situation where he had the best opportunity to win an NBA championship. Having a clearly defined objective lended well to his next step.

He defined a due diligence selection process. Factors likely included:

• The organization, management, coach, and teammates;
• The team history of success; and  
• The compensation he would receive.

Note the parallels with the fi360 Fiduciary Score™ factors that evaluate: Stability of the organization, track record of the investment, and performance relative to peers.  

Importantly, he followed the process.  He faced enormous pressure, but stuck to his process and kept his focus on his objective.  This enabled him to be disciplined and rational, avoiding potential mistakes, including:

• Listening and reacting to “market noise.”  For example, the incumbent lobbied hard for his return.  
• Chasing performance in terms of money or ego.  Certain finalist candidates offered him an opportunity to make much more money than others and also be the sole superstar on the team.
• Being complacent.  He had an opportunity to remain with the incumbent who was familiar and easy.  LeBron grew up in that location, had his family there, and all the comforts of home.

He consulted with trusted advisors throughout.  Knowing that his skills were on the basketball court, he smartly sought counsel from professionals.

He met the call to action and decided.  Executing your decision in a timely manner is important.  And remember, he has no guarantee of success (winning an NBA championship), however he has put himself in the best position to do so with the facts and circumstances now known

Let me know what you think.  Does LeBron have a future career as a fiduciary?

[By the way, if you’ve somehow managed to avoid the newscasts, radiocasts, email alerts, blog posts, tweets, and office water cooler, LeBron selected the Miami Heat.  Other finalist candidates included: the Cleveland Cavaliers (the incumbent), the New York Knicks, the New Jersey Nets, and the Chicago Bulls.  Time will tell whether LeBron's decision ultimately yields him an NBA championship.]

House insists on fiduciary responsibility

This morning, financial reform Conference Committee Chair Barney Frank emphasized the need to adopt fiduciary responsibilities for brokers when he put forth the House offer of amendments to strengthen the investor protection provisions (found in Title 9) of the financial reform bill base text.  

During his opening statement, Frank highlighted both SEC funding and fiduciary responsibility, stating that the House believes both are "essential to protecting investors."  While discussing fiduciary responsibility, he submitted  to the record a "long list of letters" in support of extending fiduciary duties to brokers.  With regard to protests raised by insurance brokers about concerns of conflicts with their ability to sell proprietary products, Frank noted that the bill allows insurance brokers to work within the jurisdiction of the companies they work for and that they don't have to go outside of those products.

Frank turned the discussion over to Representative Paul Kanjorski (D-PA), who noted that the focus of the amendments put forth by the House seek to, among other things, strengthen standards of conduct and the SEC's enforcement authority.  With regard to the fiduciary duty, Kanjorski stated, "it sounds like a complicated thing, but it's not."  He emphasized that the House is seeking to ensure that both broker-dealers and investment advisers owe the same fidelity to their customers when providing the same services to those customers.  He also stated that he believes the change is long overdue and that there is no reason to delay it, noting that if a survey was taken of the general public, most people probably would not believe that these professionals operate under different standards of care.

Kanjorski also specifically responded to "misnomers" he believes have incorrectly been attached to the House bill regarding fiduciary responsibility.  In particular, Kanjorski stated that the bill will not prevent broker-dealers from receiving commissions and does not prevent the sale of proprietary products.  He also noted that the bill states that there is no continuing duty of care after advice is provided by a broker-dealer.  In essence, the fiduciary duty would apply at the time the customer is receiving advice from the broker-dealer, but there is no continuing responsibility unless another transaction occurs.

Representative Jeb Hensarling (R-TX) spoke up in favor of the Senate provision that would require an SEC study of the difference between the standards of care between broker-dealers and investment advisors.  He reiterated concerns he had previously raised during the House Financial Services Committee markup of the House financial reform bill that the extension of the fiduciary duty will have unintended consequences for the discount brokerage business model.  Hensarling noted that Frank had worked with him in good faith to address these concerns before the bill passed on the House floor, but stated that he does not feel that language added to the bill goes far enough to address his concerns.  In particular, Hensarling stated he hopes that legislators and regulators will not just run with the legalistic title of "broker-dealer", but rather will aim to address particular activity and conduct. 

Frank responded directly to Hensarling's concerns by emphasizing that the fiduciary duty for broker-dealers will only apply to "personalized investment advice" and that there is no continuing duty after personalized investment advice (it ends the day the sale is made according to Frank).

While it is good to see the House coming out with a strong position on extending the fiduciary duty and strong responses to objections raised by the insurance and brokerage industries, it is still disconcerting to hear the members discuss fiduciary duty in a light that differs from how it applies to investment advisers, namely the fact that the bill would allow the fiduciary duty to end once a transaction closes.  This language ignores the ongoing nature of the relationship between an investment professional and investor who relies on that investment professional on more than just a transaction-by-transaction basis.  It also highlights the fact that if the fiduciary standard is extended to broker-dealers, great leadership will be required from the SEC to provide clarity on what the fiduciary standard means and how it applies to interactions between broker-dealers and investors, as well as between investment advisers and investors.  

There is still much to be discussed and debated today on the fiduciary standard, so it's fate has not yet been decided.  The Senate will be given an opportunity to extend a compromise to the House and then both sides will negotiate a "final" provision. 

UPDATE JUNE 16, 2010, 6:06pm

Senator Chris Dodd (D-CT) stated in his response to the House's offer today that the Senate conferees are not prepared to address the House offer on the fiduciary standard.  Senator Tim Johnson (D-SD), the author of the Senate provision that would require an SEC study, is working on a response that is expected to be ready within the next couple of days.  This indicates that the Senate clearly disagrees in some manner with the House's proposal to extend the fiduciary standard to broker-dealers, but the Senate has not yet outright rejected the House's proposal, which could signal a willingness to reach a compromise on the fiduciary issue. 

With no vote on cloture providing more time, Senate has opportunity to come together on fiduciary amendments

Yesterday, a vote for cloture failed in the Senate, which means the debate for financial regulatory reform will continue past this week.  The final vote revealed at least one interesting development in financial regulatory reform--that attempts by Democrats to court Maine Republican Senators Olympia Snowe and Susan Collins, who both voted for cloture, have been successful.  However, the vote ultimately failed as a result of Democratic Senators Russ Feingold (WI) and Maria Cantwell (WA) breaking from their Democratic colleagues and voting against cloture, signaling their frustration that not all proposed amendments have been considered yet.  So, for now, debate will continue for the remainder of this week and continue into next week, but a new motion for cloture will likely materialize quickly.

Some are viewing the continued debate as a positive outcome for financial regulatory reform.  For the fiduciary standard, in particular, it could signal a second (or are we now on the third or fourth?) chance to make it into a final bill.  With the Senate focused on larger issues, the fiduciary standard has not had its moment in the spotlight on the Senate floor yet.  However, complicating matters for the fiduciary standard is the trifecta of amendments put forth by Arlen Specter (D-PA), Daniel Akaka (D-HI) and Susan Collins.  Akaka's amendment at this point appears to be the greatest hope because it nearly mimics language in the bill passed in November by the House, which calls for a fiduciary duty for any broker-dealer who provides personalized investment advice to retail investors.   

Specter's and Collins's amendments, while admiral in their attempts to promote fiduciary responsibility, appear also to have created a confusing environment for the extension of the fiduciary standard. On the bright side, Specter's amendment would protect both retail and institutional investors while extending the fiduciary standard to broker-dealers. The amendment, however, seems to try to cover traditional brokerage activity that even advisory and investor groups have acknowledged should not be covered.  Specter's amendment also tries to criminalize "willful violation" of the fiduciary standard by broker-dealers, which has opened up a new can of worms that not too many seem happy to tackle. 

Collins, on the other hand, has put forth an amendment that largely tracks Akaka's amendment, but creates an unusual carve out for proprietary products, mutual funds and variable annuities.  Apparently, Collins has been vulnerable to the brokerage and insurance lobbies that have argued they won't be able to operate properly under the fiduciary standard.  Several articles have already claimed that the Collins amendment is a major disappointment and even betrayal in the eyes of advisory and consumer groups. What Collins' amendment (and Specter's for that matter) highlights to me, though, is what has gone wrong in general with financial regulatory reform and Congressional efforts as a whole.  Special interests permeate the legislative process, and what should be clear problems for which clear and simple solutions are devised, end up being muddled issues with ineffective solutions.  

When it comes to the fiduciary standard, from the beginning, investor and advisory groups have advocated for one thing:  extend the fiduciary duty to broker-dealers who provide investment advice to investors.  Do so, and you will ensure that all investment advice professionals minimize conflicts of interest and are transparent about the conflicts of interest that remain.  However, what we've ended up with is a Senate bill that calls for the issue to be further studied (despite the release of the SEC's RAND Report in 2008) and three proposed amendments, all of which in their own right fail to provide the clear and simple solution to address investor confusion in the marketplace.  Here's to hoping that the extra time bought by today's failed vote for cloture and the continuing attention mainstream media outlets, such as the Wall Street Journal and New York Times, have shown to the fiduciary standard will finally bring clarity to the issue and the simple and workable result that investors deserve.

UPDATE MAY 20, 2010, 3:58pm

A second vote for cloture this afternoon in the Senate was successful with a final vote of 60-40.   Further consideration of the Senate's financial regulatory reform bill will now be limited to thirty hours, and no more amendments may be submitted on the bill.  After the cloture vote, Senator Harry Reid (D-NV) indicated they would work to consider outstanding amendments the remainder of the day in hopes of quickly reaching final consensus on the bill.  A vote on the Senate's version of financial regulatory reform legislation could come as early as tomorrow.  With the bill nearing the finish line in the Senate, it's unlikely the amendments on the fiduciary standard will be considered on the Senate floor, but it could be included in a manager's amendment expected to be submitted by Christopher Dodd (D-CT), Chairman of the Senate Banking Committee.  If the fiduciary standard is not included in Dodd's amendment, there may still be hope that the House fiduciary provision, which extends the fiduciary standard to broker-dealers providing personalized investment advice to retail investors, will prevail when the Senate and House reconcile their respective financial reform bills in conference. 

The Goldman Sachs defense: We aren’t fiduciaries and the fair dealing standard is a low bar

Yesterday’s “Fiduciary Links” post provided links to articles that highlighted possible fiduciary ramifications of the SEC’s suit against Goldman Sachs. These articles touched upon alleged conduct by Goldman that  exemplify clear breaches of fiduciary responsibility, such as conflicts of interest that disadvantaged clients and failure to provide full and fair disclosure of material information. However, the SEC complaint against Goldman is not directed at fiduciary issues; rather, the SEC is after Goldman for failing to disclose material information that would be required even under the much lower fair dealing standard.

Back in mid-January, in testimony before the Financial Crisis Inquiry Commission, Goldman CEO Lloyd Blankfein laid out the Goldman perspective on the firm’s role in CDO deals. Here is a relevant excerpt from that testimony.

“FCIC CHAIRMAN ANGELIDES:

…Based on the review of public documents, as you know, your firm sold a significant amount of subprime mortgage-related securities. And it appears, at least according to public documents and other reports, that you may have simultaneously betted against the securities you sold to clients. According to the reports, you sold about $40 billion in 2006, 2007. In December 2006, I think, you came to the conclusion the mortgage market was heading south and you began to reduce your own positions. And many of the securities that you sold to institutional investors, other folks went bad within months of issuance. Now, one expert in structured financing said, “The simultaneous selling of securities to customers and shorting them because they believe they are going to default is the most cynical use of credit information that I’ve seen.” Do you believe that was a proper legal, ethical practice? And would the firm continue to do that practice? Or do you believe that’s the kind of practice that undermines confidence in the marketplace?

BLANKFEIN:

Well, the way it’s—let me—the short answer is this is the practice of a market maker. And I would like to explain this. But the answer is I do think that the behavior is improper, and we regret the result—the consequence that people have lost money in it, but I just want to explain—and this is a very important—and I appreciate the opportunity to do this because there’s so much press swirling around this that I really want—I really need to explain.

In our market-making function, we are a principal. We represent the other side of what people want to do. We are not a fiduciary. We are not an agent. Of course, we have an obligation to fully disclose what an instrument is and to be honest in our dealings, but we are not managing somebody else’s money. [Emphasis added]

When we sell something as a principal—which is what we are as a market maker—the next minute, that item will have gone up—in which case we’ll wish we hadn’t sold it that minute—or it will go down—in which case, we’ll actually be glad we did for our own P&L and sorry for the person who bought it. But we are market makers in that. In most of these cases, the person who came to us came to us for the exposure that they wanted to have.”

It would appear from Mr. Blankfein’s  testimony and from what we have seen so far from Goldman’s response to the SEC suit, that those who do business with Goldman in deals such as this should be aware that Goldman doesn’t consider you a client, but a counterparty. Moreover, those counterparties should know that under the Goldman interpretation of the fair dealing standard, the “obligation to fully disclose what an instrument is and to be honest in our dealings” is one that is so far removed from the fiduciary obligation for full and fair disclosure as to be almost out of sight.

If Goldman’s low-bar interpretation of the fair dealing standard holds, it offers clear and compelling evidence of why the fiduciary standard must be extended to all who give advice to investors. Opponents of the fiduciary standard have argued that the gap between fiduciary and fair dealing obligations is not great. This case provides a concrete example that nothing could be further from the truth.

Dodd proposal a fiduciary disappointment

Though not a surprise, the absence of the extension of the fiduciary standard in Senator Christopher Dodd's new proposal for financial regulatory reform is still a disappointment.  On Monday, Dodd spoke of plugging gaps and creating greater regulator accountability, but failed to back up these promises on the fiduciary front. And while groups like FSI and NAIFA pushed for and now applaud the proposed study of investment adviser and broker-dealer regulation, it's investors that would remain out there unprotected while the SEC studies issues of which it already has expert knowledge.  

The looming question is what's next?  Well, the truth is financial reform legislation is far from being a foregone conclusion.  Dodd must still gain bipartisan support for his proposal in order to successfully push it through an aggressive Senate Banking Committee mark-up schedule and then guide it through the Senate floor.  And let's not forget that a final Senate bill will still need to be reconciled with the bill passed by the House last December. As a lawyer, it's often my job to be the Debbie Downer in the room, and while this run down of the legislative process may sound dismal for investor protections, there may be hope just yet.  

Concerns about fiduciary responsibility are not U.S. specific

It was not long after we published the Practices in our first fiduciary handbook in 2003 that we were approached by a New Zealand financial services firm.  They had been referred by a common business associate and wanted to learn more about these defined fiduciary practices; it was something they felt was missing in New Zealand.  It was not our intention to expand beyond the U.S. so soon, but since that initial inquiry we have published fiduciary handbooks in New Zealand, Canada, and Australia and there is interest in doing so in Singapore, South Africa and the United Kingdom.  We have found that the Practices are substantially the same in these developed countries: managing money is managing money.

We have written numerous posts over the past several months highlighting what has been happening with financial services reform in general, both legislative and regulatory, and efforts to extend the fiduciary standard in particular.  In light of what is happening here, we decided to take a closer look at what is happening elsewhere and see if it might provide some useful insights.

New Zealand and Australia are grappling with the same issues and coming to the same conclusions; more must be done to protect those whom the fiduciaries serve: plan participants, beneficiaries, and investors.  In November 2009 the Parliamentary Joint Committee on Corporations and Financial Services in Australia completed what is commonly referred to as the Ripoll Report (www.aph.gov.au/senate/committee/corporations_ctte/fps/report/index.htm), which looked at issues associated with the collapse of Australian financial services firms including Storm Financial and Opes Prime.  The report made eleven recommendations; Recommendation 1 stated;

"The committee recommends that the Corporations Act be amended to explicitly include a fiduciary duty for financial advisers operating under an AFSL (Australian Financial Services License), requiring them to place their clients' interests ahead of their own."

Our adjunct faculty member in New Zealand recently heard from a colleague to whom he has preached the fiduciary message for several years now who said:

"I have noted that the Ripoll Report into financial advice in Australia is talking about enshrining advisers fiduciary responsibilities in legislation and that the code committee here (New Zealand) is looking at advisers fiduciary responsibilities.  It seems the time may well be coming where accredited fiduciaries would be well regarded."

New Zealand often looks to the U.S. to get a sense of where the financial services industry is headed.  With respect to fiduciary responsibility, we're please to see it appears Australia, New Zealand and the U.S. are heading in the same direction.

DoL seeking a few good nominees for the ERISA Council

Five seats open up in November for the Department of Labor's Advisory Council on Employee Welfare and Pension Benefit Plans (aka, the ERISA Advisory Council) and the DoL is soliciting nominations. The Council's function is to advise the Secretary of Labor on her functions under ERISA. The members are appointed by the Secretary to a three-year term in which they take part in at least 4 public meetings/hearings a year tackling 3-4 issues per year, eventually submitting a report on each issue with the Council's findings and recommendations.  Issues on the table for 2009 include Stable Value Funds and Retirement Security in the Current Economic Conditions , Promoting Retirement Literacy and Security by Streamlining Disclosures to Participants and Beneficiaries , and Approaches for Retirement Security in the United States.  Past issues have included disclosures, plan funding, fees, participant and advisor education, and communications. The full list of past reports can be found here.

From the official press release, here are the details for nomination procedures:

Interested persons or organizations may nominate qualified persons for membership. Recommendations must be submitted by letter, resolution or petition and signed by the person or, in the case of a nomination by an organization, by an official representative of the group making the recommendation.

Nominations should briefly describe the candidate’s qualifications and the group or field for which the candidate is being nominated, including contact information and indicating the candidate’s acceptance of the appointment if offered.

Nominations should be submitted to Larry Good, executive secretary, ERISA Advisory Council, Room N-5623, U.S. Department of Labor, 200 Constitution Avenue N.W., Washington, D.C. 20210 or to good.larry@dol.gov. Recommendations must be submitted on or before September 15, 2009.

We think this is a great opportunity for anyone who is interested in influencing policy under ERISA and we would be especially pleased to see some fi360 members, with their knowledge of fiduciary processes and dedication to promoting a culture of fiduciary responsibility, represented on the Council.

SEC Investor Advisory Committee Expresses Interest in Fiduciary Standard

The newly-created SEC Investor Advisory Committee gathered today in an open meeting at SEC Headquarters.  The goal of the committee will be to provide a greater voice to investors, and the committee will have the ability to make recommendations to the SEC on policy issues.  Today's meeting represents the committee's formal introduction to the public and also provided the committee the opportunity to discuss its agenda and organization.   

While discussing proposed future agenda items this morning, committee members showed great interest in further examining fiduciary duties.  Stephen Davis, Senior Fellow and Project Director for the Yale University School for Management's Millstein Center for Corporate Governance, specifically called for a full review of fiduciary duties and suggested that a subcommittee be formed to fully analyze the current status of the fiduciary duties in U.S. law and to compare it to international standards.  Mark Anson of Nuveen Investments noted the importance of defining what is a fiduciary standard, while Mac Hisey of AARP Financial Incorporated and AARP Funds highlighted the need to understand what investors think the standard is as well.  Barbara Roper of the Consumer Federation of America voiced concern that the fiduciary standard may be part of a broader issue related to investors' confusion about the difference between investment advisors, broker-dealers, and other investment and financial professionals and suggested that the committee take a step back and ensure that all underlying issues, including fiduciary duties, be considered when addressing investor confusion.  Mercer Bullard of Fund Democracy America noted the importance of providing predictability of what is required under a fiduciary standard in certain areas, such as how to disclose conflicted fees, while still providing some regulatory flexibility to address unpredictable areas on a fact-by-fact basis. 

Given these comments, it is clear that fiduciary duties will be a focal point at one or more future committee meetings.   This afternoon, the committee will continue to discuss future agenda items and is also expected to address possible refinements to the disclosure regime, including disclosure to investors in 401(k) plans.  For more information on the SEC Investor Advisory Committee, including today's meeting agenda and a briefing paper on disclosure issues can be found here.

Schapiro Continues to Support a Fiduciary Standard

In her testimony before the House Financial Services Committee today, SEC Chairman Schapiro continues to support the adoption of a fiduciary standard, stating: 

I therefore believe that all financial service providers that provide personalized investment advice about securities should owe a fiduciary duty to their customers or clients and be subject to equivalent regulation. As such, I support the standard contained in the Department of the Treasury bill recently put forth entitled the "Investor Protection Act of 2009." That bill explicitly would enable the Commission to promulgate rules to provide all broker-dealers and investment advisers providing investment advice to retail customers act solely in the interest of their customers or clients without regard to the financial or other interests of the financial service professional. The establishment of this investor-focused approach as a consistent standard for all broker-dealers and investment advisers providing investment advice would represent a significant step forward in the protection of retail investors.

The key to the Chairman's recent statements is the reference to "personalized investment advice."  An issue many industry leaders and regulators alike are currently struggling to address is where to draw the line between the fiduciary standard that applies to personalized advice and the suitability standard that applies to securities recommendations and general advice, so that professionals and investors can be clear on the services being provided and the duties that attach to those services.  If the Investor Protection Act of 2009 is enacted, it would be up to the SEC to define and enforce that distinction.