fi360 Blog

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.  

The potential conflict of being sponsored to attend training

In our business of delivering fiduciary training to investment professionals, we often are asked whether it is a conflict for an adviser or broker representative to be sponsored by a fund company or other product provider to attend a training program.  When in doubt, a rep should always seek guidance from his firm's compliance department on conflicts of interest.  However, there are some basic regulatory requirements that we can point to as a starting point when it comes to receiving training and education.

For broker reps, FINRA rules 2310 and 2320, and NASD rule 2830 address when a product provider of securities may conduct and pay for a training and education meeting for representatives that sell the provider's products.  As explained in these rules and previous guidance issued by NASD (now FINRA), a provider may pay for training as long as the following conditions are met:

• The representative gains the approval of his firm prior to attending
• The location of the training is appropriate to its purpose
• Attendance at the training is not tied to a sales target or other incentive
• Payment is not applied to guests of the representative
• The representative's firm maintains a record of the training as non-cash compensation received by the representative.

When these rules were first adopted, NASD explained that they are not intended to prevent a firm from designating a representative to attend training based on past performance or to encourage future performance, but attendance cannot be based on a specific target or incentive.

Thanks to our friend and ERISA attorney Fred Reish, we found out that similar standards apply to an adviser that is a fiduciary to a qualified retirement plan (or plans).  Specifically, under ERISA section 406(b), the adviser cannot use its fiduciary status to obtain additional money or valuable benefits.  A logical extension of that rule is that, if an adviser has to qualify to receive a benefit such as training (e.g., the adviser has 15 plans with the provider or at least $50 million under management with the provider), then the adviser is using his fiduciary status to get the benefit and the receipt of training would be a prohibited transaction.  On the other hand, if the provider sponsors the adviser in an attempt to get new business from the adviser, the receipt of training would not be a prohibited transaction under ERISA because the adviser would not yet be acting in the capacity of a fiduciary. 

In sum, an adviser or broker rep generally should not accept training paid for by a sponsor if the training is offered based on a specific incentive or quota set by his employer or the product provider offering the sponsorship.  Moreover, the rep should get approval from his employer before attending the training, and in particular, should get guidance from the appropriate compliance official within his firm to avoid any unintended conflicts of interest.

Financial Services Committee, Supreme Court both consider fiduciary issues

Today, the House Financial Services Committee will continue its consideration of the Investor Protection Act.  Several amendments were considered by the Committee last week that have been viewed as weakening investor protections including the fiduciary standard, prompting several advisor industry and investor advocacy groups to express their disappointment to the Committee.  The legislation is expected to be voted out of committe this week and referred to the full House.  However, even if financial reform continues its smooth progression through the House, there are indications that it may face an uphill battle in the Senate, potentially slowing down Congress' agressive timetable for executing change.

Meanwhile, fiduciary issues took center stage in another type of hearing room on Capitol Hill as the Supreme Court heard oral arguments related to compensation for mutual fund advisors. The issues came before the court in the case of Jones v. Harris Associates, in which three shareholders sued Harris Associates, LP, the advisor to the Oakmark Funds.  The shareholders claim that Harris Associates charged excessive fees and violated its fiduciary duty under Section 36(b) of the Investment Company Act of 1940, as amended in 1970.  

During oral arguments, the parties and justices mostly focused on the appropriate legal standard and analysis that should be used by courts to determine if fees are fair.   However, it's also notable that Justice Kennedy started off questioning by exploring the meaning of "fiduciary" and the scope of the fiduciary duty under the federal securities law.  Other justices joined in this line of questioning, which focused on how the fiduciary duty of Harris compares to that of corporate officers and directors, guardians, and trustees.  The shareholders' counsel answered that fiduciary duty in these circumstances meant "fair result through full information and good-faith negotiations."

Ultimately, a few justices questioned the role of courts in regulating rates, suggesting that the SEC and market competition should be the key drivers in ensuring rates are fair.  Market competition was a key factor in the 7th Circuit's decision to let a ruling against the Oakmark Fund shareholders stand, but many, including mutual fund icon, John Bogle, have thrown their support behind the shareholders and argued that funds are not competitive with one another. 

With oral arguments concluded, the mutual fund industry and shareholders can only sit by and wait for the Supreme Court to issue a decision in June.  For those looking for more immediate action on the fiduciary front, Congress appears ready to deliver in the coming months.