Tuesday, SEC chair Mary Jo White announced the SEC “should implement a uniform fiduciary duty for broker-dealers and investment advisers where the standard is to act in the best interest of the investor.” And with that, after five years of waiting[i], we finally know the SEC chief’s opinion of Dodd-Frank’s orders to investigate the matter. While this doesn’t mean the SEC for sure writes a rule, it raises the likelihood they’re headed that way. Predictably, there are cheers and jeers, though we think strong reactions on both sides largely miss the point. We’re all for more transparency in this industry, but a uniform fiduciary standard won’t ensure investors’ best interests are protected.
Most US investment professionals are currently subject to one of two regulatory standards: the suitability standard or the fiduciary standard. Brokers and most financial salespeople fall under the suitability standard, which requires them to sell investments that they reasonably believe are in keeping with a client’s basic financial situation. They don’t have to disclose conflicts of interest or put their clients’ interest first. Registered Investment Advisers[ii] (RIAs) are held to the fiduciary standard, which requires them to reasonably believe they are putting clients’ interests first and disclosing any potential conflicts of interest and how they attempt to mitigate them.
For years, regulators have pushed to broaden the fiduciary standard’s reach. The White House has backed the Department of Labor’s (DOL) plans to apply the fiduciary standard to every investment professional working with retirement accounts, like 401(k)s and IRAs—a backdoor approach to spreading it across the industry, as most brokers handle IRAs. The SEC’s unrelated potential rule charges through the front door, applying to every RIA and broker and all of their relationships. At least, we assume it would, as no one knows what the SEC’s rule would include. As White said, if the SEC decided to move forward, they’d have to first define the new standard, which could be tougher or more watered down than the current rule. They could also follow the UK’s lead and introduce new services where the rule wouldn’t apply, like “execution-only,” where the broker would merely take orders for the client, not proactively sell or recommend a security. So it’s premature to think about specifics, and at the rate regulators move, it could be years before this goes anywhere.[iii]
But, at a high level, well-intentioned as the proposed rules may be, they aren’t automatic positives for investors. Many have already pointed out flaws in the White House’s analysis of the suitability standard’s impact on investors’ returns and the potential negative consequences from imposing the DOL’s plan, and any SEC proposal will likely meet similar scrutiny. But more broadly, rules can’t be a one-size-fits-all solution for all investors’ needs. The White House’s report, for example, presumes low fees are the most important consideration for all investors—but that’s a matter of opinion, not fact, as some investors may benefit from the services provided by paying a higher fee. In our view, investors must do their due diligence to find a financial professional whose values are compatible with their own—a government-sponsored diktat won’t accomplish that.
This regulatory debate also overlooks a more fundamental issue: the blurring line between financial sales and service. Imposing a fiduciary standard, whether it’s sponsored by Wall Street, third parties, the SEC, DOL and/or the White House, won’t fix that. Before the Investment Advisers Act of 1940, financial salespeople could masquerade as advisers, yet sell their own products without disclosing any conflicts of interest—many believe this shady, rampant practice contributed to the Crash of 1929. The 1940 Act drew the line between financial salespeople and advisers to promote transparency and make the choice easier for the investor—they could know what they were buying. Likewise, some firms also incorporated this separation between sales and service into their business model to better serve their clients.
Over time, the brokerage industry has sought to blur the distinction between sales and service. To avoid the negative association many folks have with the profession, brokers started calling themselves “advisors” with an “O”—a critical, though frequently overlooked, detail. The 1940 Act recognizes advisers (with an “E”) as the group that can legally give financial advice, and this variant of the word is a clever way to get past the rule. Sales pitches are dressed up as “product recommendations,” and benign, innocent-sounding titles like “financial consultant” muddy the distinction between financial sales and advice. And a uniform fiduciary standard is unlikely to change brokers’ pay-model, which naturally puts brokers’ interests ahead of clients’—implementing an industry-wide fiduciary standard could worsen that blurring between sales and advice. Disclosing conflicts of interest doesn’t remove them, especially if they get couched in legalese and jargon. Besides, a rule change won’t ensure an adviser (or advisOr) has the knowledge, ability and experience to actually put your interests first. Being technically held to a regulatory standard isn’t a qualification or evidence of good values.
Now, we neither know what the SEC’s rule will look like nor the final form of the DOL’s proposal, and questions remain over who would be subject to new rules (e.g., what about insurance brokers selling variable annuities?). But our point still holds: A rule alone won’t guarantee investors will get the best advice for them.
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[i] Or two years, depending on how you do the math. The law passed nearly five years ago, though White has led the SEC since early 2013.
[ii] Our parent company, Fisher Investments, is a Registered Investment Adviser held to the fiduciary standard.
[iii] White alluded to this herself: “You have to think long and hard before you regulate differently something that is essentially identical conduct, and particularly when you’re in a space where retail investors need good advice.”