Thursday, March 14, 2013

The Fiduciary Landscape in 2013 ... And a Wish List

As we approach the New Year, I offer a look at the issues likely to be of most concern to pro-fiduciary advocates.  I also offer my own personal “wish list” for 2013 and beyond.

The Major Issues in 2013.

Department of Labor – Major Extension of Fiduciary Standards Forthcoming. The biggest development in the expansion of fiduciary duties, at least in the short term, will be the DOL/EBSA's release of a revised “Definition of Fiduciary” rule.  Recent reports indicated that the new proposed rule will be released in early or mid-2013. Backed by a substantial economic analysis, Assistant Secretary of Labor Phyllis Borzi, who heads up the U.S. Department of Labor's influential Employee Benefits Security Administration, will likely apply the strict ERISA fiduciary standard to nearly all those who provide investment advice to either plan sponsors or to plan participants.  Even more dramatic will be the extension of ERISA's fiduciary standard to cover IRA rollover accounts.  With these moves, ERISA's standards will apply to well over $15 trillion of financial assets held by individuals and in retirement plans in the United States – a significant portion of the overall universe of publicly traded securities held by individual Americans.

The EBSA's re-proposed rule on “Definition of Fidcuiary” will endure intense opposition, but I believe it will be adopted.  The extension of fiduciary status to nearly all those who provide investment advice to plan sponsors and plan participants will be the third leg of what I call the “Big 3” EBSA rule initiatives - the first two being the fee/cost disclosures required to plan sponsors, and then to plan participants.  The effect of the first two rules is already being seen in tens of billions (if not more) in savings for retirement plan participants.  There is no doubt that these first two rules have already impacted in a positive way the retirement security of millions of Americans already, and will continue to do so.

Yet disclosure is not the greatest disinfectant, despite assertions to the contrary.  Already reports have been heard of plan sponsors ignoring the drawbacks of high-cost products in order to obtain a “better relationship” with a chosen advisor.  Hence, the last peg of this triad of rulemaking – the extension of the definition of fiduciary - will bring forth far more good news for participants over the long term.  Over time plan sponsors, and their fiduciary advisors, will realize that all fees and costs matter, and that lower-fee alternatives must be explored and evaluated.  Greater care will be taken in the design of retirement plan portfolios, and greater due diligence will be undertaken by advisors (now bound by a fiduciary duty of due care) in reviewing all of the risk, fees, costs, and other attributes of investment products.

Securities and Exchange Commission – Any Action Likely on Section 913 of Dodd-Frank?  The ongoing influence of the state courts on the fiduciary obligations of those who provide investment advice should not be underestimated.  State common law continues to apply the fiduciary standard to many registered representatives who provide financial or investment advice, under a facts and circumstances test, as it has for well over a century.  Too many investment advisers and financial advisors ignore the state common law imposition of fiduciary standards upon their advisory activities, at their peril.  Moreover, with a growing consensus among behavioral economists that disclosure-based regimes are an inadequate response for consumer protection, and with the ongoing influence of economic theory upon the law, additional cases will likely emerge from the courts and in arbitration proceedings which apply the fiduciary standard to those who hold out as trusted advisers [such as by using titles that denote relationships of trust and confidence, such as 'financial consultant' or 'CFP(r)'] or who actually provide investment advice.  While anything can happen, I would not be surprised if we don't see a proposed rule from the SEC until 2014, or even later.

Self-Regulatory Association for RIAs – The Danger Is Greater Than Many Think
Despite the assertions of the likely new head of the U.S. House Committee on Financial Services that the SRO bill for RIAs is on the back-burner, the influence of FINRA, SIFMA, FSI, the insurance company lobby, and the Wall Street broker-dealer and investment banking lobby should not be underestimated.  As seen recently with its offer to act as arbitrator in RIA proceedings, FINRA continues to position itself as the solution for RIA oversight.  This is the same FINRA (f/k/a NASD) that, in 1942, failed to incorporate the fiduciary standard of conduct into its Rules of Conduct for brokers.  FINRA's failure continues to this day, and, in fact, FINRA in 2005 opposed the application of the fiduciary standard to ongoing investment advice provided to retail consumers.  Despite the progress likely to be made at the DOL in 2013, FINRA's move to oversee its members' competitors would, in my view, be the death knell for the fiduciary standard, and a huge blow to the ever-growing investment adviser community.

Continued Growth of the RIA Business Model.  Turning to the RIA profession, there will continue to be a slow migration of registered representatives and dual registrants away from the large Wall Street broker-dealer firms and into the hands of independent broker-dealers.  This will be an intermediate step for some, for many will likely move to RIA-only status just a few years later, abandoning their Series 7 licensure.  A few intrepid souls will move directly from larger BDs to RIA firms, or they will start their own RIA firms.  This movement toward the RIA model is fueled only in small part by the desire to escape from FINRA's rules-based regulatory regime.  In a much larger part, it is fueled by the attractiveness of being removed from the pressure to sell products which may not be in the best interests of clients.  The transition to RIA status is motivated by advisors' desire to be 'on the same side of the table' as that of their clients, and by consumers' ever-greater knowledge that less conflicts of interest equals better advice.

The Ongoing Rise of the CFP® Certification – But Will the CFP Board Lead the Profession, or Not?  The financial planning profession, while still diverse, has increasingly become centered around the CFP Board's certification process.  The rise in the number of CFP certificants will continue, although the pace may vary over time.  With its increased stature, the CFP Board of Standards will likely face closer scrutiny of its own application of the fiduciary standard upon its certificants.  The question remains ... 'Will the CFP Board lead financial planners toward a true profession bound together by a bona fide fiduciary standard, or will it merely follow and, in doing so, risk losing its chance for preeminance as the consumer mark of choice in the years to come.

(My recent blogs, found at and, and Michael Kitces' recent blog at, and Andy Gluck's articles on this subject at, discuss the issues surrounding the CFP Board's Standards of Conduct in greater detail.)

A Wish List for 2013 … and Beyond

FINRA acknowledges that all brokers providing personalized investment advice are already fiduciaries, and incorporates fiduciary standards into their Rules of Conduct.  What is “personalized investment advice”?  Just about anything other than a description of the product or security – including advice regarding strategic or tactical asset allocation, “whether this security is right for you,” etc. – is advice. Interestingly enough, FINRA (formerly known as NASD), over seven decades ago, undertook such a statement in one of their first bulletins to their broker-dealer members, stating:  "Essentially, a broker or agent is a fiduciary and he thus standards in a position of trust and confidence with respect to his customer or principal.  He must at all times, therefore, think and act as a fiduciary.  He owest his customer or principal complete obedience, complete loyalty, and the exercise of his unbiased interest.  The law will not permit a broker or agent to put himself in a position where he can be influenced by any considerations other than those to the best interests of his customer or principal … A broker may not in any way, nor in any amount, make a secret profit … his commission, if any, for services rendered … under the Rules of the Association must be a fair commission under all the relevant circumstances.” – from The Bulletin, published by the National Association of Securities Dealers, Volume I, Number 2 (June 22, 1940).

The broad range of fiduciary status is amply illustrated by the SEC’s 1942 discussion of the Stelmack decision.  The SEC summarized this decision, stating that the furnishing of investment advice by a broker was a “fiduciary function.”  The SEC stated: “In the Stelmack case the evidence showed that the firm obtained lists of holdings from certain customers and then sent to these customers analyses of their securities with recommendations listing securities to be retained, to be disposed of, and to be acquired … The [U.S. Securities and Exchange] Commission held that the conduct of the customers in soliciting the advice of the firm, their obvious expectation that it would act in their best interests, their reliance on its recommendations, and the conduct of the firm in making its advice and services available to them and in soliciting their confidence, pointed strongly to an agency relationship and that the very function of furnishing investment counsel constitutes a fiduciary function.”  From the 1942 SEC Annual Report, p. 15, referring to In the Matter of Willlam J. Stelmack Corporation, Securities Exchange Act Releases 2992 and 3254.

FINRA’s Aspiration to Become SRO for RIAs Is Soundly Rejected by Congressional Leaders.  FINRA’s continued refusal, in recent decades, to acknowledge the fiduciary status of brokers providing individualized investment advice, and its seven-decade-old failure to incorporate fiduciary standards into its Rules of Conduct, are evidence enough of why FINRA should never have its jurisdiction extended to cover the RIA community.  (If they reversed seven decades of opposition to fiduciary standards, and endorsement of the failed suitability standard, I would reconsider my opposition to FINRA).

I’ve previously written extensively about the issue of FINRA’s power grab over RIAs, and what a dismal result this would be for advisors and consumers alike, in two articles published by RIABiz: and

Use of a title denoting a relationship of trust and confidence results in broker’s fiduciary status per se.  Such titles would include “wealth advisor,” “wealth manager,” “investment advisor,” “financial consultant,” “financial advisor,” “financial planner,” and any designation or certification incorporating these or similar terms (such as ChFC, CFP, PFS, etc.).  Why is this important?  Let’s listen to some early musings by the SEC.

In its 1940 Annual Report, the U.S. Securities and Exchange Commission noted: “If the transaction is in reality an arm's-length transaction between the securities house and its customer, then the securities house is not subject' to 'fiduciary duty. However, the necessity for a transaction to be really at arm's-length in order to escape fiduciary obligations, has been well stated by the United States. Court of Appeals for the District of Columbia in a recently decided case: '[T]he old line should be held fast which marks off the obligation of confidence and conscience from the temptation induced by self-interest.  He who would deal at arm's length must stand at arm's length.  And he must do so openly as an adversary, not disguised as confidant and protector.  He cannot commingle his trusteeship with merchandizing on his own account…’"

Seventh Annual Report of the Securities and Exchange Commission, Fiscal Year Ended June 30, 1941, at p. 158, citing Earll v. Picken (1940) 113 F. 2d 150.  

The SEC also “has held that where a relationship of trust and confidence has been developed between a broker-dealer and his customer so that the customer relies on his advice, a fiduciary relationship exists, imposing a particular duty to act in the customer’s best interests and to disclose any interest the broker-dealer may have in transactions he effects for his customer … [BD advertising] may create an atmosphere of trust and confidence, encouraging full reliance on broker-dealers and their registered representatives as professional advisers in situations where such reliance is not merited, and obscuring the merchandising aspects of the retail securities business … Where the relationship between the customer and broker is such that the former relies in whole or in part on the advice and recommendations of the latter, the salesman is, in effect, an investment adviser, and some of the aspects of a fiduciary relationship arise between the parties.” (1963 SEC Study, citing various SEC Releases.)

Two other professors stated this point much more succinctly: “[T]o give biased advice with the aura of advice in the customer’s best interest — is fraud.” (Professors James J. Angel and Douglas M. McCabe, Georgetown University, Ethical Standards for Stockbrokers: Fiduciary or Suitability? Sept. 30, 2010).  Available at

The SEC reverses its September 2007 proposed rule, and understates that “switching hats” (from fiduciary to non-fiduciary status) is permitted only extremely rarely, and that wearing “two hats” at the same time is impossible under the law.  There’s an old adage, from an eloquent Tennessee jurist writing just before the Civil War. This judge stated that the fiduciary doctrine “has its foundation, not so much in the commission of actual fraud, but in that profound knowledge of the human heart which dictated that hallowed petition, 'Lead us not into temptation, but deliver us from evil,’ and that caused the announcement of the infallible truth, that 'a man cannot serve two masters.’”

Having given this a lot of thought, I don’t think it is possible to “switch hats” from a fiduciary to nonfiduciary one (except in very, very rare cases), or wear two hats at the same time for the same client. The temptation to not act in the client’s best interest is too great. Moreover, the client will never understand the dramatic shift which occurs when the fiduciary hat is removed; if the client did understand it, he or she wouldn’t allow it.

While principal trades may occur, they must still fall within the fiduciary standard of conduct – i.e., the proposed transaction must be in the best interests of the client, measured objectively and taking into account all of the facts and circumstances of the situation at hand.  It must be affirmatively shown that an agency trade, when available, was not better for the client.

The SEC’s Division of Investment Management, and SEC Commissioners, get their act together to enact a broad series of reforms.   These include, but are not limited to;
  1. 12b-1 fees phased out, as anti-competitive in nature and contrary to fund directors’ duty to shareholders.  It also amounts to indirectly paid, but still prohibited, "special compensation," in my view.
  2. “Portfolio turnover” ratio re-defined as the average of sales and purchases of securities within a fund, rather than the lower of the two figures, in order that investors are not misled by the published, and frequently-referred-to, metric.
  3. Absent repeal by Congress, the SEC reviews the payment of soft dollar compensation for reasonableness, and actual substantial use of investment research provided in return for payment of soft dollars.
  4. The insidious practice of payment for shelf space terminated.  This is contrary to the fiduciary principle which all brokers must follow.
  5. Securities lending revenue is defined to be an asset of the fund, much as has recently occurred in a decision within the EU.  Fees for management of securities lending are included as part of the fund’s investment advisor’s fee.
DOL/EBSA’s “Definition of Fiduciary” Rule is Proposed and Finalized.  A strong ERISA “sole interests” fiduciary standard is applied to all those who provide advice to plan sponsors and to plan participants.  The rule extends to all IRA accounts.  As a result, plan sponsors and participants finally receive advice – from all advisors – that is truly in their sole interest.

A more far-out wish?  Tax simplification for DC and DB Plans.  Congress consolidates all types of defined contribution plans into one form – IRA accounts governed by ERISA, with uniform limits on contributions, with auto-enrollment and auto-escalation features (with opt-out mechanisms), and with self-directed options always available (still governed by ERISA, however).  Substantial limits on loans are imposed, if they are permitted at all.  The IRS works with EBSA to formulate required minimum distribution schedules which provide a more sensible scheme of distribution from IRA and qualified retirement plan accounts over time. And Congress consolidates all types of directed benefit plans, over time, into one type.

Even More Far-Out?  Remove Tax Incentives for Sales of Life Insurance, Annuities as Forms of Investments.  Along the way, I would hope that Congress terminates the tax-deferral feature of nonqualified annuities, and the tax-deferral provided within life insurance contracts as to any withdrawals (including loans) during lifetime.

The CFP Board of Standards Moves to Improve its Standards of Professional Conduct.  The CFP Board’s current application of the fiduciary standard needs to evolve, as I have written previously in two articles found at

In Conclusion.

Opportunities exist in 2013 for a strengthening and expansion of the fiduciary standard on several fronts.  Yet, the immense threat of FINRA remains, and those RIAs and financial planners who ignore this threat do so at their own peril.  If the FINRA threat is abated, significant progress is likely at DOL/EBSA, and this may well set the stage for later action by the SEC to embrace the fiduciary standard for all those who provide personalized investment advice - as was done in the early part of the 20th Century.

Ron A. Rhoades, JD, CFP®
Program Chair, Financial Planning Program
Asst. Professor, Alfred State College Business Department

(This article reflects the author’s personal views, and are not necessarily those of any institution, organization, or firm of which the author may be part.)


  1. I think that there has not been a significant change of problems from last year. Some of last year's problems are still present and the government is still trying to resolve it. I just wish that there will be more tax benefits for this year and that taxes won't increase anymore as it is already very heavy for average families like us.

  2. Have just encountered your page and I guess you should be complimented for this piece. More power to you!


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