Friday, March 29, 2013

What's in a Name? - The "Pretend" "Advisor" and Fraud

I had the unique experience of having three guest speakers for my classes over the past two days. All three were from the life insurance / annuity industry and all three held Series 6 licenses, and hence were also registered representatives of a broker-dealer.

The guest speakers spoke of "cold calling" and "warm calling." They spoke of the high payouts available on annuities and permanent life insurance sales (as if that would be attractive for my students). They spoke of how they spend 60-70 hour weeks, most of it prospecting.

But what was really disturbing were two practices. First, they held themselves out as "advisors." Second, they all talked of the importance of gaining the trust and confidence of the clients.

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.

In 1963, in its Special Report on the securities industry, the SEC also noted that it:

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 Special Study.

In the latter half of the 20th Century new sales techniques evolved, as did salespersons’ view of themselves.  Codes of ethics were developed, high-pressure sales techniques were sometimes disavowed, and needs-based selling became a new paradigm.

Later this evolved into “trust-based selling” – now taught by consultants to practitioners, and by academics to their students.

Where do we stand today?  In the 2nd edition of the textbook, Sell (Cengage Learning, 2012), Professors Ingram, LaForge et. al. state that trust, when used as a sales technique, answers these questions:

    “1. Do you know what you are talking about? – competence; expertise
     2. Will you recommend what is best for me? – customer orientation
     3. Are you truthful? – honesty; candor
     4. Can you and your company back up your promises? – dependability
     5. Will you safeguard confidential information that I share with you? – customer orientation; dependability.”

(Sell, p.27).  In looking closely at the list above, it appears that questions 1, 3 and 5 are closely associated with the fiduciary duty of care.  Question 2 is close to the proposition of “acting in the client’s best interests” – one of the major aspects of the fiduciary duty of loyalty.  And Question 3, acting with honesty and candor, translates into the fiduciary duty of utmost good faith.

Of course, as any experienced financial advisor knows, trust-based selling is not just taught from books.  Many (if not nearly all) practice consultants extoll the virtues of a “consultative approach” as a means to not only secure the sale, but also to generate referrals.  Financial advisors are taught techniques such as the “Discovery Conference,” where exploring the personal details of clients’ lives results in building the foundations of trust for a long-term relationship.  Having experienced one of these workshops myself (which this author found to be extremely valuable in subsequently building his own financial planning practice), the stress is upon getting to know the clients, and their goals and values, extremely well, through a process designed to build trust and confidence – prior to any discussion by the financial advisor of a product or service.

There is nothing inherently wrong with a trust-based sales process.  In fact, one might applaud the depth of relationships between financial advisor and client that results from a trust-based, relationship-cultivation process.

Yet, under the law, there are two types of commercial relationships.  One is the arms-length relationship, in which seller and buyer negotiate with each other over the terms of the transaction at hand.  It is an adverse relationship, and from the customer’s perspective the doctrine of caveat emptor (“buyer beware”) applies.

The other type of relationship is the fiduciary-entrustor relationship.  In this type of relationship the provider of services (either management of assets, or the provision of advice) adopts a wholly different role.  The fiduciary becomes bound by fiduciary duties of due care, loyalty and utmost good faith to the entrustor (the “client” in our context of investment or financial advice).  The fiduciary, in essence, “steps into the shoes” of the client, and makes the decisions (or provides the advice) as if the fiduciary was the client.  In other words, the fiduciary is bound to act in the sole or best interests of the client.  As explained by Professor Laby, “What generally sets the fiduciary apart from other agents or service providers is a core duty, when acting on the principal’s behalf, to adopt the objectives or ends of the principal as the fiduciary’s own.”  [Arthur B. Laby, SEC v. Capital Gains Research Bureau and the Investment Advisers Act Of 1940, 91 Boston Univ. L.Rev. 1051, 1055 (2011).]

Somewhere along the way, the practice consultants omitted to tell the financial advisors that “trust-based selling” - designed to achieve a relationship of trust and confidence - results in consumer confusion, at the minimum.  More importantly, trust-based selling increases the likelihood of fiduciary status for the financial advisor, applying state common law.  This is true regardless of how the financial advisor is licensed or regulated (whether as a registered representative of a broker-dealer firm, investment adviser representative of a registered investment adviser firm, dual registrant, or even just a life insurance agent).

In essence, trust-based selling often transforms arms-length, commercial buyer-seller relationships into fiduciary-client relationships.

In recent years massive marketing campaigns by Wall Street firms have touted their “objective advice” from “financial consultants” who attended their client’s soccer games and made so many believe that the “advice” received would result in the ability to afford that second home on the beach.  Even long-respected firms like Goldman Sachs have been perceived, at least at times and by some, to “throw clients under the bus” [see], apparently in violation of their adopted Code of Business Conduct and Ethics in which the firm commits “to conduct our business in accordance with … the highest ethical standards.”

And, as seen recently in my classroom, the brokers / life insurance agents before me (none of whom possessed Series 65/66 licensure), all stated that they always called themselves "advisors" and "consultants" - and one even stated, "My firm wants me to call myself a salesman, but if I did that I would be unable to secure appointments."

There exists a fundamental truth that “to provide biased advice, with the aura of advice in the customer’s best interest, is fraud.” [Angel, James J. and McCabe, Douglas M., Ethical Standards for Stockbrokers: Fiduciary or Suitability? (September 30, 2010), at p.23.  Available at SSRN:]

It has not always been so. Only lax enforcement by the SEC, FINRA (whose multiple failures to raise standards are well-known), and others in recent decades is to blame.

But I sense a shift in the tide. There are many of us who believe that frauds should not go unchallenged, and that consumer confusion should not be permitted to exist forever.

Those who use titles and designations, such as "financial advisor" or "CFP" or "ChFC" or "financial consultant" - and who then don't adhere to the fiduciary obligations attendant to such representations - in essence commit intentional misrepresentation. Let's call it for what it is - "fraud" - plain and simple.

The time has nearly arrived, as DOL and SEC rulemaking is soon underway, to speak up.  And speaking up will be essential, given the hundreds of millions of dollars of lobbying efforts being spent by those who desire to continue existing fraud-ridden sales practices.

Who should speak up?
  • Those advisors who desire that consumers not be misled, and instead receive trusted advice - when trusted advice is provided and/or (through use of titles or designations) represented as being provided.
  • Consumers themselves, tired of having their trust betrayed by those who do not subscribe and adhere to their fiduciary obligations.
  • Those federal and state securities and insurance regulators, as well as advisors and consumers, who desire that truth be spoken, and who desire to combat the pervasive misrepresentations and frauds that have crept into the financial services industry in recent decades.
We should not live in a society in which pervasive fraud - i.e., holding out as trusted advisors, and then failing to adhere to the duties imposed from the resulting fiduciary rleationship - is continued to be permitted to occur.

There is a simple maxim I heard expressed by a state securities commissioner nearly a decade ago. "Do not lie, cheat or steal. Say what you do. And do what you say.

Enough said. For now. More on this subject, and how to reach out to the SEC and DOL, in the weeks to come. - Ron Rhoades, JD, CFP(r)

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1 comment:

  1. I was looking for this type of information and am glad to have on your blog.


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