Wednesday, March 12, 2014

Does SEC Chair Mary Jo White Possess Courage? Do We?

With SEC Chair Mary Jo White informing the financial services industry that a decision on whether, and how, to move forward with the fiduciary standard is due by the end of this year, the outlook for the fiduciary standard remains cloudy, at best.

From my discussions with Washington insiders, in all likelihood there are two commissioners in favor with moving forward with the Dodd Frank Act's authorization under Sect. 913 to impose, by rule, fiduciary standards on brokers providing investment advice, and two commissioners are opposed (and favor enhancing disclosures, only). SEC Chair Mary Jo White has been keeping her own views on the fiduciary standard very close to the vest, at least when speaking publicly or in private conversations with pro-fiduciary advocates. While some fiduciary advocates believe that the SEC Chair is opposed to fiduciary standards, there is no concrete evidence of such a stance.

There are many possible outcomes by the end of this year.

First, the SEC may delay acting for years, and hence may not take any action in 2014. Such is not an unusual outcome in Washington, DC.

Second, many pro-fiduciary advocates fear a watered-down "new federal fiduciary standard" which would impose only enhanced disclosure obligations and in which clients could easily waive fiduciary protections. Of course, the fiduciary standard requires much more than disclosure of conflicts of interest; a true fiduciary standard requires the fiduciary to ensure any action taken is substantively fair to the client, for no client would ever provide informed consent to be harmed. Additionally, core fiduciary obligations cannot be waived easily under the common law, as Wall Street would like to have the SEC believe, and as the SEC OCIE turns a blind eye to now. (All they have to do is look at a dual registrant's Form ADV, Part 2A and client relationship agreements - and the forced waiver by clients of fiduciary obligations is all right there, in plain sight.)

By way of further explanation, there is an old adage in the law - a fiduciary cannot wear two hats. Yet, that's what Wall Street desires with its proposed "new federal fiduciary standard" - i.e., being called a fiduciary, but being permitted to essentially engage in all of the corrupt business practices which engender consumer harm presently. Wall Street touts its "new federal fiduciary standard" - but it's not a fiduciary standard at all, nor anything close to it!

The late Justice Benjamin Cardoza long ago warned against the "denigration" of the fiduciary standard through particular exceptions. This is what pro-fiduciary advocates fear the most, as the revolving doors of the SEC have long led to "regulatory capture" of the agency by Wall Street. We have seen over the past three decades the SEC retreat from the enforcement of true fiduciary standards, as it has permitted Wall Street to twist the fiduciary standard. It has been a long time since the SEC has stood up and said "no" to Wall Street's business practices.

There are billions and billions of dollars a month at stake - excessive fees and costs that Wall Street and the insurance companies make – that substantially detract from the returns of the capital markets which should, instead, flow more to investors. Because of the money at stake, Wall Street will do whatever it takes to ensure that the SEC remains Wall Street-friendly. In essence, the SEC lacks the courage to tackle Wall Street's perverse business practices. Where is Joseph P. Kennedy (the Chair of the SEC in its early days, who banned many of the practices he himself participated in back in the 1930's), when you need him? Hopefully his legacy will live on in the current SEC Chair.

Third, it is possible that the SEC will vote to take no action under Sect. 913, as to applying fiduciary standard by rule. In this case brokers may still be held to be fiduciaries, applying state common law (which dictates in many, but not all, states that brokers are fiduciaries when they are in a relationship of trust and confidence with their clients). But FINRA arbitration has diminished this threat, as most arbitrators have been led to believe that fiduciary duties can be waived (they cannot), that customer agreements which denote the nature of the account as "advisory" or "brokerage" control (they do not), and all that is required when a conflict of interest is present is its disclosure (much more is required). Of course, FINRA's discharge of some arbitrators who don't adhere to FINRA's anti-fiduciary stance is just another colossal FINRA failure, and further evidence of the fact that FINRA exists not to serve the public, but rather to protect broker-dealers.

Fourth, it is possible that legislation would emerge from Congress which would impose new economic analysis requirements upon the SEC before proceeding under Section 913. Last year Wall Street lobbied extensively for such legislation, and the result was a substantial delay in the DOL's rule-making efforts. Even now, Wall Street and the insurance companies are pouring money into the re-election campaigns of many a Senator and Representative, to try to get such legislation enacted this year. And the visits to the halls of the Senate and House office buildings by Wall Street and their many lobbyists and proxies far outnumber, by perhaps 20 to 1 (or much worse), visits by consumer advocates.

Fifth, the SEC may take another route entirely. As suggested by former Asst. Director of the SEC’s Division of Investment Management, Bob Plaze, a “best interests” standard could be enacted for brokers under the ’34 Act. I personally don’t see the benefit of proceeding down this compromise path – it just seems to muddy the waters, further. This would, I believe, be just the "compromise" Wall Street desires. They will continue to represent to the world that they act in the "best interests" of their customers, yet remain free to disclaim away their duties and engage in the same business practices they do today which cause so much harm to their customers.

Sixth, the SEC could adopt a different interpretation of the “solely incidental” exception for broker-dealers from the application of the Advisers Act, as few can argue that the main business of brokers today is not trade execution, but rather the delivery of advice. And/or the SEC could dictate, as would seem logical, that receipt by brokers of 12b-1 fees (which, in my view, are “advisory fees in drag”) amount to “special compensation” which trigger the application of the Advisors Act and its fiduciary duties.

Lastly, it is also possible that a true, bona fide fiduciary standard will be imposed, by rule, by the SEC, upon brokers who provide personalized investment advice, pursuant to one of the different paths created for the SEC under Section 913 of the Dodd Frank Act.

What would imposing a bona fide fiduciary standard mean, for brokers?

At its core the fiduciary standard constrains greed. This will require the business practices of brokers to change. For example, variable compensation arrangements (i.e., getting paid more to sell one product over another) might be eliminated pursuant to the authority granted the SEC under Section 913. The SEC could prohibit other forms of compensation of fiduciaries, such as payment for shelf space and other "revenue-sharing' arrangements. It could impose a bevy of restrictions, such as those imposed in countries such as Australia and the United Kingdom.

Of course, the brokers won’t like this. They will say that any rule the SEC should adopt should be “business model neutral.” That the fiduciary standard should adapt to current business practices. This is an evil notion, which would denigrate a standard of conduct that is thousands of years old. The business practices of brokers must evolve to fit the fiduciary standard, not vice versa.

I would note that this is not a battle between competing business models, as some suggest. It is not a battle between RIAs and BDs, as some at the SEC have long believed.

Indeed, personally I would much rather that brokers remain brokers. Why? It is so easy for knowledgeable fee-only investment advisers to gain clients from the major Wall Street firms, given the high total fees and costs, tax-inefficient portfolios, and poor asset allocations that the vast majority of the clients of Wall Street's major broker-dealer firms endure.

But the harm caused to tens of millions of my fellow Americans by the ill-designed suitability standard do not relegate the RIA community to silence. Rather, we would prefer to see the fiduciary standard more broadly imposed, even if it means losing a competitive advantage over brokers.

The SEC must recognize that the world has changed. Once commissions were deregulated in 1975, most consumers did not want to pay high fees to brokers for trade execution. Over the past four decades, with the demise of pension plans and the rise of defined contribution plans and IRAs, the growth in the type and sheer number of investment alternatives, and the ever-more-complex tax laws, the financial world which individual investors were thrust into required a great deal of advice. Hence, brokers changed their business model, and advice became predominate, and trade execution services became ancillary to the advice. But, under intense lobbying pressure from Wall Street, the SEC did not impose fiduciary standards upon broker’s advisory activities. It took the Dodd Frank Act to point out to the SEC its folly, and to suggest and provide an avenue for the SEC to act correctly.

If brokers are going to hold out as advisors (a development that occurred over the past 30 years, which the SEC did not stop, even though it cautioned against it in the early '40's and early '60's), and/or if brokers are going to provide personalized investment advice (more than just describing the products that they sell), then they have crossed the line and have acquired fiduciary status. In other words, by their actions and words brokers have consented to the imposition of fiduciary obligations. (This is the manner in which brokers find themselves as fiduciaries, applying state common law.) Moreover, consumers have a reasonable expectation that they can trust their "financial consultant." In such event, the full range of fiduciary obligations - designed to protect the client - should apply. Brokers, in such event, should not be shielded by FINRA's inherently low suitability standard, which essentially was designed to protect brokerage firms when they engaged in trade execution services for a customer. Nor should they be shielded by mere disclosure requirements, since substantial academic evidence confirms what we all know - consumers don't read, and don't understand, disclosures.

There are many battles over the fiduciary standard taking place - the DOL, state courts, FINRA arbitration, OCC (for bank trust departments), CFTC, and ... the SEC.  The battle for SEC Chair Mary Jo White's vote, for the future financial security of hundreds of millions of Americans, and - indeed - for the future economic growth and prosperity of America itself (endangered by the sludge of Wall Street, no longer an oil that greases the wheels of capitalism, due to Wall Street’s excessive extraction of rents) - all of these remain in the balance. Only time will tell if Mary Jo White has the courage to stand up to Wall Street, or whether she will be just another in a long string of SEC Chairpersons who have taken their marching orders from Wall Street's oligarchy.

If I had to place my bet, I would have to, at this time, "follow the money." Wall Street and the insurance companies are pouring many, many millions of dollars into Washington, DC this year to stop the DOL and the SEC from moving ahead with regulatory extension of the fiduciary standard of conduct. In fact, I have heard that Wall Street firms, in collaboration with each other, have committed huge sums of money to “do whatever it takes” to stop the fiduciary standard from being applied. SIFMA, FSI and the many hired guns of Wall Street firms and insurance firms are besieging Washington, and will continue to do so.

Brokers will also continue to support FINRA's quiet lobbying to become the SRO over RIAs, which would be a death knell for the fiduciary standard and the end, over time, of most small RIA firms.

What could change this from happening? Only a concerted, active educational effort by investment advisers, consumer advocates, and the various financial planning groups. At present, only a few consumer groups - AARP, Consumer Federation of America, Americans for Financial Reform, among others - are actively engaged in the battles in Washington, D.C. Much more support is required, especially from the independent investment adviser and financial planner communities.

For an example of action which could be taken, many RIAs could plan now to join the Investment Adviser Association's day of Congressional visits, typically held in May or June. (Email for specific information about any upcoming events planned.) Even more advisors could ask to meet with their Senators and Representatives back in the local offices, to educate them on these issues (such visits are very powerful). We must all recognize that 2014 could well be the pivotal year for the fiduciary standard, and - as a result - the definitive year as to whether financial planning will ever arise to the level of a true profession.

We’ve been involved in the fiduciary “debate” for well over a decade. Chances are you may be one who is “tired” of all these issues. That is part of Wall Street’s strategy – seek delays, and wear out the pro-fiduciary advocates. Yet, now, 2014 could well be a pivotal year. If we care about these issues, this is our time to take action in some fashion. Now - not a year from now. And each one of us in his or her fashion – not just the “others” who have been actively involved to date.

We must recognize that, even with increased engagement by the independent RIAs and financial planners in the halls of Washington, DC, the outcome is uncertain. Mary Jo White's courage - to take on the mighty power of Wall Street oligarch's - or her lack of courage - may well be the deciding factor as to whether bona fide fiduciary standards will rightly be imposed upon all who provide personalized investment advice to our fellow Americans. Let us all hope that the SEC Chair possesses such courage, as well as the wisdom to proceed down the right path and toward a better America.

Let us also hope that we, ourselves, will persevere, and continue to seek to edu.cate and inform policy makers, despite the deluge seen from the anti-fiduciary crowd. Let us hope that we will have the courage to endure, and press on, for the benefit of all of our fellow Americans, and America itself.

Ron A. Rhoades, JD, CFP(r) serves as Chair of the Steering Group for The Committee for the Fiduciary Standard, a group of volunteer leaders of the financial planning profession dedicated to advancing the fiduciary standard of conduct for all investment and financial advisory activities. Ron also serves as Program Chair for the Financial Planning Program at Alfred State College, Alfred, New York, where he provides instruction in Investment Planning, Retirement Planning, Insurance and Risk Management, Employee Benefit Planning, the Personal Financial Planning Capstone Course, and Business Law. To contact Ron, please e-mail him at Thank you.


  1. Thanks Ron. As usual, an excellent analysis of the situation. IMHO, the current fiasco over the fiduciary standard can be summed up with two quotes. The first comes from the late General Norman Schwarzkopf, who said, "the truth is, we always know the right thing to do. The hard part is doing it." The second quote comes from the play "1776," with John Adams telling the Constitutional Congress, "piddle, twiddle and resolve, not a damned thing do we solve."

    While I totally agree with your analysis, there is some hope for addressing these abuses from the litigation side. In Regulatory Notice 12-25, FINRA clearly stated that brokers have a duty to always act in a customer's best interests. FINRA further supported this position by citing various enforcement decisions that announced this position in ruling against brokers. Legal decisions such as Carras v. Burns (516 F.2d 251) have helped investors by ruling that brokers will be held to a fiduciary standard, even on non-discretionary accounts, when a broker is deemed to have taken de facto control over an account, when a customer lacks the experience, knowledge and/or understanding to independently evaluate the broker's recommendations and the risks involved with same. Such cases, along with the ongoing decisions carrying on the investor protection steps emerging from the Braden-Tibble-Tussey trilogy, do provide hopes for investors.

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