The Fiduciary Standard Likely Stalls in D.C., But New Directions Are Possible

The Fiduciary Movement Stalls in D.C.

The election of President-elect Trump has shifted the landscape for regulatory initiatives over the next several years. While much remains uncertain, three major developments likely to occur include:

First, the delay and eventual repeal (via new rulemaking) of the April 2016 DOL Conflicts of Interest (Fiduciary) Rule and its related exemptions is highly likely. The reality is that it is very, very easy for an agency to delay the implementation of a rule, and then to eventually kill it by eventual adoption of a new rule. Such was actually done by the Obama administration to a prior “definition of fiduciary” final rule that was adopted in the waning days of the Bush administration. While the situation here is different, the principle – that it is very, very difficult to challenge an agency’s delay of the implementation of a rule – remains the same.

Second, there will be a renewed attempt by FINRA to oversee registered investment advisers, either through legislation or by a FINRA-favorable SEC “third-party exam” rule. Unlike the proposals in 2011 for expanded FINRA authority, that were eventually defeated, the likelihood of a FINRA “win” is much greater this time around.

Third, Congress will attempt to repeal the Dodd Frank Act of 2010, including its authorization to the SEC to apply some form of fiduciary standards to brokers who provide personalized investment advice. The U.S. Senate, through the filibuster powers the Democrats possess, may not permit such a wholesale repeal. Nevertheless, the SEC would be highly unlikely to exercise its authority to apply a bona fide fiduciary standard upon brokers, given the pressure on its budget Congress could bring to bear. (In addition, the SEC will likely be composed of 3 Republican commissioners, and 2 Democratic commissioners. The application of the fiduciary standard shouldn't be a partisan issue, but it is.)

I would add that any hope for reforming the SEC’s application of the fiduciary standard under the Advisers Act seems remote. The SEC currently permits the wearing of “two hats,” the “switching of hats,” the disclaimer of most fiduciary duties by those who dual registrant firms that operate under the Advisers Act, the use of titles that infer a relationship of trust and confidence while actively disclaiming that such a relationship exists, and the provision of wholesale financial and investment advice that is clearly not “solely incidental” to the sale of a security or investment product. Moreover, the SEC long ago permitted the application of the inherently weak suitability standard (which actually lowers the standard of due care applicable to most service product providers) to the selection of mutual funds and other pooled investment vehicles. It would take an extremely strong and independent new SEC Chair to change the SEC’s misguided direction of the past four decades and fix all of this. Quite frankly, such is not in the cards.

Yet, despite the likely delay in advancement of fiduciary standards through legislative and/or government agency action, there are steps we can pursue to advance our emerging profession.

So, what is the way forward? In my view, the next four years could involve several possible initiatives not involving federal or state legislation or agency rulemaking.

Step 1: We Can Oppose the FINRA Threat to a Bona Fide Fiduciary Standard

Of the foregoing potential developments, the increased chances for a FINRA takeover of RIAs is most troubling. This could lead to FINRA undertaking rule-making for RIAs, thereby imposing a rules-based regime that is burdensome (especially to smaller RIA firms) and unnecessary.

Moreover, FINRA’s influence on how the fiduciary standard evolves and is enforced would result in a “casual disclosure-only” “new federal fiduciary standard” that is anything but a true fiduciary standard. Consumers' best interests would not be protected; they would only receive vague warnings that something might be up - from those who otherwise state that they act in the customer's "best interests." In essence, the state of fiduciary law, as applied to the delivery of financial and investment advice, could be set back for decades to come.

We must devote resources to this effort to oppose FINRA’s takeover of the RIA community, and the subsequent eventual evisceration by FINRA of the fiduciary standard. All of our professional associations must devote their resources to this, and when called upon each of us individually should reach out to policy makers with well-crafted messages.

Step 2: CFP Board: Please, Please, Please ... Lead, Don’t Follow

The CFP Board must lead, not follow. It must adopt a principles-based, yet clearly applicable and bona fide, fiduciary standard for all those who hold the Certified Financial Planner™ certification.

If you are a CFP® and if you are providing investment advice, you are a fiduciary. Or retirement planning. Or estate planning. Or tax planning. Or insurance planning. No exceptions. The fiction that one can do just “one element” of financial planning and not be a fiduciary should be relegated to the CFP Board’s past. If you either hold out as a CFP^® or actually undertake those activities, you should be a fiduciary.

Additionally, the fiduciary duties should be more clearly expressed. There should exist a non-waivable, non-disclaimable duty to act in the client’s best interest at all times, under the fiduciary duty of loyalty. If a conflict of interest exists, it must be properly managed so that the client is not harmed.

The 237 words contained in the DOL’s Impartial Conduct Standards could be utilized and adapted for such a promulgation of the fiduciary principle. This would include the fiduciary duty of due care and the duty to invest following the requirements of the prudent investor rule. I would suggest, however, that a client could choose the prudent investor rule to not apply to some or all of the client’s investments, if the client is provided a clear statement to that effect and provides informed consent. This would permit the development of new and novel investment strategies, provided the client is informed of the potential risks of such strategy, achieves a proper understanding of those risks, and provides informed consent.

The CFP Board is undergoing the process of reviewing and revising its standards of conduct, at present. We should support the CFP Board in that endeavor, and patiently await the outcome.

However, if the CFP Board does not fix the loopholes in its current rules, both as to when fiduciary status is applied and as to what fiduciary status means, then it would be worthwhile for practitioners to consider alternatives to the CFP Board. In other words, if the CFP Board fails to move the profession forward, then we should consider whether following the CFP Board is in a true profession’s best interests.

Step 3: Raise the Bar for Portfolio Construction and Investment Selection

If you asked most individual clients if their portfolios were being managed “prudently” and “expertly,” most would assume that would be the case. Sadly, that is just not so. In point of fact, a wide variety of unproven investment strategies are utilized. Often both risks and cost are taken on by individual investors who receive investment advice.

Additionally, due diligence criteria for the selection of specific investments often lack any reasonable basis. At the same time, other due diligence criteria that clearly result in the better selection of investments (especially pooled investment vehicles) are given little if any consideration.

We need to raise the bar as to the proper management of investment portfolios. As alluded to previously, I believe the default standard of due care owed to individual investors should include the application of the prudent investor rule (PIR). The PIR contains the duty to minimize idiosyncratic (diversifiable) risk and the duty to not waste client assets. Individual investors can choose to have their advisers not be bound by the PIR, but only after they are clearly advised of the risks present and of the fees and costs involved for the implementation of an investment strategy not subject to the PIR.

In essence, we need to raise the bar on the profession’s due diligence, both as to investment strategies and the selection of investments (especially pooled investment vehicles). We need to be better at researching and selected investment strategies that possess a high probability (over the long term) for outperformance and/or risk reduction. We need to be much better at conserving the client’s assets.

The DOL’s Best Interests Contract Exemption was poised to do this for ERISA-governed and IRA accounts, through the application of the Best Interests Contract Exemption, its Impartial Conduct Standards, and by means of the Prudent Investor Rule (PIR) contained therein. Since the DOL rules applying this higher standard are likely to be delayed and eventually killed, the profession (through the CFP Board, if possible) needs to move forward, instead. In essence, our profession should adopt the prudent investor rule as the “default” standard for the provision of investment advice. Again, clients may opt out of the standard,

I am not suggesting that we cut our fees as advisers. Rather, by become better experts in the design and management of investment portfolios, as well as by properly managing the behaviors of our clients, we will even more deserve professional-level compensation. Expert, trusted advice deserves to be well-compensated, for such advice is very valuable.

Step 4: Continue to Win in the Marketplace.

While the public is much more aware of the need for their financial or investment adviser to be a “fiduciary,” many individual consumers don’t understand this term. And, even among those that do, they are susceptible to misdirection from broker-dealer firms and insurance companies (and their various representatives) that state they will “seek to act in your best interests” or “can operate as a fiduciary.” Additionally, the terms “fee-based” remains, when describing many firms or advisers or practices, a misleading statement when proper explanation of the term is not provided.

So, distinctions must be made. Perhaps the best distinction is being “fee-only.” Even better would be the promulgation of a designation, or certification, that consumers can recognize. (Sorry, NAPFA, but “NAPFA-Registered Financial Advisor” fails to resonate as an effective mark, given the length of the term; a more “catchy” mark is needed. Perhaps “NETA” – “NAPFA Expert Trusted Adviser.”)

Additionally, checklists can and should be continue to be developed in which good, detailed questions are asked by consumers of their current and/or prospective financial advisers. Through such checklists and accompanying explanatory language, consumers can be educated about the dangers of proprietary products, principal trading, and product-based compensation schemes. Some of these checklists exist already, but they could be improved upon.

The past two decades has seen the rise of AUM-based compensation. This trend will continue, as both consumers and good advisers seek to avoid the insidious conflicts of interest that so pervade much of financial services today.

Conclusion

The application of the fiduciary principle to the provision of investment and financial advice, via government action, is likely now delayed for at least several years to come.

Yet, into this vacuum those concerned about our profession and its development can continue to act. We can, together, oppose the FINRA takeover of the independent RIA community. We can voluntarily adopt higher standards for CFP^® certificants, both as to adopting a non-waivable, sensibly applied duty of loyalty and a more appropriate standard of due care.

And, collectively and individually, bona fide fiduciaries can continue to prevail in the marketplace.

We might wish, on behalf of our fellow Americans, a more rapid application of fiduciary principles to the delivery of investment and financial advice. But, for several years to come, such is unlikely to occur. Yet, in the near future we can act to better lay the foundations for a true profession, and in so doing serve the interests of our friends, neighbors and clients. And, in so doing, we can promote the long-term application of the fiduciary principle, the accumulation of better savings and investments, and the long-term economic vitality of America itself.