My Financial Services Regulation Wish List for the Trump Administration

Dec. 22, 2016


1. Keep the U.S. Department of Labor "Conflicts of Interest" Rule. Why?

• The core of the rule is principles-based. Only 237 words ... that's the Impartial Conduct Standards it applies.
• It has already led to decreased asset management fees.
• It has been shown that small investors can, and will be served, under a fiduciary standard.
• Businesses large and small want the fiduciary standard - so they can rely upon the advisers to their retirement plans, and hold them accountable. No more plan sponsors left "holding the bag" as "retirement plan consultants" escape liability for their really poor recommendations under the inherently weak and ineffective suitability standard.
• Many, many investment advisers are able and willing to provide such services, often aided by technology.
• It will accelerate the trend away from arms-length product sales, and toward fiduciary-client relationships. Fiduciary status is justified given the high degree of information asymmetry, the necessary reliance by individual Americans on financial and investment advisers.
• As trust in financial advisers grows, under a fiduciary standard, so does the rate of utilization of financial advisers. This is a good thing - as Americans need help to save more and invest more wisely.
• It provides a foundation for financial and investment advisers to, eventually, become a true profession.
• Greater accumulations of capital will result, as investment fees/costs come way down. In turn, this results in:
• Greater financial security for Americans, as they enter and are in retirement.
• Greater capital accumulation by Americans. And a lower cost of capital for corporations.
• In essence, this "supercharges" U.S. economic growth. Greater capital accumulation provides the fuel necessary to transform innovations into new products and services.

2. Sunset B.I.C.E. after three years.

• The DOL's Best Interests Contract Exemption is complex. Trying to accommodate commissions and other inherently conflicted sales practices, and fit them into a fiduciary-client relationship, is what causes the complexity.
• As the years go by, B.I.C.E. may be interpreted so that its very tough requirements become weakened.
• The industry is moving toward fee-based accounts. Good firms that understand how the fiduciary standard truly operates (e.g., Merrill Lynch, etc.) already have rejected the use of B.I.C.E.
• It's best to permit B.I.C.E. for a limited period as a means of transition, then to sunset it.

3. Have the SEC alter how it enforces the Advisers Act.

• If a person or firm holds out as a "financial adviser" or "wealth manager" or "retirement consultant" or "financial planner" or otherwise uses a title that evokes an adviser-client relationship, they should be held to the fiduciary requirements of the Advisers Act - at all times and without exception.
• If the primary role of the person is to provide investment advice, rather than to execute transactions, the "solely incidental" exclusion to the definition of investment adviser should be applied properly and that person should be required to register as an investment adviser and to comply with the fiduciary duties arising from the Advisers Act.
• Large amounts of broker-dealer advertisements suggest that advice is the primary component of the broker-customer relationship, and it is certainly understood that way from the standpoint of the customer.
• The process of executing trades no longer requires the skill it took in the 1930's, due to the involvement of automated systems, and the improvements in market liquidity.
• Registered representatives have been provided education on "trust-based sales techniques," without understanding that the formation of a relationship of trust and confidence with a client leads to fiduciary status under state common law.
• The recommendation of another investment adviser should be subject to the fiduciary standard of the Advisers Act. This includes recommendations of separate account managers, as well as recommendations of mutual funds. (The doctrine of suitability was originally intended to shield brokers from liability when their primary role was in executing a trade for a customer; the doctrine should have never been extended to the recommendation of pooled investments.)
• No more wearing of two hats. No ability to switch hats. Once you are a fiduciary to a client, your status as a fiduciary continues, and it extends to all aspects of the adviser-client relationship.
• Estoppel and waiver have limited applicability to fiduciary relationships. Sect. 215 of the Advisers Act needs to be properly applied to prevent both "disclaimers" of core fiduciary duties and seeking client "waivers" of them.
• The SEC must realize that, although the securities laws generally are based upon disclosures, the Advisers Act went much further. We have fiduciary standards because disclosures are largely ineffective. A huge body of academic research supports this conclusion.
• Say what you do. Do what you say. A fiduciary steps into the shoes of the client, and acts - with all of the expertise required of a professional adviser - with total loyalty to the client's interests.
• Let's not keep permitting "particular exceptions" (as the late Justice Benjamin Cardozo opined) to erode the fiduciary standard of conduct. Let's conform the industry to the standard, and not the standard to the industry.

4. Clean up mutual fund regulation.

• Europe and Canada have stronger disclosures of mutual fund / ETF fees and costs than the U.S. possesses. We lag behind, again, instead of leading the way.
• "Portfolio turnover" is measured incorrectly. It should not be the lower of sales or purchases divided by the fund's net assets, but the average of them. This important statistic - as the SEC now permits it to be calculated - can often mislead investors.
• Require in all mutual fund / ETF advertising truthful comparisons to broad-based indexes. No more comparing active funds only against indexes that exclude index funds in their computations.
• Do away with state-based and municipality-based retirement accounts. This is not the essential role of government.

5. Work to reduce regulatory overkill.

• Every regulation on the books should be reviewed. Does it work? What is the burden of the regulation, versus its benefit?
• Increase the number of RIA exams for verification of assets (i.e., custody); but decrease substantially the number of RIA exams for everything else. Investment advisers are professionals - treat us like such. And use the SEC's limited resources to combat the most egregious frauds.
• Take a good hard look at FINRA. With hundreds of pages of rules, it still has utterly failed the vision of its creators - Senator Maloney and others - who sought to create an organization that would raise the securities industry's conduct to the highest levels. In fact, FINRA has opposed raising standards at every turn. FINRA embraces conflicts of interest at every turn, rather than seek to minimize them - even broker-dealer fines levied by FINRA become part of FINRA's budget (thereby lessening the fees assessed against broker-dealer firms!). Consider whether FINRA's oversight of market conduct regulation should be transferred back to the SEC, or snapped altogether.

Lastly, permit me to include an economic imperative in my "wish list." Invest in people - through education. The most effective intervention to promote long-term economic growth is that of expanding educational opportunities for all. Yet, financial support for higher education has diminished over time. This, along with increased federal regulatory mandates (requiring more administrative staff to comply with all the regulations), has led to high tuition costs and, as a result, huge student loan debt burdens.

Additionally, interference in primary and secondary education (mandatory testing, etc.) has created the perverse incentives ("teach to the test," etc.) that have diminished the quality of the education provided by dedicated teachers in our schools. Multiple-choice test questions encourage a focus on recognition via cramming for tests and exams. Students now focus more on the acquisition of test-taking skills for multiple-choice exam questions, rather than the acquisition of true understanding of concepts and long-term memory formation. From the standpoint of a college professor, students entering college lack critical thinking, writing, and verbal communication skills one would expect from a college freshman. While I willingly tackle the challenge of increasing these skills in my students, a better foundation in these skills before students enter college would lead to a better overall college learning experience.

As technological progress destroys many jobs, our society is in need of a more educated workforce - especially graduates of high-quality vocational educational programs. Let's invest in education, and reduce regulatory burdens imposed from above upon colleges, high schools, and primary schools. In so doing, empower America to meet the demand for the skilled jobs of tomorrow.

Ron A. Rhoades, J.D., CFP® is an Asst. Professor of Finance at Western Kentucky University's Gordon Ford College of Business, where he serves as Director of its Financial Planning program. This article represents his views, alone, and are not those of any institution, organization or firm with whom he may be associated. Follow Ron on Twitter: @140ltd. To contact him, please email: Ron.Rhoades@wku.edu.