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Saturday, May 18, 2013

Common Sense Redux: The Legal and Economic Imperative behind the DOL/EBSA'S "Definition of Fiduciary" Re-Proposed Rule

The Employee Benefits Security Administration (EBSA) of the U.S. Deparatment of Labor is currently examining whether to re-proposed its "Definition of Fiduciary" proposed rule, which would expand the application of the fiduciary standard upon providers of investment advice to plan sponsors, plan participants, and IRA account owners. This phamplet summarizes the legal and economic imperatives for the DOL/EBSA to proceed with such re-proposal, and the benefits resulting therefrom for all Americans, and for America itself.

To obtain a PDF version of this phamplet, please e-mail 

S U B J E C T S.

I.          Absent Preemption under ERISA, Fiduciary Duties would already be applied to Retirement Advisors under State Common Law.

II.       Thoughts on the Present State of Affairs for American Consumers.

III.     The Application of Fiduciary Standards is Consistent with Capitalism.

IV.     Examining Several Arguments.

“If men were angels, no government would be necessary.” - James Madison


Printed and Distributed in New York.
18 May 2013


It must be recognized that a well-functioning financial system is not the ends, but rather the means.  Our financial institutions and their products and services can and must perform several vital functions in our society. Through prudent, principles-based regulation:

·   The financial system should enable savings, an essential step toward the accomplishment of individual financial goals as well as the fostering of the formation of capital.

·   Through trust in financial institutions and financial advisors, individuals should utilize a portion of their savings to participate in the capital markets. 

·   Through specialization of function, our financial system should promote efficiencies in modern society, enabling the entire economy to grow larger and stronger.

·   One consequence of specialization in today’s modern society, combined with the greater complexities in financial products and in the capital markets, is the necessary application of fiduciary principles.

·   Through the application of the fiduciary standard of conduct trust in investment and financial services will be enhanced, leading to greater allocation of capital to the capital markets. This will fuel greater U.S. economic growth.

·   The fiduciary standard will enable our fellow Americans to save more, and invest better, for their future retirement security. In so doing, burdens from government to provide for many senior citizens will be lifted, leading to less government expenditures and, over the long term, lower tax rates and burdens for all.

This pamphlet is Copyright ® 2013 by Ron A. Rhoades, JD, CFP®. Permission is given to all to reproduce and to distribute this “Common Sense Redux” pamphlet, or any portion thereof, to any person, provided that no compensation is received therefore.


America faces a highly uncertain future. Many economic challenges lie ahead for our country. As government’s ability to provide for the financial and health care needs of retirees dwindles, our fellow Americans largely possess inadequate retirement security, a situation compounded by the excessive rents taken from retirement accounts by Wall Street firms.
The U.S. Department of Labor, through the Employee Benefits Security Administration’s re-proposed rule, “Definition of Fiduciary,” is an important component of a greater answer to these economic and financial challenges. Phyllis Borzi’s vision for the proper application of fiduciary standards to all providers of advice to plan sponsors and plan participants reflects a long-needed reform – empowered by common sense.
I. Absent Preemption under ERISA, Fiduciary Duties would already be applied to Retirement Advisors under State Common Law.
Early FINRA Pronouncement: Brokers are Fiduciaries. In an early pronouncement by the self-regulatory organization for broker-dealers, FINRA (formerly known as NASD) confirmed that brokers were fiduciaries: “Essentially, a broker or agent is a fiduciary and he thus stands 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).
Distinguishing Fiduciary vs. Non-Fiduciary Relationships. There are two types of relationships between product and service providers and their customers or clients, under the law. The first form of relationship is an “arms-length” one. This type applies to the vast majority of service provider – customer engagements. In these relationships, the doctrine of “caveat emptor” generally applies, although this doctrine is always subject to the requirement of commercial good faith. Additionally, this doctrine may be modified by imposition of specific rules or doctrines by law, such as the disclosure regime contemplated by securities laws and the low requirement of “suitability” imposed upon registered representatives of broker-dealer firms (i.e., brokers).
The second type of relationship is a fiduciary relationship. This involves a relationship of trust, which necessarily involves vulnerability for the party who is reposing trust in another. In such situations one’s guard is down; one is trusting another to take actions on one's behalf.  Under such circumstances, to violate a trust is to infringe grossly upon the expectations of the person reposing the trust. Because of this, the law creates a special status for fiduciaries, imposing duties of loyalty, care, and full disclosure upon them. Hence the law creates the “fiduciary relationship,” which requires the fiduciary to carry on with their dealings with the client (a.k.a. “entrustor”) at a level far above ordinary, or even “high,” commercial standards of conduct.

              The Sales Relationship                       The Trusted Advisor Relationship

            Product Manufacturer                        Client

                 represented by                           represented by
              Broker (Salesperson)                    Fiduciary (Advisor)

                 who sells to                          who shops on behalf of the client among

                      Customer                            Product Manufacturers
State Common Law: Brokers are (Already) Fiduciaries.  As alluded to in the early statement by FINRA, above, most brokers providing investment advice are already fiduciaries, applying state common law. This is regardless of how they are registered or licensed (i.e., as registered representatives of broker-dealer firms, as investment adviser representatives of registered investment adviser firms, or as insurance agents). Fiduciary status attaches because the broker is providing advice in a relationship of trust and confidence.
Holding out as a “retirement advisor” or “financial planner” has been held sufficient to invite a relationship of trust and confidence. And, of course, actually providing investment services of an advisory nature bring with it the imposition of fiduciary status upon the advisor. [For cases applying these principles under state common law, see “Shh!!! Brokers are (Already) Fiduciary … Part 1: The Early Days,” available at
The U.S. Securities and Exchange Commission (SEC) repeatedly held, for much of the 20th Century, that brokers were often fiduciaries. The SEC “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 … [broker-dealer 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.)
ERISA’s Definition of Fiduciary and Pre-Emption of State Common Law. The regulations issued by the U.S. Department of Labor in the mid-1970’s, applying ERISA, provided significant loopholes to the application of fiduciary status to providers of investment advice to qualified retirement plan sponsors and to plan participants. At the time these regulations were issued, most investments were held in pension plan accounts; 401(k) accounts were still in their infancy.
Since that time there have been significant changes in the retirement plan community, with more complex investment products, transactions and services available to plans and IRA investors in the financial marketplace, and a shift from defined benefit plans to defined contribution plans [including 401(k) accounts].
Interestingly enough, ERISA preempts state common law. [See Lewis v. Alexander, 685 F.3d 325 (U.S.Ct.App.3rd Cir. 2012), cert.den. Alexander v. Lewis, 2013 U.S. LEXIS 738 (U.S., Jan. 14, 2013) ("Against nonfiduciaries, ERISA confines plaintiffs to equitable relief. See 29 U.S.C. § 1132(a)(3). By styling their ERISA claim as a state-law claim, the plaintiffs seek to hold Regions—a nonfiduciary—personally liable. The Supreme Court has  rejected such attempts to supplement the remedies available under ERISA: '[A]ny state-law cause of action that duplicates, supplements or supplants the ERISA civil enforcement remedy conflicts with the clear congressional intent to make the ERISA remedy exclusive and is therefore pre-empted.' Aetna, 542 U.S. at 209.")] See also Nat'l Sec. Sys. v. Iola, No. 10-4154, No. 10-4155, U.S.Ct.App.3rd Cir., 700 F.3d 65; 2012 U.S. App. LEXIS 23063 (2012), cert. den. Barrett v. Universal Mailing Serv., 2013 U.S. LEXIS 2996 (U.S., Apr. 15, 2013), for a more detailed discussion of preemption under ERISA.]

Hence, absent the mid-1970’s regulation which provided such broad loopholes, we would have seen the application of the fiduciary standard of conduct under state common law upon the providers of investment advice to plan sponsors and plan participants. ERISA’s preemption, combined with a definition of “fiduciary” which is clearly at odds with the express statutory language found in ERISA and also not in accord with the burdens imposed by today’s complex financial world, has in essence negated, rather than enhanced, the protections afforded to plan sponsors and plan participants.
The Application of the Fiduciary Definition to IRA Accounts. As to the U.S. Department of Labor’s proposed application of fiduciary standards to IRA accounts, it should be noted that section 4975(e)(3) of the Internal Revenue Code of 1986, as amended (Code) provides a similar definition of the term "fiduciary" for purposes of Code section 4975 (IRAs).  However, in 1975, shortly after ERISA was enacted, the Department issued a regulation, at 29 CFR 2510.3-21(c), that defines the circumstances under which a person renders “investment advice” to an employee benefit plan within the meaning of section 3(21)(A)(ii) of ERISA. The Department of Treasury issued a virtually identical regulation, at 26 CFR 54.4975-9(c), that interprets Code section 4975(e)(3). 40 FR 50840 (Oct. 31, 1975). Under section 102 of Reorganization Plan No. 4 of 1978, 5 U.S.C. App. 1 (1996), the authority of the Secretary of the Treasury to interpret section 4975 of the Code was transferred, with certain exceptions not herein relevant, to the Secretary of Labor. Hence, the U.S. Department of Labor possesses the authority under existing law to apply its new definition of fiduciary to IRA accounts.
Financial Advisors Cannot Negotiate Away Fiduciary Status. The courts have consistently held that a fiduciary relationship need not be created by contract, and that contract terms as to whether fiduciary status exists are not controlling.
By way of explanation, fiduciary status arises out of any relationship where both parties understand that a special trust or confidence has been reposed. “A fiduciary relation does not depend on some technical relation created by or defined in law. It may exist under a variety of circumstances and does exist in cases where there has been a special confidence reposed in one who, in equity and good conscience, is bound to act in good faith and with due regard to the interests of the one reposing the confidence.” In re Clarkeies Market, L.L.C., 322 B.R. 487, 495 (Bankr. N.H., 2005).
Stated differently, once a relation between two parties is established, its classification as fiduciary and its legal consequences are primarily determined by the law rather than the parties. Legal principles of “waiver” and “estoppel” have limited application in determining whether fiduciary status is applied.
These guiding principles in the application of fiduciary status are not recent; they were known early on in circumstances wherein agreements signed by customers of brokers attempted to negate fiduciary status. In discussing the decisions of two early cases, FINRA stated:  “In relation to the question of the capacity in which a broker-dealer acts, the [judicial] opinion quotes from the Restatement of the Law of Agency: ‘The understanding that one is to act primarily for the benefit of another is often the determinative feature in distinguishing the agency relationship from others. *** The name which the parties give the relationship is not determinative.’ And again: ‘An agency may, of course, arise out of correspondence and a course of conduct between the parties, despite a subsequent allegation that the parties acted as principals.’” (N.A.S.D. News, published by the National Association of Securities Dealers (now known as FINRA), Volume II, Number 1 (Oct. 1, 1941).
Providing “Advice” without Application of Fiduciary Standards Constitutes Fraud, Under State Common Law. Many brokers and insurance agents hold themselves out as “financial consultants” or “financial planners” or “retirement advisors,” yet deny fiduciary status. Yet, as explained by Professors James J. Angel, Ph.D., CFA and Douglas McCable, Ph.D., to hold oneself out as an “advisor” (or similar terms) and fail to comply with the fiduciary duties implied by that representation is deceptive: The relationship between a customer and the financial practitioner should govern the nature of their mutual ethical obligations. Where the fundamental nature of the relationship is one in which customer depends on the practitioner to craft solutions for the customer’s financial problems, the ethical standard should be a fiduciary one that the advice is in the best interest of the customer. To do otherwise – to give biased advice with the aura of advice in the customer’s best interest – is fraud. This standard should apply regardless of whether the advice givers call themselves advisors, advisers, brokers, consultants, managers or planners.” Ethical Standards for Stockbrokers: Fiduciary or Suitability? (Sept. 30, 2010).
Commissions are not Prohibited by the Application of Fiduciary Standards. The receipt of a commission, as was the typical manner in which brokers were compensated for much of the 20th Century, was not prohibited by fiduciary status.  Of course, this was in a time of fixed commissions. Difficulties only arise under the fiduciary standard when compensation varies, or is differential, with the advice being given. Hence, providers of advice to retirement plan sponsors and their participants can continue to charge commissions. Commission-based compensation is not, in and by itself, contrary to fiduciary principles, provided the commissions do not vary with the advice being given and provided that the compensation received by the advisor is reasonable for the services provided.
II. Thoughts on the Present State of Affairs for American
        Consumers of Financial Services and Products
We have a problem in America. The world is far more complex for individual investors today than it was just a generation ago. There exist a broader variety of investment products, including many types of pooled and/or hybrid products, employing a broad range of strategies. This explosion of financial products has hampered the ability of plan sponsors and individual investors to sort through the many thousands of investment products to find those very few which best fit within the retirement plan or individual investor’s portfolios. Furthermore, as such investment vehicles have proliferated, plan sponsors and individual investors are challenged to discern an investment product’s true “total fees and costs,” investment characteristics, tax consequences, and risks. Simply put, retirement plan sponsors and their participants are at a vast disadvantage.
Information asymmetry is vast and will never disappear. Disparities in the availability of information, or its quality, or its understanding, lead to advantages by those endowed with the ability to decipher, discern and apply the information correctly. It must be recognized that efforts to enhance financial literacy, while always worthwhile and important, will never transform the ordinary American into a wholly knowledgeable consumer of financial products and services, just as we cannot expect the average American to perform brain surgery. Given the sophisticated nature of modern financial markets and complex array of investment products, it is not just the uneducated that are placed at a substantial disadvantage – it is nearly all Americans. Hence, other means are necessary to negate advantages brought on by information asymmetry.
If disclosure alone was sufficient, there would be no need for the fiduciary standard of conduct. Substantial academic research has revealed that disclosure is not effective as a means of dealing with the vast information asymmetry present in the world of financial services. Indeed, as the sophistication of our capital markets had increased, so has the knowledge gap between individual consumers and financial advisors. Additionally, academic research now reveals that disclosures, while important, can lead to perverse results – i.e., worse advice is provided if the advisor, following disclosure, feels unconstrained by the application of the fiduciary standard of conduct.
The need to embrace fiduciary principles for certain actors.  Because of the vast information asymmetry, and the many behavioral biases consumers possess which deter them from effectively spending the time and effort to read and understand mandated disclosures, there exists a great need for financial and investment advice. In such situations, our fellow citizens place trust and confidence in their personal financial advisor. It is right and just in such circumstances that broad fiduciary duties be applied to these financial intermediaries. The absence of appropriate high ethical standards for all providers of personal financial advice, whether to plan sponsors, plan participants, IRA account owners, or others, is a glaring current gap in the financial services regulatory structure.
The need to ensure distinctions between the types of financial intermediaries.  Individual consumers should be empowered to more easily identify the difference between the financial advice role (to which fiduciary status should attach) and the product marketing role (an arms-length relationship, to which only far lesser obligations, such as ensuring suitability, apply). Currently these roles are closely intertwined, and it is exceedingly difficult for consumers to distinguish between them (in part because the product marketer type of intermediary possesses no incentive to make that distinction clear). Our regulators possess the authority and the ability to ensure that consumers are not misled by the use of titles and designations, and they should ensure that all those who hold themselves out as trusted advisors – or who actually provide advisory services – are bound to act in the best interests of their clients under the fiduciary standard of conduct.
III. The Application of Fiduciary Standards is Consistent with Capitalism.
“Opportunism.” The undeniable truth is that capitalism runs on opportunism. In his landmark work, The Wealth of Nations, Adam Smith described an economic system based upon self-interest. This system, which later became known as capitalism, is described in this famous passage:
It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.
(Smith, p. 14, Modern Library edition, 1937).
As Adam Smith pointed out, capitalism has its positive effects. Actions based upon self-interest often lead to positive forces which benefit others or society at large. As capital is formed into an enterprise, jobs are created. Innovation is spurred forward, often leading to greater efficiencies in our society and enhancement of standards of living. As Adam Smith also noted, a person in the pursuit of his own interest “frequently promotes that of the society more effectually than when he really intends to promote it.” (Smith, p. 423)
Taken to excess, however, the self-interest which is so essential to capitalism can lead to opportunism, defined by Webster’s as the “practice of taking advantage of opportunities or circumstances often with little regard for principles or consequences.” A stronger word exists when consequences to others are ignored - “greed.” We might define “greed” in this context as the selfish desire for the pursuit of wealth in a manner which risks significant harm to others or to society at large. Whether through actions intentional or neglectful, when ignorance of material adverse consequences occurs, the term “greed” is rightfully applied.
Gordon Gekko in the film Wall Street, who famously declared that “Greed, for lack of a better word, is good,” got it wrong. Opportunism itself – acting in pursuit of one’s self-interest - does not always lead to greed. Rather, it is only when the pursuit of wealth causes significant undue harm to others does such activity arise to the level of greed, and in such circumstances the rise of greed is not “good.”
What would Adam Smith say today?  Even Adam Smith knew that constraints upon greed were required. While Adam Smith saw virtue in competition, he also recognized the dangers of the abuse of economic power in his warnings about combinations of merchants and large mercantilist corporations.
Adam Smith also recognized the necessity of professional standards of conduct, for he suggested qualifications “by instituting some sort of probation, even in the higher and more difficult sciences, to be undergone by every person before he was permitted to exercise any liberal profession, or before he could be received as a candidate for any honourable office or profit.” (Smith, p. 748, see also pp. 734-35. As seen, “Smith embraces both the great society and the judicious hand of the paternalistic state.” Shearmur, Jeremy and Klein, Daniel B. B., “Good Conduct in a Great Society: Adam Smith and the Role of Reputation.” D.B Klein, Reputation: Studies In The Voluntary Elicitation Of Good Conduct, pp. 29-45, University of Michigan Press, 1997.)
In essence, long before many of the professions became separate, specialized callings, Adam Smith advanced the concepts of high conduct standards for those entrusted with other people’s money.
What would Adam Smith, if he were alive 250 years later, observe regarding the modern forces in our economy? He would likely opine, given the economic forces that led to the recent (or current) Great Recession, that unfettered capitalism can have many ill effects. Indeed, he would observe that for all of its virtues, capitalism has not recently been a very pretty sight. And he would likely proscribe many cures – including prudential regulation through the application of fiduciary principles of conduct.

IV. Examining Several Arguments.
The Application of the Fiduciary Standard will Result in Lower Fees and Costs for our Fellow Americans.
Many times the broker-dealer industry has opined that commissioned-based accounts, rather than advisory accounts, are less costly to consumers. They argue that the application of the fiduciary standard will raise fees and costs, which in turn will be borne by investors. In reality, the exact opposite effect occurs.
Unlike (typically non-fiduciary) registered representatives of broker-dealer firms and insurance agents of insurance companies, fiduciary advisors possess the duty to ensure that the total fees and costs associated with any investment product, and with the receipt of investment advice, remain reasonable. Studies proffered by opponents to the fiduciary standard ignore many of the hidden fees and costs of investment products. Only fiduciary advisors must consider such “hidden fees and costs” when undertaking due diligence prior to recommending an investment product to a client.
Moreover, 401(k) and other qualified retirement plan accounts enjoy the potential of economies of scale. As plan sponsors select available investment options, and the services to be provided to plan participants, they can ensure – with fiduciary advice – very low levels of fees and costs.
Ensuring reasonableness of fees and costs is important. Substantial academic research compels the conclusion that the higher the fees and costs associated with an investment product, the lower the returns for the investor. Moreover, over a long period of time even paying 1% a year more than necessary can result in an accumulation of wealth far below that of other investors not burdened by such an incremental fee. In essence, high fees threaten the retirement security of our fellow Americans.
The application of the fiduciary standard casts fear, but only upon Wall Street firms and their ability to extract high rents from our fellow Americans. As stated in economist Simon Johnson’s seminal article, The Quiet Coup (2009): “From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.”
 It is imperative that the fees and costs associated with retirement accounts, including IRA accounts, be reduced as a means of better ensuring the retirement security of all Americans. The application of the fiduciary standard of conduct is the best way to achieve this result.
Can Small Investors Be Served Cost-Effectively Under the Fiduciary Standard? – YES!
In a recent interview, a lawyer representing the securities industry "cautioned that applying a fiduciary duty to brokers who sell IRAs could force them out of the market and leave investors without guidance and … [he] stated: ‘We’re not trying to tilt the playing field … The objective is to provide the best information possible so that [plan] participants can make the best decision. But if there is fiduciary liability associated with the provision of information to participants, that information will dry up, which is exactly the opposite of what the GAO is recommending.’ Mark Schoeff, Jr., "GAO: Workers hurt when rolling over 401(k) plans to IRAs" (InvestmentNews, April 3, 2013).
Wall Street's repeatedly warns that applying the fiduciary standard would leave small investors without the ability to access advice. Yet, there is no credible evidence to back up such a position. In fact, the reverse is true – with the application of the fiduciary standard more and better advice will result for plan participants and IRA account owners.
Wall Street's hollow threats and attempts at obfuscation ignore fundamental economic principles. In 1970, Nobel-Prize winning economist George A. Akerloff, in his classic thesis, The Market for "Lemons": Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3 (Aug., 1970) demonstrated how in situations of asymmetric information (where the seller has information about product quality unavailable to the buyer, such as is nearly always the case in the complex world of investments), "dishonest dealings tend to drive honest dealings out of the market." As George Akerloff explained: “[T]he presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.”  Akerloff at p. 495.
In other words, as long as Wall Street is able to siphon excessive rents from investors, through conflict-ridden sales practices resulting in higher costs for individual investors (and lower returns), the business model Wall Street seeks to preserve will continue to attract bad actors. It's only human nature ... "join our firm and your compensation potential is virtually unlimited" is Wall Street's "promise" - ignoring of course the requirement that the new employee is required to sell not only expensive and often proprietary investment products, but indeed his or her very soul.
What will happen if the fiduciary standard is applied to the delivery of advice to all plan sponsors, plan participants, and individual investors in IRA accounts, through potential DOL (EBSA) rulemaking? Economic principles and common-sense logic indicate that three dramatic developments will occur.
First, once individual investors know that they can trust the words coming out of the mouths of their financial advisors, the demand for financial advice will soar. Currently far too many individuals distrust Wall Street, and - given their inability to discern between high-quality, fiduciary advisors and low-quality, non-fiduciary advisors - they simply choose to stay away from all advisors. In essence, the adverse smell of non-fiduciary advisors infects the entire landscape of financial advisors today; this smell will disappear if the fiduciary standard is properly applied.
Second, we will see a surge in the availability (supply) of fiduciary-bound financial and investment advice. More and more actors will be attracted to become such fiduciary advisors. As many, many already have, they will be attracted to a true profession in which they sit on the same side of the table as the client and assist the client in achieving their hopes and dreams. These advisors receive not just professional compensation from providing expert, trusted advice, but they also receive the immense joy from assisting their fellow man in a manner consistent with fiduciary obligations.
Third, the quality and quantity of advice will also soar. Currently Wall Street's legions are primarily "asset gatherers" and product salespersons. Much of the training provided is on how to sell - i.e., to close the deal. Fiduciary financial advisors, on the other hand, bound by fiduciary standards, are required to exercise due care in all aspects of the advice they provide. Clients will receive better budgeting advice, increased levels of savings, and better investment advice as increased due diligence is required of all advisors.
I can hear those on Wall Street bemoan such logic ... "Surely, you jest," they would say. "No advisor can afford to serve small clients, without selling expensive products to them!" Yet, I ask, what is the compensation paid on a Class A mutual fund, for a client who has $20,000 to invest? 5.75%, plus a small (0.25% or less, typically) trailing 12b-1 fee (in theory, in perpetuity) - in addition to fund management and administrative fees and transaction costs. In this example, a Wall Street firm (and its representative) would receive a $1,150 sales load, plus more over time. Clearly this is a large fee, imposed on a small investor, under the current conflict-ridden sales regime.
The fact is that there exist many financial advisors out there right now who will provide advice on an hourly basis or for a flat fee or under some other form of professional-level compensation arrangement. And the advice provided won't be just relating to the sale of an expensive product; rather for the same or lower fees paid by the client the professional fiduciary advisors will provide the clients with better financial advice and investment advice, and far more comprehensive advice at that.
Let us permit fiduciary advisors to be paid at professional-level compensation, for truly expert advice in the client's best interest. Wall Street may be unable to extract enough rents for its current business model to survive under the fiduciary standard, but there are plenty of independent, objective, trusted professionals who will take Wall Street's place, and who will do a far better job for the individual investor in the process.
What is Wall Street really stating? Wall Street whining really comes down to this: “We can't fleece small investors if a fiduciary standard is applied.” Stated differently, “Our business model is only highly profitable for us if we can push proprietary, expensive products and other wares under the weak 'suitability' standard, which permits us to recommend the highest-cost products for our client, even if our clients are substantially disadvantaged by same. We love the financial services sector and its current ability to siphon off 35% or more of the profits of this country. We love our bonuses. Don't disturb our greedy practices, and permit more of the returns of the capital markets to flow to individual investors!”
Applying the Fiduciary Standard – The Question of “Choice.” In his February 3, 2011 comment letter to EBSA, Timothy Ryan, Jr. asserted on behalf of SIFMA: “The proposed regulation will limit access to markets, investment products and service providers. Limited availability and decreased competition will result in higher costs and spreads and adversely impact market efficiency. Service providers and counterparties that choose to continue to provide services to, and trade with, plans and IRAs will incur a multitude of new costs, much of which will be passed on to clients.” Specifically, SIFMA further notes: “Investment options will be curtailed. Plans will be prohibited from engaging in swaps, restricted in their use of custody, lending, cash management, and futures strategies, and limited in their access to alternatives.”
The “limited choice” argument refuses to recognize the effect of the application of the fiduciary standard of conduct. The fiduciary standard, in essence, does constrain the actions of those providing advisory services and may prohibit recommending certain products or services to a client. This is because the fiduciary standard operates as a restraint on self-serving conduct, and upon greed.
Nor is there any real evidence to suggest that restricting plans from “engaging in swaps” and “futures strategies” or other risky practices will be bad for plan sponsors, plan participants, or IRA account owners. Only the high fees extracted by Wall Street from these types of arrangements will be negated.
Moreover, the U.S. Department of Labor has never been given a mandate to preserve conflict-ridden sales practices, nor to preserve any business model which has become outmoded through the process of time. The DOL / EBSA is well within its statutory mandate to adopt rules which prohibit certain conflict-ridden product sales practices, and instead to apply the fiduciary standard to investment advisory activities.
The Fiduciary Standard Could “Disrupts Capital Markets” or “Adversely Affect the Economy.” In reality, the current system of costly securities underwriting and commission-based product sales results in distortions in the capital markets system and a misallocation of capital. Economists generally believe that the current financial structure results in wholesale misappropriations of needed capital.
Evidence of such is quite apparent – the flow of investor’s funds into heavily hyped mortgage-backed securities in recent years, leading in large part to the most recent economic “Great Recession.” If most individual investors were represented by fiduciary investment advisers, rather than served by broker-dealers selling manufactured products out of their own inventories, no doubt the risks of such mortgage-backed securities would have earlier become more well-known (as fiduciary investment advisers possess a duty to discern risks of the investment products they recommend), and the Great Recession may have been alleviated, if not averted in its entirety.
Moreover, less capital is available presently to fuel economic growth, due in large part to the substantial distrust by individual investors of those registered representatives and insurance agents who pose as “financial consultants” and “financial advisors.” It is well documented that public trust is positively correlated with economic growth (Putnam 1993; LaPorta, LopezdeSilanes, Shleifer, and Vishny 1997; Knack and Keefer 1997; Zak and Knack 2001) and with participation in the stock market (Guiso, Sapienza, and Zingales 2007).
It must be remembered that, fundamentally, an economy is based upon trust and faith. Continued betrayal of that trust by those who professor to “advise” upon qualified retirement plans and IRA accounts, while doing so under a non-fiduciary standard, only serves to destroy the essential trust required for capital formation, thereby undermining the very foundations of our modern economy.
The Fiduciary Standard Will Promote Economic Growth, Job Creation, Retirement Security, and Lead to Lower Future Taxes. The adoption of the fiduciary standard of conduct for all providers of investment advice to retirement plan accounts and IRAs will assist in restoring trust to our financial services industry, resulting in greater investment of capital by individual investors. As the cost of capital is lowered, this in turn will propel a new era of economic growth in our country, leading to new job creation and new opportunities for all.
Moreover, the adoption of the fiduciary standard is essential to our fellow Americans who are saving and investing for retirement. While Wall Street’s excessive rents will diminish under the application of the fiduciary standard of conduct, the fees and costs associated with retirement account investing will also diminish. Our fellow citizens will, as a result, possess a far greater balance in their retirement accounts in future years. This will come at a time when federal and state and local governments, constrained by debt, will be unable to provide additional services to those of our citizens who have failed to adequately save and invest for retirement. In essence, the application of the fiduciary standard of conduct will remove a future burden upon government, and lower tax rates in the future will be possible.
In summary, I urge you to support the DOL / EBSA’s efforts to properly apply ERISA’s fiduciary standard of conduct upon all providers of investment advice to qualified retirement plans and IRA account owners. The benefits to all Americans, and to America itself, are too compelling to not undertake this important step.

About the Author

Ron A. Rhoades, JD, CFP® serves as Program Director for the Financial Planning Program at Alfred State College, Alfred, New York, where he is an Asst. Professor in the Business Department and teaches business law and the advanced courses within the financial planning curriculum.

Professor Rhoades also serves as Chair of the Steering Committee for The Committee for the Fiduciary Standard, a group of dedicated volunteers formed to advocate for the application of authentic fiduciary standards upon all providers of investment and financial advice. The Committee seeks to inform and nurture the public discussion on the fiduciary standard through education on the fiduciary standard.

Ron Rhoades is solely responsible for the content of this publication; the views expressed herein do not necessarily represent the views of any organization, institution, association or firm with whom he may be associated. Please submit any comments or suggestions regarding this publication to Thank you.

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