Thursday, January 3, 2019

Part 2 of a Series on the Regulation of Financial and Investment Advice, and the Future of the Profession

Part II: Proposed Form CRS Obfuscates, Rather Than Informs

   And ... How YOU Can Make a Difference ... Through Advocacy

by Ron A. Rhoades

The S.E.C.’s proposed Form CRS is deeply flawed. Even the RAND Corporation, in a study paid for by the SEC, thinks so.

The following is a fictional and completely hypothetical exchange between the Chair of a U.S. Congressional Committee and current Chair of the U.S. Securities and Exchange Commission, Jay Clayton. It is the type of exchange that would result from proper Congressional oversight – if procedural rules permitted such extended questioning, and if those testifying before Congress would not seek to answer evasively or ambiguously.

Committee Chair: “Welcome back, SEC Chair Clayton.”

Mr. Clayton: “Madam Chairman, I wish I could say it was a pleasure to be here again, after yesterday.”

Committee Chair: “Let’s use our limited time productively, shall we. In today’s hearing we are examining the U.S. Securities and Exchange Commission’s proposed rule in which a form, ‘Client Relationship Summary,” has been set forth. Before we look at this ‘Form CRS’ itself, Mr. Clayton, let me ask you – Why do you call this a ‘client’ relationship summary rather than a ‘customer’ relationship summary? Is the title of this form not misleading?”

Mr. Clayton: “I don’t follow you, Madam Chair.”

Committee Chair: “I’m not surprised. Mr. Clayton, is it not true that there are two fundamental types of commercial relationships under the law, that between a seller or distributor of products or services and the purchaser of those goods and services, and that between a fiduciary, such as an investment adviser, and the purchaser of those advisory services.”

Mr. Clayton:“That is my understanding as well, Madam Chair.”

Committee Chair:“Good. Now, the retail investor served by a broker is a customer. In fact, FINRA’s suitability rule uses the term ‘customer’ to describe the retail investor. Even in the recent Fox, Merritt study, ‘Securities Market Issues for the 21st Century,’ it was noted that broker-dealer conduct requirements include providing recommendations that are suitable for the customer. Yet, in that same study, Fox and Merritt noted that have investment advisers – those who act as such under the ’40 Act – possess fiduciary obligations that run to their clients. So, I ask you, is not the very title of your disclosure form, “Client Relationship Summary,” misleading … should not it be “Customer or Client Relationship Summary.”

Mr. Clayton: “I believe the term ‘client’ can refer to an investor served by both a broker and by an investment adviser.”

Committee Chair: “But, in the ’34 Act, the term customer is utilized, and in fact there exists FINRA Rule 2090, the ‘Know Your Customer’ rule. Yet, in the ’40 Act, the term ‘client’ is often used. In fact, ‘investment supervisory services’’ means ‘the giving of continuous advice as to the investment of funds on the basis of the individual needs of each client.’ I am just curious as to why a proposed Regulation that seeks to inform consumers about the nature of the relationships that exist between brokers and their customers, and between investment advisers and their clients, starts out with this obfuscation.”  

Mr. Clayton: “Again, Madam Chair, it is our intent to provide good information to retail consumers, not to confuse them.”

Committee Chair: “Well, Mr. Clayton, as we shall explore today, Form CRS does not inform investors, it merely further muddies the waters for all investors, which I suspect is precisely what broker-dealers desire.”

Mr. Clayton: “Of course not, Madam Chair.”

Committee Chair: “Mr. Clayton, do you mean to tell me that brokers, who have long used ‘trust-based selling’ techniques, who have long been permitted by the Commission to use titles such as ‘financial consultant’ and ‘wealth manager’ that suggest a relationship of trust and confidence exists, when in fact none so exists, would not be pleased to see the distinctions between brokers and their competition, fiduciary investment advisers, clouded.”

Mr. Clayton: “I don’t believe that is the intent of the brokerage industry.”

Committee Chair: “Mr. Clayton, the SEC’s  Office of the Investor Advocate hired the RAND Corporation back in 2008 to do a study of broker-dealers and investment advisers, did it not?” 

Mr. Clayton: “Yes.”

Committee Chair: “And in that study, it was found that, and I quote from a later RAND Corporation report about the 2008 study, ‘participant understanding of types of financial services and financial professionals was low.’”

Mr. Clayton: “Yes. Based on my discussions with many retail investors over the last several months, it is clear to me that too many retail investors are not aware of the material aspects of their relationships with their investment professionals.”

Committee Chair: “So you proposed this Form CRS, to aid investors in understanding the nature of their relationship with their broker or investment adviser.”

Mr. Clayton: “Yes.”

Committee Chair: “Yet, the RAND Corporation’s study of your proposed Form CRS found that a significant percentages of investors stated in response to survey questions that important sections of the proposed Form CRS were ‘difficult’ or ‘very difficult’ to understand. In fact, almost one-quarter of respondents described the ‘Types of Relationships and Services’ and ‘Our Obligations to You’ sections as ‘difficult’ or ‘very difficult’ to understand. The responses were even higher for the ‘Fees and Costs’ and ‘Conflicts of Interest’ sections, with approximately thirty-five percent of respondents describing these sections as ‘difficult’ or ‘very difficult’ to understand.”

Mr. Clayton: “That appears to be correct.”

Committee Chair: “Under your mock-up of Form CRS, brokers would state, in describing the obligations owed to their customers, that ‘We must act in your best interest and not place our interests ahead of yours.’ Yet, as our hearing yesterday revealed, that is not the case. Under your proposed Regulation Best Interests, brokers do not possess a fiduciary duty of loyalty, are not required to act in the best interests of their customers as that term in commonly understood under existing law, and brokers can and will place their own interests ahead of the interests of their customers.”

Mr. Clayton: “We disagree on these points, Madam Chair.”

Committee Chair:“Yet, for investment advisers, your mock-up states, for investment advisers, that they are held to a fiduciary standard, but it does not state that investment advisers have the obligation to act in the best interests of their clients, as required by established fiduciary law.”

Mr. Clayton: “That is true, Madam Chair.”

Committee Chair: “In fact, if your regulation compels a broker or investment adviser to provide this Form CRS to its clients, by falsely representing that brokers are required to act in the best interests of their customers, would not the SEC be requiring the broker or investment adviser to undertake a misrepresentation that could, in certain circumstances, amount to fraud?”

Mr. Clayton: “I do not agree, Madam Chair.”

Committee Chair: “Also, does not the RAND report illustrate what we also discussed yesterday – that written disclosure is largely ineffective in helping retail investors. In fact, the responses to specific questions about the Form CRS disclosures revealed that a significant number of those surveyed did not understand important sections of the form. To no one’s surprise, those surveyed still had a general misunderstanding of the different standards governing brokers and investment advisers. And the RAND report also found that many consumers were unable to synthesize and apply the information contained in Form CRS.”

Mr. Clayton: “Not every consumer will always be aided by disclosures, Madam Chair.”

Committee Chair: “But the issue here is, why does the SEC seek to impose a costly disclosure regime upon both brokers and investment advisers that does not clarify the distinctions between brokers and investment advisers, but rather obscures these distinctions, thereby further confusing retail investors?”

Mr. Clayton: “I disagree with your characterization of Form CRS, Madam Chair.”

Committee Chair: “And I myself am mystified. Not by your Form CRS, for it is abysmal. Not by Reg BI, which is nothing more than an attempt to cast brokers, who are in arms-length relationships with their customers, as trusted advisers – when there is no legal obligation for the broker to actually act under a duty of loyalty to the customer. I am mystified that you indicate, despite all of the problems found with Form CRS, that you intend that the Commission move forward to promulgate this burdensome, ill-advised disclosure regime.”

Mr. Clayton: “We have made no final determination as to whether Form CRS will be adopted, and we are considering some changes to it.”

Committee Chair: “This is just another waste of resources by the SEC. If you pursue this path, Mr. Clayton, a future SEC, under a different Administration, will have to fix the tragic mess you are creating. Mr. Clayton, you will likely go down in history as the worst Chair in the long history of the U.S. Securities and Exchange Commission, and your actions may very well threaten the SEC’s continued existence. There should be no reason to continue to fund a government agency that has been captured by the very industry it regulates, and the functions of the SEC should be transferred to other government agencies. This hearing is concluded.”

* * * * * * * * *

In the transcript of the fictional hearings set forth above and in Part I, I have attempted to demonstrate the fallacy that the SEC is acting in the best interests of consumers, or the consuming public. For those interested, I urge you to read the text of the proposed rules, and the various comment letters, to judge for yourself the efficacy of the SEC’s proposals to accomplish their intended purposes.

You, the reader – likely an industry professional – have no doubt grown tired of the “fiduciary wars,” which have been ongoing for more than a decade. But I urge you not to despair.

2019 may well be a watershed year for those who care about the future of the emerging profession of financial and investment advice. Against the backdrop of a court’s overturning of the U.S. Department of Labor’s Conflict of Interest and related rules, and the SEC’s bungling, several state securities administrators, and/or state legislatures, may step in to feel the void. First up may the New Jersey Bureau of Securities, which will likely release in early 2019 a proposal to impose fiduciary duties upon brokers who provide investment advice.

And, of course, the Certified Financial Planner Board of Standards, Inc., with its new Code of Ethics and Standards of Conduct, effectively makes all Certified Financial Planners™ “F.A.A.T.” – fiduciaries at all times. And, unlike the vagaries and ambiguities found in the SEC’s Proposed Regulation BI, the CFP Board’s standards clearly state that its certificants will be fiduciaries and that “CFP® professional must … [p]lace the interests of the Client above the interests of the CFP® professional and the CFP® Professional’s Firm.”

The fact of the matter is that most individuals who provide investment and financial advice want to be fiduciaries to their clients. They want to be expert, trusted advisers. They want to possess deep relationships with their clients. New entrants to the profession, including the increasing number of graduates of university CFP-registered programs, nearly all want to join professional firms that possess a strong fiduciary culture. And, without a doubt, when explained properly to a client, every client wants to be able to trust their provider of investment advice.

These fiduciary battlegrounds matter. There will be wins, and there will be losses. But, without a doubt, over time the fiduciary standard will become universally applied to all providers of financial and investment advice, as it has in other countries. There may be (and should be, in my view) a well-defined place for those who don’t provide investment advice, in order that they product sales may continue. But, at some point in the future, 90% or more of retail consumers will be served by fiduciary advisers, under a strong and non-waivable fiduciary standard.

However, this won’t happen automatically. The shift from sales to advice, and from non-fiduciary brokers to fiduciary investment advisers, won’t continue to progress unless those who desire a true profession demand it. That is why your voice is so important. You must work to “build the record” – to show how consumers are harmed by non-application of the fiduciary standard of conduct. To demonstrate how you – if you are already acting as a fiduciary – will be harmed by this most recent SEC attempt, using proposed Reg BI and Form CRS – to effect a smokescreen to mask the distinctions between fiduciary and non-fiduciary actors.

Hopefully you will ask, “What can I do, now?” With the new Congress comes the opportunity for renewed oversight of the SEC. Oversight hearings can, as illustrated, challenge the SEC’s proposed Reg BI and Form CRS. Such hearings can focus unwanted attention on Chair Jay Clayton’s push to enact these ill-advised regulations, and in so doing stop them from coming into existence.

The answer to the question lies in your own hands. Contact your U.S. Representative. Contact your U.S. Senator. Visit them at their local offices. If they are not available, ask to meet with their legislative staff. Prepare and fax to your Senator or Congressman a letter stating your objections to the SEC’s proposals, and (if you are able) relay in that letter the substantial harm you have seen caused to an investor by non-application of the fiduciary standard of conduct to all providers of investment advice. Enclose a copy of these two articles, which might make for interesting reading by legislative staff. Or reference one or more comment letters that you find to be in accord with your own views.

Also, seek to influence, when the opportunity arises, standards of conduct at the state level. New Jersey, Nevada, and New York all have pending current rulemakings that could substantially improve upon standards of conduct for providers of investment and financial advice. Other states may follow in 2019.

One way to seek influence is to join with others in FPA's Advocacy Days - in Washington, DC (typically in May or June), and in state capitols throughout the year. Visit FPA's Federal and State Advocacy Days web page to learn more.

If we desire a true profession someday, we must first achieve a bona fide fiduciary standard of conduct for all providers of investment advice. Thereafter, the remaining steps to a true profession become much easier. But we cannot move forward to that day when each of us is proud to call each and every one of our colleagues a “professional” – unless you continue to support the fiduciary standard.

In addition to advocacy at the national and state levels, there is more that you can do. Such as by adopting fiduciary standards in your own firm. Fee-only financial advisors can join and adopt NAPFA’s Fiduciary Oath. Everyone can adopt The Committee for the Fiduciary Standard’s Fiduciary Oath. And firms can also adopt The Institute for the Fiduciary Standard’s “Best Practices.” Or, do as I have done, and adopt all three!

When we achieve a bona fide fiduciary standard of conduct for all providers of investment and financial advice – and I am certain that such day will come someday (as it already has in some other countries) – then we will see the demand for financial and investment advice soar. Consumers won’t be afraid that they will be taken advantage of. Many more consumers will receive what they so desperately need – sound, trusted advice empowering them to save more and to invest much better.

It doesn’t take a rocket science to see how the adoption of the fiduciary standard will also help business owners large and small (plan sponsors) avoid liability. And, we can easily surmise, more saving and better investing will make for a more efficient capital markets, with a greater accumulation of capital, thereby fostering U.S. economic growth.

But it all begins with you – making the individual decision – to lead. To assist all of your colleagues that desire to become a member of a true profession. To act now – by contacting your Senators and U.S. Representative, today.

Ron A. Rhoades, JD, CFP® is the Director of the Personal Financial Planning Program at Western Kentucky University’s Gordon Ford College of Business. A professor of finance, tax and estate planning attorney, investment adviser, and Certified Financial Planner™, he has long written about application of fiduciary law as the delivery of financial planning and investment advice. This article represents his personal views, and are not necessarily the views of any institution, organization, nor firm with whom he may be associated.

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