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SEC Recommends Strict Fiduciary Standard For Broker/Dealers

In a Dodd-Frank study released over the weekend, the SEC recommended that all brokers and financial advisors adhere to the same strict fiduciary standard that currently applies to investment advisers when they provide personalized investment advice to retail customers. But two Commissioners expressed their dissent for the study's conclusions in a separate letter to Congress.

An SEC study released over the weekend recommends raising standards for the delivery of financial advice by brokers and broker/dealers and could represent a major push towards a more uniform regulatory framework for the fragmented wealth management business. The study, which runs around 200 pages long, was mandated under section 913 of the Dodd-Frank financial services regulatory reform act, passed in July of last year.

In its study, SEC staff recommend that all brokers and financial advisors adhere to the same strict fiduciary standard that currently applies to investment advisers when they provide personalized investment advice to retail customers. Some consumer advocates and investment adviser groups had worried that any uniform standard recommended by the SEC would be watered down.

The study cites confusion among retail investors about the different legal responsibilties of brokers and investment advisers as the reason such a uniform fiduciary standard for all financial advisor professionals is needed.

Two SEC Commissioners, Kathleen A. Casey and Troy L. Paredes, were sufficiently disappointed with the study’s conclusions, however, that they wrote separately to express their views. The Commissioners charge that the study fails on two counts: 1) It does not adequately prove that such changes in regulation would enhance investor protection. 2) It does not adequately assess the costs to broker/dealers, investment advisers and retail investors. They suggest further research and analysis is needed before the SEC writes any new rules.

Casey and Paredes' opposition to the study's conclusions could make it more difficult for the SEC to implement its recommendations. Dodd-Frank section 913 gives the SEC authority to write new rules based on the recommendations in the study, so it doesn't need further Congressional action. But at least three out of five commissioners must vote to support any new rulemaking.

And yet, thus far, groups on both sides of the issue seem to be cautiously applauding the report’s results. In statements following the release of the report, Fi360, The Committee for the Fiduciary Standard, the Financial Planning Coalition and the Securities Industry and Financial Markets Association (SIFMA) voiced their support for the SEC’s conclusions. (Neither FINRA, the broker/dealer SRO, FSI, a trade group for independent broker/dealers, nor the Investment Advisor Association, a trade group for investment advisers, had released official comment letters as of Sunday evening.)

Clearly, there are plenty of hurdles left, however, before the SEC writes new rules. Investment adviser groups urged the SEC to act quickly to implement rulemaking, anticipating attempts to stall the process on the part of broker/dealers. Meanwhile, SIFMA wrote in its letter that while it supports a uniform fiduciary standard, it still has some concerns about broker-dealers’ ability to serve customers under the recommendations made in the report.

In its statement, SIFMA writes that “upon initial review we believe that the SEC has appropriately articulated a workable comprehensive approach for personalized investment advice for retail customers. It is especially important that the SEC recognized that any fiduciary standard should not pick business model winners and losers, and that the Commission will need to issue interpretive guidance to allow firms to operationalize this new standard.”

SIFMA and other critics on the broker/dealer side of the industry have charged that a uniform fiduciary standard might be prohibitively costly for some firms and investors, and that it could reduce investor product and service choice. But the report notes that retail investors should “continue to have access to the various fee structures, account options, and types of advice that investment advisers and broker-dealers provide,” according to an SEC press release that accompanied the report.

On the other side of the aisle, Fi360 commended the SEC study for emphasizing the need to prohibit certain conflicts of interest, rather than just disclose them to investors, and the need, on the other hand, for new plain English and point-of-sale disclosures. “The report also appears to reject one point of contention, that simple written disclosure is sufficient to mitigate the corrosive influence of conflicts of interest,” said Fi360 in its statement. “The report recognizes that the fiduciary duties of loyalty and care are compromised when conflicts are permitted to be disclosed away at the outset.”


Which conflicts might come under the knife? The two biggest and most obvious ones--commission-based compensation and proprietary products--will not, by themselves, be considered violations of the fiduciary standard, says the study. But these carveouts were already specified under Dodd-Frank. Moreover, broker/dealers and brokers will not have an ongoing fiduciary duty to a client once they have provided the investment advice--if, for example, they later want to sell that client products in a pure brokerage account. This will help preserve client choice and make the regulatory changes business-model neutral, says the study.

It appears that whatever conflicts the SEC might prohibit could be identified in the future, over time. “With investment advisers, the Commission and Staff have identified numerous conflicts of interest over time through interpretive guidance, rulemakings, enforcement actions and no-action letters,” says the report. “The Staff believes that the Commission should help broker-dealers similarly identify their conflicts of interest as specifically as possible so as to facilitate broker-dealers’ smooth transition to compliance with the uniform fiduciary standard.”

On the other hand, the study recommends very specific areas in which the SEC should issue interpretive guidance or rulemaking so that broker/dealers will know specifically how the fiduciary standard applies to their business. For example, it recommends specific guidance for principal trading, and specific definitions of the duties of loyalty and care required under the fiduciary standard, and of personalized investment advice.

It also recommends harmonizing regulation of broker/dealers and investment advisers in other areas, including advertising and other communications, use of finders or solicitors of clients (i.e. business contacts who provide referrals), supervision, licensing and registration of firms, licensing and continuing education requirements for advisors and books and records.

Cost Analysis

The final section, the last 20 pages of the report, is dedicated to an analysis of the potential outcomes of rulemaking and the potential costs associated with the various outcomes. The report says the actual specific dollar costs are difficult to quantify, and were not provided by industry participants in comment letters. Among other things, and in broad strokes, if the study's recommendations are adopted, the following things might happen and raise costs for broker/dealers:

1) Some broker-dealers might choose to hire additional compliance staff and amend internal supervisory structures.

2) Broker-dealers initially would incur costs in order to conduct an assessment of their business practices, review any conflicts of interest, and determine what changes, if any, were needed to their customer agreements and disclosures and other business practices.

3) Those broker/dealers that choose to de-register and re-register as investment advisers and those dual registrants that opted to convert advised brokerage accounts to advisory accounts would incur one-time costs associated with this switch, but would also reduce ongoing costs associated with broker/dealer compliance.

Ultimately, the report says that while better information about costs would have been helpful, it would not have been essential because the "recommendation to adopt a uniform fiduciary standard is intended to address the integrity of personalized investment advice to retail investors and is based on a desire to promote full, fair and clear disclosure of relevant conflicts."

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