Despite the U.S. Court of Appeals' recent rebuke of the SEC in Financial Planning Association vs. Securities and Exchange Commission, the regulator appears ready to continue to reduce the fiduciary protections afforded by the Investment Advisers Act of 1940 to consumers of investment services.
First, there is the "two hats" special rule proposed by the SEC in September that would permit a dual registrant to act with the same client/consumer both as a fiduciary on investment advisory accounts and not as a fiduciary with respect to brokerage advisory accounts.
It is obvious that consumers of investment services neither understand nor are able to discern the dual registrant's status as he or she switches between being a fiduciary, or otherwise having to act in the consumer's best interest, to being a product salesperson.
The plain language of the Advisers Act has an exception for persons and their relationships, not accounts. "Two hats," if enacted, would open the door to the use of "bait and switch" activities, which none of us wants to see.
The SEC also appears ready to continue 12b-1 fees in 2008, with only minor modifications.
What's the difference between a 12b-1 fee, deducted by the mutual fund company and paid to the broker-dealer firm, and a fee-based brokerage account? Nothing. And this reminds me of an old maxim taught to all lawyers in law school — "you cannot do indirectly what you cannot do directly." In other words, "if it walks like a duck ..."
The SEC seems ready to pursue a course that is clearly not in the best interests of the consumer in spite of:
Admissions from brokerage firms and many registered reps in their comment letters to the SEC that 12b-1 fees pay for ongoing advisory services.
The clear language of the legal decision, that anything other than commissions is "special compensation."
The fact that the SEC defined 12b-1 fees as "relationship compensation" in a recent final rule (the bank exemption).
One key SEC staffer recently noted that the FPA "will rue the day" it brought its lawsuit, as the SEC petitions Congress for relief from the Advisers' Act requirements. Despite stating that it will defer any decisions regarding "financial planning" as activity subject to the Advisers Act, the SEC continues to permit broker-dealer firms to undertake activities that are clearly both financial planning and investment advisory in nature. (Has anyone seen the recent commercial promoting retirement planning, with its small print that the plan presented is somehow, and inexplicably, not "financial planning"?)
Despite all of the foregoing, 2007 saw many developments favorable to consumers. The Certified Financial Planners Board of Standards Inc. in Denver adopted revised rules of professional conduct applying the fiduciary standard to all of its registrants, and at all times.
The FPA's leadership expressed support for a universal fiduciary standard of conduct, under the law, for all financial planners.
The "Focus on Fiduciary" campaign of Arlington Heights, Ill.-based National Association of Personal Financial Advisors continues to enlighten consumers.
A 2007 California court decision further clarified that federal securities law does not prevent state securities regulators from attacking fraudulent activities undertaken by registered reps. Federal securities law does not pre-empt state common law applying fiduciary duties to relationships based upon trust and confidence.
Following an ever-growing body of court decisions, the Texas Court of Appeals held that state common-law fiduciary duties existed in Western Reserve Life Assurance Co. of Ohio (based in St. Petersburg, Fla.) vs. Graben, where a dual registrant who sold a variable annuity continued to provide advice on fund selection.
State securities regulators increasingly attack equity-indexed annuity sales through the application of fiduciary standards of conduct when advice is given to remove funds from other investment accounts, and the current president of the Washington-based North American Securities Administrators Association, Karen Tyler, stated at NASAA's annual conference that securities regulators must "afford investors protection parity. This does not mean taking the path of least resistance to the lowest common denominator. This means regulators must work collaboratively to elevate the standard of care obligation for anyone entrusted to make recommendations or give advice pertaining to the money of others. For all financial professionals, the interests of the client must come first at all times. Investors deserve no less."
While many broker-dealer firms continue to argue that they just seek to preserve "consumer choice," we know that consumer choice already exists — either an advisory relationship or an arm's-length sales relationship. The role of the SEC is not to conform regulation to "industry practices" (which led to such abuses as the stock analyst scandal earlier in this decade), but rather to conform industry practices to the law. The SEC's public perception as a leader in the protection of consumers, and its "inside the Beltway" respect as one of the best of our federal agencies, is likely to continue to deteriorate should the SEC continue to blur the lines in the application of the Advisers Act and its fiduciary protections.
It is commonly argued that the financial world has changed. Yes, it has. With continuing evolution of modern portfolio theory and its offshoots, tens of thousands of mutual funds and other products — among them exotic products designed to either assume or alleviate risks — have been created, many of which have hidden fees and costs. All of this has led to a world that is far more complex for consumers than that which existed in 1940. The "knowledge gap" between consumers and financial advisers has never been greater. Fiduciary principles that apply when there is a placement of trust and a substantial disparity in knowledge will be even more relevant in 2008 and beyond.
It is time for the SEC to reverse course and apply broad fiduciary duties to all those holding themselves out as trusted advisers, to everyone who undertakes financial planning (whether "comprehensive" or "discrete") and to all other investment advisory activities.
Consumers deserve trusted advice. If they cannot make reasoned decisions about financial planning and investments, in 2008 and the years ahead there will be greater pressure on governments to provide for their future welfare. While major forces oppose application of fiduciary standards, securing a better future for all Americans simply requires the common sense to see the compelling need for fiduciary duties to apply to all financial advisory activities.
Diahann W. Lassus, CFP, Chairman, NAPFA industry issues task force; chairman and president of LassusWherley Associates PC of New Providence, N.J.