Fiduciary Corner

Fiduciary foes: Don't count your chickens

Rule-making process, including cost-benefit analysis, favors advocates of a high standard

Sep 4, 2011 @ 12:01 am

By Blaine F. Aikin

When Republican members of the House Financial Services Committee warned the Securities and Exchange Commission to halt the process of fiduciary rule making, it was a pretty blatant signal that the stage has been set for a courtroom showdown.

Echoing comments by SEC members Kathleen Casey and Troy Paredes, the panel members questioned whether appropriate cost-benefit analysis had taken place to justify the extension of a high fiduciary standard of care for investment advice.

Given the July 22 appellate court decision finding that the SEC acted “arbitrarily and capriciously” in issuing a new rule regarding shareholder access to company proxy-voting processes (See “Proxy case could haunt SEC, Labor fiduciary rules,” Aug. 22), it can be expected that this will be the major proving ground for a court challenge no matter what the rule looks like. However, if opponents of the fiduciary standard think that it is a given that a cost-benefit analysis will favor their position, they might want to think again.

I can think of at least four reasons why the rule-making process generally, including the cost-benefit discussion, favors the position of fiduciary advocates.

First, the high-cost argument espoused by those in the broker-dealer and insurance communities who are arguing for a watered-down version of the standard is self-incriminating. Pure logic dictates that advice rendered under a diluted standard is worth less than high-standard advice.

If given a generic choice, at the same price, between a financial adviser who is accountable to a high standard of competency and objectivity and a lower-standard adviser who is permitted conflicts, investors will choose the former 100% of the time. It is equally clear that the potential for a cost-benefit challenge hinges on the assumption that low-standard advice comes at a discount.

Second, despite the sound logic that lower-standard advice should cost less, there is almost no evidence to suggest that it actually does. This is almost certainly because of well-documented investor confusion about which advisers are held to a fiduciary standard and which aren't.

Both high-standard and weak-standard proponents agree that there is confusion that must be reconciled under one consistent standard.

Weak-standard proponents propose to accomplish this by continuing to accept conflicts of interest and adding stronger disclosure requirements. High-standard proponents counter that conflicts inherently are at odds with what it means to be a fiduciary and point to ample evidence that disclosures don't work.

Third, the door to a claim of “arbitrary and capricious” rule making swings both ways. The SEC would find it hard to defend in court a rule that weakened the standard.

The SEC is obligated to carry out rule making that is in accordance with the law. Dodd-Frank gives it authority to expand the standard and to assure that it is no less rigorous than that established under the Investment Advisers Act of 1940.

The SEC is also obligated to consider a rule's effect upon efficiency, competition and capital formation, in addition to investor protection.

The SEC studied the fiduciary standard as required under Dodd-Frank and recommended extension of the bona fide standard. Although that study has been criticized for not going far enough with respect to cost-benefit analysis, courts have recognized that a regulatory agency isn't expected to base every action it takes on empirical evidence.

Friends and foes of the standard alike have publicly recognized the need for better investor protection. Yet if the weak-standard proponents get their way, investors served by advisers already subject to the standard will become less protected as a byproduct of extending a diluted standard to advisers who now get away with giving advice without any fiduciary accountability.

Under that circumstance, in-vestor advocates and associations of professional advisers almost certainly would force the SEC into court to confront the compelling case for preserving and extending the bona fide standard and the charge of arbitrary and capricious rule making.

My final point is captured in a quote from Oscar Wilde: “Nowadays, people know the price of everything and the value of nothing.”

Calculating the cost of extending the standard to all who give advice is worthwhile but shouldn't be done in disregard for the true value of fiduciary conduct. The fiduciary duties of loyalty and care equate to principles of objectivity and competence.

These form the foundation upon which trust is built and they can't be compromised without undermining the basis for trust. There is great peril in putting a price on our principles.

Blaine F. Aikin is chief executive of Fiduciary360 LLC.

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