As regulators struggle to harmonize retail-advice rules, blending them into a single fiduiciary standard, count on hearing some sour notes from the industry. In fact, nowhere is the debate over investment advice standards more discordant than surrounding the term "harmonization."
Over the next two years, harmonization will be at the heart of the work of the Department of Labor and the Securities and Exchange Commission as they try to formulate regulations for retail investment advice.
While the ultimate goal, ideally, would be to create a single, uniform standard for both investment advisers and brokers that investors could readily understand, many in the advice industry have doubts about whether that is achievable. They believe it is more likely that the agencies will come up with a watered-down version of the existing standard that investment advisers currently live by, or create an ostensibly new standard for brokers that won't go beyond requiring some additional disclosure.
The DOL's fiduciary duty rule, which requires brokers to act in the best interests of their clients in retirement accounts, was partially implemented in June. Now the agency is in the middle of a review of its enforcement mechanisms, mandated by President Donald J. Trump, that could lead to significant revisions.
Meanwhile, the SEC is drafting its own fiduciary rule, one that would apply to all types of advice — not just retirement advice. With an 18-month implementation delay pending for the DOL rule — from Jan. 1, 2018, to July 1, 2019 — both the SEC and DOL have promised to work together on advice standards.
Advisers currently must meet a fiduciary, or best-interest standard, while brokers adhere to a suitability standard that requires them to take into account an investor's risk tolerance and needs, but allows them to sell products that give the broker the highest revenue.
Looming over the effort is the possibility that the differing advice standards under which investment advisers and brokers operate will be melded, creating the so-called harmonization of advice. The question is: Can it be done? And if so, what would this newly harmonized standard look like?
'Meeting in the middle'
"There's been a lot of talk about harmonizing the rules," SEC investor advocate Rick Fleming said at a TD Ameritrade Institutional conference in Washington earlier this month. "To me, that means meeting in the middle — you bring down the [Investment] Adviser Act [of 1940] standard and sort of bring it up on the B-D side. Big danger of that happening. That's something I'm very worried about. Something I'll be working very hard to prevent."
Knut Rostad, president of the Institute for the Fiduciary Standard, predicts a race to the bottom.
"Both agencies are heading toward a lower standard," Mr. Rostad said. "Based on what we're hearing, there's no question that fiduciary will be transformed into a suitability and commercial-transaction regime with additional disclosure. Disclosure doesn't work."
The SEC has a tendency to favor disclosure because that is the foundation of its regulatory approach. "The SEC is big on disclosure," Mr. Fleming said. "Disclosure, while helpful, is not always sufficient."
An alternative to drawing up a single standard based on disclosure would involve keeping investment advisers under their current standard, while formulating a new standard for brokers that relies on strengthened disclosure of their fees and conflicts of interest.
This approach could gain momentum because adviser advocates don't want their best-interest regime watered down, as industry opponents of the DOL rule now have more influence over the DOL and SEC than they did during the Obama administration, when the DOL rule was finalized.
Comment letters the SEC has collected over the last five months to guide its consideration of a fiduciary rule make clear that the financial industry favors a disclosure-based regulation.
The Financial Services Institute, which represents independent broker-dealers and financial advisers, is recommending a two-tier disclosure system. The first tier would include general statements about the standard of care owed to the client by the financial firm, the scope of the relationship and a general description of the financial adviser's compensation. Expanded disclosure about account fees and charges as well as information about investment products would be posted online.
In its comment letter, the Securities Industry and Financial Markets Association called on the SEC to develop a best-interest standard for brokers "that encompasses a duty of loyalty, a duty of care and enhanced up-front disclosures."
A major trade association representing broker-dealers, banks and asset managers, SIFMA rejects the idea of a uniform fiduciary standard that would cover both investment advisers and brokers, given the "inherent differences between B-Ds and IAs."
"To move forward, the SEC should consider establishing a best-interest standard of conduct for B-Ds that builds upon their existing regulatory regime," Kevin M. Carroll, SIFMA managing director and associate general counsel, wrote in a July 21 comment letter.
On that point, SIFMA agrees with the Investment Adviser Association, which represents registered investment advisers. The IAA wants the SEC to leave investment advisers alone and craft a new advice standard for brokers.
"Pursuing a single 'harmonized' standard of conduct also would not effectively serve investors because it would result in a weakening or 'watering down' of the existing robust fiduciary standard applicable to investment advisers," wrote Gail Bernstein, IAA general counsel, in an Aug. 31 comment letter.
Robert Plaze, a partner at the law firm Proskauer Rose, sees the potential for compromise in the IAA and SIFMA letters — a compromise that's needed, he says, because of the deep divisions among SEC members over advice standards that have prevented progress on the issue.
"There's a political and policy need to re-imagine the broker-dealer standards of care and apply them rigorously," said Mr. Plaze, a former deputy director of the SEC Division of Investment Management. "I am very much hopeful that you can have a standard that would be vigorous but at the same time recognize the different roles B-Ds play in the markets."
Leaving advisers under the 1940 Act while enhancing suitability could break the logjam, said Skip Schweiss, TD Ameritrade Institutional managing director of adviser advocacy and industry affairs. Differences that would have to be ironed out would then center on the duty of loyalty and care and disclosures for brokers.
"That seems like a debate over the middle ground rather than at the polar ends of the spectrum that we've been having for the last decade," Mr. Schweiss said.
(More: The Fiduciary Journey)
But it's not as if the fierce and protracted debate over advice standards has suddenly entered the land of milk and honey.
"The fact that we're both talking about the framework is new, and a potential opportunity," said IAA president and chief executive Karen Barr. "The devil is in the details."
Indeed, tension over the specifics is already evident. In its letter, the IAA writes that the new broker standard should be "no less stringent than the Advisers Act fiduciary standard." SIFMA says that up-front disclosure should be "principles-based" but says that brokers should not have a continuing duty of loyalty to the customer after selling an investment product.
Fred Reish, a partner at law firm Drinker Biddle & Reath, anticipates that the SEC will toughen disclosure standards for brokers. The tension will be between generic disclosures, which require less work, and individualized disclosures, which are more expensive and labor-intensive but also more meaningful to investors.
"We're trending toward the day where financial institutions will have a protected page on their website for every investor, but we're not there yet," Mr. Reish said.
Although Mr. Reish predicts that transaction-based compensation for brokers will be allowed as long as it is properly disclosed under new advice rules, he doesn't anticipate that the SEC will water down the fiduciary standard for brokers.
"I don't think they'll take suitability, enhance it a little bit and call it fiduciary," Mr. Reish said. "They're going to take to heart that they're working on a fiduciary standard."
Indeed, the SEC can't stray too far from the DOL rule, which, in its finalized form, mitigates broker conflicts of interest, according to supporters of the measure.
The parts of the rule that have been implemented require brokers to act in their clients' best interests, charge reasonable compensation and avoid misleading statements. But while the rule is under review, DOL is relaxing enforcement.
"Trying to pull back from that is going to be met with opposition," said Blaine Aikin, executive chairman of Fi360, a fiduciary training and accreditation firm. "I wouldn't rule out harmonizing to the DOL standard. I don't see a lot of latitude but to top up. It's awfully difficult to ratchet down from a standard the DOL has already set and that firms have already adjusted to."
It's unlikely, though, that industry opponents of the DOL rule will sit still while the SEC raises the suitability standard to something that looks more like the fiduciary standard governing advisers. That raises the stakes to find the middle ground.
"I'm interested in making things better for investors rather than perfect, because if you demand perfect, you get nothing," Mr. Schweiss said.