In the lexicon of regulatory reform, “harmonization” is a key word. Securities and Exchange Commission Chairman Mary Schapiro introduced the term in testimony and materials presented to the Senate Committee on Banking, Housing and Urban Affairs on March 26 when she listed “harmonize investment adviser and broker-dealer obligations” as an anticipated activity of the SEC for 2009. She also said that the SEC is studying the need to “break down the statutory barriers that require a different regulatory regime for investment advisers and broker-dealers even though the services they provide often are virtually identical from the investor's perspective.”
In June, the Obama administration's “Financial Regulatory Reform: A New Foundation” report moved harmonization beyond the study stage by proposing that the “SEC should be given new tools to increase fairness for investors by establishing a fiduciary duty for broker-dealers offering investment advice, and harmonizing the regulation of investment advisers and broker-dealers.”
The imagery of breaking down statutory barriers to regulatory efficiency and increasing fairness for investors is strong and positive.
Even so, this may be a rare instance when the architects of reform have understated prospective benefits. In particular, little attention has been paid to the benefits of harmonization for the representatives of broker-dealers who provide advice and understand the fiduciary nature of advisory activities but are constrained by company policies geared toward compliance with a suitability standard.
In recent months, the volume of calls and e-mails I have received from financial advisers in wire-house firms has steadily increased. These advisers overwhelmingly want to know the odds that the fiduciary standard will be recognized as governing law for “their side of the business,” and they want to know what they can do to help make it happen.
Why do these advisers want to be held to the higher fiduciary standard?
First, they are already operating according to a fiduciary ethic, and second, they are tired of being portrayed as profiteers rather than professionals.
These advisers recognize that their clients
trust and rely upon them, and consequently, they serve as “functional fiduciaries.” They also know that with that role come the fiduciary duties of loyalty and due care, along with obligations to provide full and fair disclosure, and to avoid or properly manage conflicts of interest.
Therefore, they adhere to fiduciary principles because they think that they ought to do so — they are guided by a fiduciary ethical standard, irrespective of whether their firm seeks to characterize their services as being subject only to a lower suitability standard of regulatory governance.
In the murky world of non-fiduciary “incidental advice” and dual registration, which allows broker-dealer reps to switch from wearing fiduciary to non-fiduciary hats almost at will, broker-dealers generally seek to preserve the opportunity to resolve any disputes with clients by being accountable only to the suitability standard. Any overt indication of fiduciary status by their reps undermines this strategy; therefore, reps are often not permitted to acknowledge fiduciary status in client relationships, or use designations that are associated with fiduciary responsibility.
This places brokerage-based advisers at a considerable competitive disadvantage when knowledgeable prospective clients ask about the advisers' ability and willingness to be held to the fiduciary standard. Competitors who accept fiduciary status recognize this area of vulnerability and encourage prospective clients to pursue this line of inquiry.
If there is a client dispute, a broker-based adviser's firm is likely to argue as a first line of defense that the suitability standard applies even when the adviser believes — or even knows — he or she acted in a fiduciary capacity. The adviser is left with the difficult choice of either denying what he or she truly believes or supporting the client's position and planning for a change in employment status.
Finally, it is extremely difficult for even the best-intentioned individual to conform consistently to a fiduciary ethic in a predominantly sales-oriented suitability culture.
Now that Congress is back in session, work on financial reform will resume, including the administration's proposed fiduciary-centric form of harmonization. Brokerage-based advisers who operate under a strong fiduciary ethic will be important behind-the-scenes advocates who are ready for reform to raise the regulatory standard to the level of their conduct.
Blaine F. Aikin is the president and chief executive of Fiduciary360 LP.
