Some time ago, a reporter asked me a simple yet profound question: “If everyone providing investment advice were held to a fiduciary standard of care, how would things be different than they are today?”
Before the financial crisis, the reporter's question would have been asked in the broad context of whether a fiduciary standard should be imposed upon broker-dealer representatives who provide any level of advice.
However, now that regulatory reform is a front-burner issue, and a virtual consensus has formed on the need for a consistent or “universal” fiduciary standard to apply to all investment advisers, it is clear that not everyone is operating under the same assumptions as to what a “universal” fiduciary standard would entail.
There is a very real possibility that the effort to harmonize the regulations governing broker-dealer representatives and investment advisers will involve lowering fiduciary requirements for investment advisers to minimize the extent to which the standard for brokers must be raised.
In my view, a key objective of reform must be to avoid diminishing the standard of care afforded some investors in the process of strengthening it for others.
The fiduciary standard established under Employee Retirement Income Security Act of 1974 for pension plans is the most robust and clearly defined in law, and it is backed by a large body of case law and regulatory advisory opinions established over the past 35 years. This should be the model for reform.
How will things be different if a robust fiduciary standard, grounded in the Employee Retirement Income Security Act, is adopted for all advice givers? The high-level answer is that the advice would be uniformly recognized and regulated as a professional service. The era of regulating brokers under a commercial standard that treats advice as a byproduct dispensed without fiduciary accountability would end. What that means in practical terms is:
• Greater adherence to professional principles and reduced reliance upon prescriptive rules. Fiduciaries are governed by key principles such as duties of loyalty, prudence and utmost good faith. They are responsible for applying sound professional judgment, competence and diligence in relationships of
trust. That means brokers would be governed by more than just rules to assure fair trade, investment suitability and proper execution of transactions.
• Consistent emphasis upon competent management of portfolios. Advice is focused on crafting portfolios that meet client goals over the long term, rather than just the purchase or sale of specific investments.
• Reduction or elimination of sales-based compensation systems. Conflicts of interest that are inherent in product-specific sales quotas, bonuses or penalties can influence the advice offered to clients and severely compromise the fiduciary duty of loyalty. Eliminating these sales incentives would allow financial intermediaries and advisers to serve the exclusive best interests of the client more consistently.
• Increased emphasis on investment expertise. Because fiduciary obligations are among the highest known to law, financial services providers would be compelled to spend more on professional development to avoid regulatory penalties and litigation expenses that would arise if their employees failed to meet the expert level of competence required of fiduciaries. Similarly, product wholesalers would require better training to explain how the products they offered served to fulfill fiduciary obligations.
• Investment products would become more competitive on the basis of their merits as investments. As fiduciaries occupied a more central role in product distribution, product manufacturers would lose their ability to buy business through extraordinary incentive compensation. Instead, fiduciaries' due diligence and monitoring responsibilities would force product providers to disclose all material information, assure fees and expenses were “fair and reasonable,” and provide features and benefits that were investor-centric.
The low public perceptions of financial intermediaries and advisers would climb as a new era of fiduciary responsibility and accountability took hold and the positive outcomes were recognized widely.
But these benefits cannot be realized with a watered-down standard. Attempting to balance the interests of investors with those of the financial services industry instead raises more questions, such as who can be trusted and who stands to benefit most in an investor-adviser relationship.
Blaine F. Aikin is president and chief executive of Fiduciary360 LP in Sewickley, Pa.
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