As reported here last week, a federal appeals court has struck down the Securities and Exchange Commission’s broker-dealer exemption, stating that the commission lacks the authority to grant brokers broad exceptions to rules that apply to investment advisers.
Although the suit was filed by the Denver-based Financial Planning Association, the ruling affects not just financial planners but all brokers and advisers whose activities are, or potentially could be, governed by the Investment Advisers Act of 1940.
I think that the decision is best summarized by the court’s reference to an earlier Supreme Court case, SEC v. Capital Gains Research Bureau Inc. (1963): “A fundamental purpose, common to these statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.”
The IAA arose from a consensus between industry and the SEC “that investment advisers could not ‘completely perform their basic function — furnishing to clients on a personal basis competent, unbiased and continuous advice regarding the sound management of their investments — unless all conflicts of interest between the investment counsel and the client were removed.’”
This fight isn’t about whether fee-based accounts should be overseen by NASD or the SEC; it is about defining the standard of care a client deserves when provided investment advice. This fight is about acknowledging that there is a sizable segment of the financial services industry that is providing investment advisory services to clients, and current regulations don’t define the appropriate oversight.
This fight is also about defining the term “investment adviser” in a meaningful way so that the public can discern the difference between a traditional broker, a money manager and an investment adviser.
Praise for the FPA
To state my position clearly: The FPA deserves a standing ovation for its courage and tenacity in challenging the SEC.
The exemption wasn’t in the best interests of either the public or the investment industry. The exemption has been particularly harmful to the broker/consultants who have wanted to do the right thing for their clients but have been prevented from doing so.
I think that as an industry, we may have made the mistake of drawing up sides: brokers versus fiduciary advisers. I know I certainly have been guilty of it.
But in reality, the bad guys have been the regulatory bodies and industry associations that have refused to acknowledge that the investment industry has been changing — fundamentally and permanently.
Our current regulatory structure is based on the IAA, a law that was passed 67 years ago when the industry comprised traditional transaction brokers and money managers, and the public knew the difference between the two. That all changed some 30 years ago when a number of factors triggered an evolutionary process.
The first was the passage of the Employee Retirement Income Security Act and the legislated requirement that fiduciaries demonstrate procedural prudence in the management of investment decisions. This act spawned the creation of the investment advisory industry.
The second factor was the proliferation of no-load investment products and managed accounts, which allowed investment advisers to operate under an RIA model, instead of a broker-dealer. This facilitated the investment adviser’s requirement to serve in a fiduciary capacity when advising ERISA clients.
The third factor was the creation of the financial warehouses — the custodial platforms such as those of Charles Schwab & Co. Inc.,
Fidelity Investments, Pershing LLC and TD Waterhouse (now TD Ameritrade) — which could facilitate the trading and custody of no-load products and managed accounts.
The fourth factor was the introduction of the personal computer — loaded with investment planning tools that previously had to be run on mainframe computers. This significantly lowered the investment advisory industry’s barrier to entry and made it possible for a small, local investment adviser to provide the same level of service as a major brokerage firm.
The next factor was the move toward comprehensive investment and financial planning, as opposed to the execution of securities transactions and the sale of financial products.
And the final factor was the move toward brokerage firms’ putting assets under management and their creation of fee-based accounts — a move that was in fact in the best interests of clients.
As a result of these factors, the “investment adviser” has evolved into a new industry — neither an investment adviser as defined by the IAA (which applied the term to money managers) nor a broker, but something in between. Such an adviser is best defined as a professional who provides comprehensive and continuous investment advice; the operative words being “comprehensive” and “continuous.”
We don’t know how many investment advisers there are, but the number is estimated to be well in excess of 100,000.
Neither the regulations of the SEC nor those of Washington-based NASD seem appropriate to describe the role of the investment adviser. In fact, the multitude of compliance rules are meaningless and don’t adequately address competence or objectivity — the very attributes clients expect most from investment advisers.
Because of the trust and confidence clients put in them, investment advisers are fiduciaries — whether they acknowledge it or not. Often their clients also are fiduciaries and depend upon the investment adviser for help in managing their own fiduciary roles and responsibilities.
What are the implications of vacating the broker-dealer rule? Perhaps now Congress and regulators will announce that it is time for a change — that it is time to acknowledge that a new industry has emerged and that our current regulatory structure doesn’t provide the appropriate oversight.
Now is the time for broker-dealers to acknowledge what their leading broker consultants have been pleading for years: “Let us serve our clients as investment advisers; don’t put us in the position of being product salespeople.”
It is time to acknowledge the importance of the role of investment advisers in helping to manage our nation’s liquid investible wealth and the significant impact investment advisers can have on our country’s fiscal health.
Donald B. Trone is president of the Center for Fiduciary Studies and chief executive of Fiduciary360 LP, both in Sewickley, Pa.
