fi360 Blog

Fiduciary Links: New SRO Bill draft on the horizon?

 >>>>We learned last week that an updated SRO bill draft is expected to be released by the House Financial Services Committee sometime soon. In September, Rep. Spencer Bachus released a draft bill that would have authorized the creation of one or more SROs for investment advisers. The bill was never formally introduced, likely due to prohibitive opposition in the Senate, as well as a vocal outcry from adviser groups. Fi360 was generally opposed to the bill, arguing that adequately funding the SEC to perform adviser examinations is the best solution to improving adviser oversight. We were pleased, however, that the bill did leave room for a new adviser-specific SRO, rather than simply empowering FINRA to do the job.

We don’t know what the new draft will look like, though fi360 Senior Policy Analyst Duane Thompson speculates that new bill could be “somewhat different from the original discussion draft.” If that is the case, we hope it is because Congress has realized that the SEC isn’t only the better-suited regulator, it is also the cheaper option. However, if they remain committed to the SRO route, we would remind Congress that there is a startup adviser SRO readying itself to be a true self-regulator for advisers, rather than hoping the suitability/rules-focused FINRA can adapt to the fiduciary/principles-focused world of RIAs. 

>>>Last week, our fiduciary links post touched on SIFMA's fiduciary comments to the SEC. This week, the conversation continues with comments from The Institute for the Fiduciary Standard, The Derivative Project, and an article in RIABiz. Links to each are below.

• Institute for the Fiduciary Standard to SEC: SIFMA Proposal Harms Investors [The Insitute for the Fiduciary Standard]
• Retirement Savers Need A Bona Fide Advocate and Their Day in Court [The Derivative Project]
• Fearful that the SEC has been overworked, lobbied and bullied into a SIFMA stupor, fiduciary crowd launches 16-page missile [RIABiz] 

Now on to the rest of the best links from the past week:

Fiduciary Links: SIFMA’s fiduciary comments a matter of interpretation

The most recent focal point in the ongoing debate on what a universal fiduciary standard of care will look like and how it will be implemented centers around SIFMA’s proposed framework and the reaction to it from a group of consumer and professional organizations.

SIFMA originally submitted their comments to the SEC in July of last year about a proposed framework for establishing a uniform fiduciary standard as part of Dodd-Frank rulemaking. SIFMA’s proposal was for a new fiduciary standard that would apply to both registered representatives and advisors who provide personalized investment advice.

Then, just last week, a joint letter from a number of consumer and financial professional organizations, including members of the Financial Planning Coalition, AARP, Consumer Federation of America, Fund Democracy, and Investment Adviser Association, used the SIFMA proposal as a basis for their comments, including their proposal that the existing Advisers Act fiduciary standard be extended to include all personalized investment advice, the solution favored by fi360 as well.

Blogger Michael Kitces also chimed in, commenting that perhaps this exchange could be a turning point in the debate, as two of the major factions in the discussion seem to have found common ground that a fiduciary standard of care doesn’t mean the end of the commissions or the sale of proprietary products. However, SIFMA’s response to Kitces made it abundantly clear that a ’40 Act solution is still an insurmountable hurdle for industry consensus.

And it is with SIFMA’s direct address regarding the Kitces piece that we would like to chime in. With a little help from fi360 Senior Policy Analyst Duane Thompson, highlighted below are three points made by SIFMA about its opposition to a uniform fiduciary standard, along with our comments (which appear in italics):

SIFMA blog: "[SIFMA] has long supported a uniform fiduciary standard for brokers and investment advisors who provide personalized investment advice to individual retail customers.”

Comment: Flip flop in SIFMA position from three years ago.  In testimony before Congress on March 10, 2009, SIFMA president Tim Ryan testified before the Senate Banking Committee and called the fiduciary standard under federal law “an obsolete regulatory regime.” Instead he touted a ‘universal standard of care,’ claiming that the “RAND report makes clear that individual investors generally do not understand, appreciate, or care about such legal [meaning fiduciary] distinctions.” (You can refer to page 8 of his testimony)

SIFMA blog: “We’ve testified to that fact, provided comment letters and studies, and offered up a framework as to how a uniform fiduciary duty can be written.”

Comment: Forgotten in its comments is a much-needed explanation of the difference between ‘uniform’ and ‘double standard.’ In SIFMA’s letter to the SEC last July, it suggested that “existing case law, guidance, and other legal precedent developed under Section 206 of the Advisers Act would continue to apply to investment advisers. While there would be many parallels, this Section 206 precedent would not [emphasis added] apply to broker-dealers…”

SIFMA blog: “…work with Congress to establish an SRO for advisers (like FINRA exists for the brokers) so they are examined a little more often than the current SEC exam rate of once every 11 years.”

SIFMA (and FINRA) love to make this comparison in support of an SRO. Technically the numbers are accurate. However, what the numbers fail to show is that most advisory firms are far smaller than BD firms and very few have branch offices. Branch offices are often where the problems occur.  If FINRA’s inspection rate of the 163,640 branch offices of member firms were compared to the RIA exam rate, then the comparison would be radically different.  Instead of examining FINRA’s 4,560 broker-dealer home offices once every two years, its exam rate of branch offices, based on the 800 branch office inspections made last year, is ONCE EVERY 204 YEARS. (163,640 branch offices divided by 800 exams = 204.55 years.)

Now on to the rest of the best links from the past week:

A changing of the fiduciary guard

When you see the phrase "changing of the guard," most think of formal ceremonies at famous places like Arlington Cemetery's Tomb of the Unknown Soldier or London's Buckingham Palace, where one set of sentries are relieved by another.  But it takes place in countless locations around the world on land or at sea where personnel (usually military) pass responsibility for standing duty, or guard, or watch to their assigned replacements.  Whether formal or informal, it's meant to signify that duties or responsibilities have been transferred.  Last week, I believe I witnessed a fiduciary changing of the guard.  Let me explain.

I met a Denver police officer while teaching an Accredited Investment Fiduciary (AIF) class several years ago.  I remember John because it is unusual for an investment steward to attend our AIF training; particularly a police officer.  But John was unusual for other reasons.

It was clear as we interacted during class that he was truly passionate about his role as trustee for the police officer's retirement fund.  He spoke of how he was earnestly trying to make a difference in ensuring that the retirement plan and the associated assets were managed properly.  He was pleased to be in class learning about what an investment fiduciary process should look like.  After earning his AIF designation, he went on to attend our Accredited Investment Fiduciary Analyst (AIFA) training and earned the AIFA Designation.  He is one of only a handful of investment stewards to do so.  I interacted with John via email or phone several times after that class and it was clear to me that John was making a difference as a fiduciary advocate in the Denver area.  I learned just recently that John died from cancer in late February.

This past week while teaching another AIF Program at Rice University, one of the students introduced himself as a police officer for the city of Birmingham.  I replied that I knew another police officer from Denver and Dexter responded immediately that it must be John.  I was surprised and pleased to hear that they knew each other.  Dexter explained to me during a break how John had been after him for several years now to attend the AIF training and that they were both passionate about properly fulfilling their fiduciary responsibility.  When he learned that John had died, he resolved to attend the training because he had promised John that he would do so.  I couldn't help but think that I was witnessing the changing of the guard.

I expect Dexter will carry on where John left off; exhorting his fellow police officers in fiduciary roles to get educated about their duties and responsibilities so they can properly fulfill them.  He will be beating the fiduciary drum in Birmingham just as John had done so well in Denver.  We can all learn from their example.

Fiduciary Links: Suggestions for a more financially literate investing public

>>>>As part of the SEC’s Dodd-Frank Act-mandated requirement to conduct a study regarding financial literacy among investors, the agency recently requested public comment on how to improve disclosures, what information is most useful for investors to make informed decisions regarding the selection of financial intermediaries, products, and services, and how to increase the transparency of expenses and conflicts of interest.

Fi360 is among 43 individuals and entities who submitted comment. Among the recommendations we make are:

• The Jump$tart Coalition’s standards for saving and investing are an appropriate framework for defining “financial literacy” for the investing public.
• The SEC should require disclosures to be in language that is both fundamental and direct, so that a high school senior can understand them.
• An RIA’s fiduciary obligations already require  disclosure of conflicts of interest at the time specific services are provided, not just at the outset of the relationship with delivery of Part 2.
• The SEC should stress the fiduciary duty of due care of advisors and other intermediaries when the effects of major life changes, age, and other timing issues may impair an investor’s ability to make informed decisions.
• The SEC should consider a “side effects” disclosure for investment products, similar to the FDA’s requirements for pharmaceutical companies.
• The SEC should consider an abbreviated risk warning system for ‘volatile’ investment products, similar to the Hazardous Materials Information System used by DOL’s Occupation, Safety and Health Administration to denote fire risk.
• The SEC should consider adopting similar fee and services disclosure requirements recently enacted by the DOL, i.e., 408(b)(2) for investment advisory services.
• The SEC should add clear language on the differences between the fiduciary and suitability standards of care to their investor.gov website.
• In lieu of creating a rules-heavy framework for a uniform fiduciary standard for brokers and advisors, the SEC should instead stress the broad fiduciary duties in regulatory guidance and sweeps, deficiency letters, and fiduciary breaches in enforcement actions.

We believe that the current state of financial literacy is analogous to actual literacy rates in the early 19^th century for Americans. Investors lack the most basic skills for making investment decisions and therefore are dependent on the intermediaries they entrust to their financial well-being. For these reasons, we feel that disclosures must be harmonized and made stronger and more straightforward. A quick review of some of the other feedback received by the SEC, however, reveals that not everyone feels the same. A number of comments called for less disclosure or for disclosure systems that are even more complicated than what exists now, recommendations that don’t really seem to address the fundamental goal of creating a more financially literate public.

At the end of this study, the SEC is to report back to Congress on its findings along with “a strategy to increase the financial literacy of investors in order to bring about a positive change in investor behavior.” It is our hope that the SEC recommends adopting a number of the measures we have presented for the benefit of investors. Industry instincts for self-preservation and the status quo are strong, though and as we have seen in other areas of regulation, reform can be a slow and uncertain process. But given the current status of financial literacy and disclosure and the low bar currently being set by the industry at large, it would seem that an opportunity exists for advisors who have nothing to hide in terms of their fiduciary processes and commitment to their clients to distinguish themselves by adopting a more progressive approach to their education and disclosure activities.   

Now on to the rest of the best links from the past week:

Fiduciary Links: Structuring the IPS for 401(k) plans

>>>>Fiduciary News last week took a look at the “traditional” structure for the investment policy statement, as defined by the CFA Institute, and offered how that structure should be adapted to 401(k) plans. Included in those adjustments are expanding the plan information to include participant demographics and service providers to the plan, fulfilling 404(c) investment option obligations, and how tax considerations and distribution phase considerations may not have a place in the 401(k) IPS.

The key take away from the article is that the IPS is a critically important document for any investment portfolio that will look different depending on what type of portfolio you serve. If you’re a 401(k) plan sponsor or advisor, make sure you check it out. In addition, take a look at our previous blog post on maintaining the IPS and why we consider it the single most important  function an investment fiduciary performs.

>>>>It’s not often that fiduciary concepts go viral to the public via social media, but in the past couple of weeks, we’ve seen it happen twice.

The first was >the very public resignation of a Goldman Sachs executive that appeared in the New York Times. The topic was at the top of search engines and one of Twitter’s highest trending subjects for a few days. For a good perspective on the controversy, check out Knut Rostad’s blog post for the Institute for the Fiduciary Standard. For him, the most interesting aspect of the controversy is that it is perfectly within the rules for any firm to act as Gold is alleged to have done.

The second is a YouTube video from HighTower that you may have already seen. It looks at the problems with building a diet based solely on the recommendations made by your butcher.

Now on to the rest of the best links from the past week:

Fiduciary Links: Is your technology platform ready for a fiduciary standard?

>>>>In the SEC’s  Study on Investment Advisers and Broker-Dealers, the agency notes that one cost for broker-dealers that go fiduciary is related to, “developing or acquiring new technology” (see page 149). Last week Citi released a white paper that addresses this cost. In Broker-Dealers as Fiduciaries?: How the SEC Staff’s Study Could Raise the Bar for Investment Advice, the findings of the SEC study are summarized, which arrives to a conclusion that many BD technology platforms are not equipped for a fiduciary conversion because they were designed for the suitability standard and are outdated.

The paper explores four recommended improvements for technology platforms that they believe are necessary to accommodate the fiduciary standard of care for investors:

• Automatic linkage from front-to-back of investor information, risk profile, restrictions, proposed portfolio and portfolio execution
• Aggregation across all investment vehicle types
• Household reporting AND rebalanc­ing across multiple account types (e.g., brokerage, retirement, trust)
• Tax optimization at the individual (tax return) level

>>>>If you haven’t seen it already, make sure you check out the recently published paper by professors Michael Finke and Thomas Langdon, The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice. The paper uses an analysis of states that have a uniform fiduciary standard of care versus those that do not to see what impact the distinction has on broker saturation and the cost of services in those states. Duane Thompson wrote a blog post on the study last week, and we will be hosting Professor Finke for a webinar on the subject this Thursday at 4 p.m. ET. You can register here.

>>>>Finally, don’t forget that our annual conference is coming soon. We just released the slotted agenda for the April 25-27 event in Chicago. Take a look to see which sessions you could stand to benefit from attending, not to mention the great opportunity to network with some of the leading fiduciary thinkers and advocates. You can register for the conference here.

Now on to the rest of the best links from the past week:

The Real Cost of Broker Advice

The key refrain from opponents of a fiduciary rule for brokers can be summarized in one sentence:  “SEC, do your economic analysis, or else.”  ‘Or else’ means, of course, the implied threat of a legal challenge, an area where the SEC has not fared well in court when judged on the economic impact of a rule proposal on the securities industry.

Of course, the devil is in the details.  How do you project future costs of a uniform fiduciary standard for brokers and investment advisors where there is little in the way of empirical data?

As it so happens, there is little-known precedent on the broker side for a fiduciary standard.  In fact, the SEC should welcome the findings in a newly published study by Texas Tech that looks not at cost projections, but at the real world impact today under existing state common-law standards.  The study, authored by associate professor Michael Finke, Ph.D., and business law professor Thomas Langdon, J.D., CFA®, CFP®, was underwritten by fi360 and several investment advisor advocacy groups, as well as the Pittsburgh-based Roger and Brenda Gibson Family Foundation.

Titled “The Impact of the Broker-Dealer Fiduciary Standard on Financial Advice,” the 31-page academic report is based on a legal review of the common-law standards for brokers, which vary considerably across the country, and was broken into two categories.

The most important feature of the study was a so-called ‘saturation analysis,’ which compared broker populations around the country to the number of family households, focusing primarily on the four states with a clear fiduciary standard to the 14 non-fiduciary states.  The remaining 32 states and the District of Columbia were isolated from the study, based on their categorization as ‘quasi-fiduciary’ states where there was evidence of a limited fiduciary standard but no clear fit with the fiduciary or non-fiduciary categories.

The second part of the study involved a random telephone survey of 207 brokers, conducted in November and December 2011, in the combined 18 fiduciary and non-fiduciary states.  Registered representatives were asked to respond to issues raised by critics of a fiduciary standard, who claim that the higher standard would cause many brokerage firms to abandon middle-market and rural populations, charge higher fees, and offer fewer choices of investment products.  In both instances, the broker population in the study was narrowed to those having passed the Series 6 or 7 exams – the others not being required to provide retail investment advice to the public – and to winnow out those who were not also dually registered as investment adviser agents.  The researchers determined that it would be difficult to sort out the fiduciary advisory activities of dual registrants under the Investment Advisers Act of 1940 from the analysis of their other advisory activities as brokers under a suitability standard.

The results of the study should give pause to those who claim the financial world is going to Hades in a hand basket if a fiduciary standard is imposed on brokers.

Fiduciary Links: We need your input for annual fiduciary survey

>>>For the second consecutive year, fi360 is partnering with AdvisorOne on a fiduciary survey to gauge trends and attitudes of investment advisors about the fiduciary standard. The survey will look at how attitudes and understanding of issues has changed since last year’s survey, as well as delve deeper into topics of particular interest today.

The more responses we receive, the better, so your input is much valued and appreciated. The survey will be open through the first week of April. Please take a few minutes to complete this year’s survey.

>>>>We also have our first Resources webinar of 2012 coming up! Join us for a discussion on the impact of the broker-dealer fiduciary standard on financial advice from 4:00-5:00 p.m. EDT on Thursday, March 22. A recently published study by Dr. Finke looks at existing differences in state broker-dealer common law standards of care to test whether a relatively stricter fiduciary standard of care impacts the ability to provide services to consumers in an actual market environment. Dr. Michael Finke, associate professor at Texas Tech University will discuss the results of his study, and Roger Gibson, chief investment officer at Gibson Capital will discuss what this new information means for advisors.

The session will be moderated by fi360’s Duane Thompson and will include the opportunity for Q&A. The session is free and will be reported for one hour of continuing education credit for the AIF and AIFA. Register here.

Now on to the rest of the best links from the past week:

Are your investment management fees excessive?

In a recent 401(k) plan excessive fees case, Kraft Foods agreed to pay $9.5 million to settle participant claims that they violated ERISA in permitting excessive investment management fees in their plan.  In what is often the case, they agreed not to risk litigation in a plan fee challenge and also to take steps to reform its plan.  This is not an isolated case, and it highlights how important it is to understand exactly how much a plan is paying and exactly what those fees are buying.

The final ERISA plan disclosure regulations, 408(b)(2) and 404(a)(5), are designed to shed even greater light on the services being provided to and the fees being paid by plan sponsors and their participants.  From our classroom observations, it appears that this journey has already begun.

At a recent AIFA Program at the Thunderbird School of Global Management, we were involved in our usual case study work.  It's always interesting to gauge the student's reactions to the case study scenarios as they are largely dependent on experiences they have had with their own or prospective clients.

One case study depicts an advisor relationship with a 401(k) plan sponsor in which the compensation arrangement is believed to be excessive.  Even though we do not necessarily advocate going with the cheapest service provider, we do advocate that the fiduciary must be satisfied that the compensation being paid is tied to the services being provided and that it is fair and/or reasonable.

What is fair and/or reasonable when it comes to fees and expenses?  Watching the case study team members interact in the past has demonstrated that there can be wide differences of opinion, but this most recent class exemplified the evolution that has taken place over the past 5-10 years towards greater consensus. The group was on much more even footing when it comes to how such a determination should be made, by making a comparison between what is being paid and what is being received in terms of services provided and then benchmarking against similar service providers or industry averages. Clearly, the availability of better fee information today than in the past has led to a more prepared advisor.

Fiduciary Links: 408(b)(2) doesn't have to be a burden, so use it to your advantage

>>>>Late last year, a Transamerica survey of retirement plan advisors found that looming 408(b)(2) fee disclosure requirements were the number one most pressing business issue they faced. And now that the rules are final and have an effective date attached, those concerns are even more real for most advisors. But just because you have a new layer of compliance to deal with, doesn’t mean you should be dreading your fee disclosure obligations.

In his new Fiduciary Corner column for InvestmentNews, Blaine looks at how advisors can use the new disclosure rules to their advantage.  The now standardized disclosure will make it more readily apparent which advisors are offering services under conflict-free compensation arrangements and with fiduciary accountability aligned to the responsibilities of the plan sponsor. Exceptional advisors will be able to use the disclosure to establish relationships by communicating a game plan to clients for how they will work together to execute responsibilities effectively and proficiently; in essence, establishing the advisor as an indispensible fiduciary coach.

>>>>For the second consecutive year, fi360 is partnering with AdvisorOne on a fiduciary survey to gauge trends and attitudes of investment advisors about the fiduciary standard. The survey will look at how attitudes and understanding of issues has changed since last year’s survey, as well as delve deeper into topics of particular interest today.

The more responses we receive, the better, so your input is much valued and appreciated. Please take a few minutes to complete this year’s survey.

>>>>There is only one more week to enter the 2012 fi360 Article Competition. The competition is a chance for AIF and AIFA designees to have their original writings published both by fi360 and media partner AdvisorOne. If you have written an article or newsletter over the past year that helps fiduciaries better understand or perform their role or advocates for higher standards of care for investment advice, we urge you to take a look at the official rules for this year’s competition and consider submitting it. The winner will receive $1,000 and be featured by AdvisorOne. All submissions will be published to fi360.com and have a chance to be printed by AdvisorOne.

Now on to the rest of the best links from the past week: