Is a Gutted Fiduciary in Our Future?

An SEC staff recommendation would gut the many protections provided by the fiduciary standard that have been developed over the centuries.

W. Scott Simon


Jesse “Big Daddy” Unruh (1922-1987), who dominated California politics for many years as the Speaker of the Assembly and then as State Treasurer, purportedly said: “Money is the mother’s milk of politics.”

No sentient human being with any knowledge of our politics and culture could doubt the truth of that maxim. At the national level, highly organized special interest groups with lots of members whose livelihoods can be bettered (or worsened) by passage of federal laws or promulgation of federal regulations make hefty political contributions to politicians who return the favor by looking out for the special interests of that membership, often at the expense of the body politic. It’s a never-ending cycle that is designed to ensure adherence to the three simple goals of just about every politician out there: 1. get elected; 2. get re-elected; 3. See No. 2.

We can see how Unruh’s maxim works (and has worked) in the “wrestling match” that has taken place over the last few years concerning the efforts of the U.S. Department of Labor (DOL) and the U.S. Securities and Exchange Commission (SEC) in seeking to rework their respective definitions of what it means to be, and operate as, a fiduciary in the financial services marketplace. Special interest groups such as the Securities Industry and Financial Markets Association have thrown millions and millions of dollars at Congress in their quest to ensure that their members are not subject to any legally meaningful fiduciary duties.

In turn, Congress has placed enormous political pressure on Phyllis Borzi at the DOL, who is charged with redefining what a fiduciary is, and Mary Jo White at the SEC, who has the responsibility to come up with a new “uniform” fiduciary standard that would apply to both broker-dealers (B/Ds), who are subject to the suitability standard of conduct under the Securities Exchange Act of 1934, and registered investment advisors (RIAs), who are subject to the “best interests” fiduciary standard in accordance with the Investment Advisers Act of 1940 (’40 Act).

I have written about this wrestling match about a half-dozen times in this column, focusing primarily on the DOL’s efforts in the retirement plan arena because my registered investment advisory firm is involved with the DOL wholesale side of retirement plans rather than the SEC retail side of individual investors. This month, though, I’d like to briefly examine the SEC side and some of the issues involved there.


Among the most important goals of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) were reformation of the B/D industry and the establishment of strong new fiduciary standards. In particular, section 913 of Dodd-Frank mandated that the SEC staff examine whether B/Ds should be–as RIAs already are–subject to the best interests fiduciary standard of conduct found in the ’40 Act when providing personalized investment advice about securities to their retail customers. In January 2011, the SEC staff issued its “Study on Investment Advisers and Broker-Dealers” in which it proposed adoption of a new “uniform fiduciary standard” that would apply to both B/Ds and RIAs. The SEC staff’s proposed standard, intended to supplement existing fiduciary standards found in the ’40 Act, reads as follows: “The standard of conduct for all brokers, dealers, and investment advisers, when providing personalized investment advice about securities to retail customers (and such other customers as the Commission may by rule provide), shall be to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer, or investment adviser providing the advice.”

It is important to note that Dodd-Frank never authorized the SEC staff to study whether B/Ds (along with RIAs) should be subject to a “uniform” or “harmonized” fiduciary standard of conduct but rather, as noted, whether B/Ds should become subject to the best interests fiduciary standard of conduct in accordance with the ’40 Act when providing personalized investment advice about securities to their retail customers.

In any event, the uniform fiduciary standard that was recommended by the SEC staff appears to be a fiduciary standard no less stringent than currently applied to RIAs under the ’40 Act–which would be in accordance with the mandate of Dodd-Frank. But that begs the question: If the two are essentially the same, why didn’t the SEC staff simply recommend elimination of the B/D exclusion from the definition of “investment adviser” in the ’40 Act–i.e., make B/Ds investment advisers and be done with it? Or, for that matter, why didn’t the SEC staff recommend that B/Ds be subject to the duty of care and other requirements of the ’40 Act just like RIAs are?

The answer to these questions is found in the executive summary of the SEC staff’s Study on Investment Advisers and Broker-Dealers: “the Staff believes that these alternatives would not provide the Commission with a flexible, practical approach to addressing what standard should apply to broker-dealers and investment advisers when they are performing the same functions for retail investors.” Translation: We need to accommodate the business practices and fee structures of B/Ds and dually registered (i.e., as both B/Ds and RIAs) financial services firms employing thousands of registered representatives with millions of clients who invest trillions of dollars. Money and the business models of well-connected special interest groups trump the protections afforded to consumer investors by fiduciary duties.

This will allow Dodd-Frank’s mandate for accommodation–complete with the blessing of the “fiduciary” moniker no less–of such business practices as preserving commission-based accounts, episodic advice (i.e., not requiring B/Ds to have a continuing duty of care or loyalty to a retail customer after providing personalized investment advice), principal trading, the ability to offer only proprietary products to customers, et al.

The Gutting of the Fiduciary Standard

The consequence of the SEC staff’s recommendations is nothing less than a wholesale gutting of the fiduciary standard. I have seen this kind of thing applied over the years (and wrote about it here) in contracts between plan sponsors and certain service providers: name yourself as a fiduciary but then slip in nuanced contractual language to eliminate the fiduciary duties that the service providers would otherwise owe to plan participants. This gives such providers the best of both worlds: They get to call themselves “fiduciary”–but without being on the hook for owing any legally meaningful responsibilities (and liabilities) to plan participants that would be required of a fiduciary.

But if the SEC were to go ahead and gut the fiduciary standard in the retail milieu of individual investors by allowing such business practices and fee structures, there would be no need to hire clever attorneys to draft nuanced contractual language because the practices would be blessed by the government with the force of law.

Yeah, that’s the ticket: Maintain the fiduciary standard (“Look, I’m a fiduciary!”) but gut the many protections provided by the fiduciary standard that have been developed over the centuries (“And I get to engage in non- fiduciary business practices because they are now blessed by the government!”).

Individual investors finding themselves in this kind of situation created by the SEC will have the worst of both worlds: They will think they’re receiving the legal protections of a traditional fiduciary but instead are at the mercy of the business practices of a gutted fiduciary. With a fiduciary like that, who needs enemies?

W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.

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