SEC Faces Its Own Debate on Fiduciary Advice Standards

Transcripts from a tough SEC hearing called earlier this month show it's not just the Department of Labor considering changes to the application of the fiduciary standard.

The Securities and Exchange Commission (SEC) is hard at work developing a recommendation for a uniform fiduciary advice standard to be applied widely across advisory and broker/dealer channels.

Officials confirmed during a July 16 meeting of the SEC’s Investor Advisory Committee that the market regulator is progressing in its effort to strengthen and align fiduciary standards for financial advisers and broker/dealers. One industry expert called before the committee remarked that it has been a little more than a year and a half since the SEC first said it would look to extend the fiduciary duty to broker/dealers and other parties when they give personalized investment advice to their customers. 

“We have been told that the staff and various divisions of the commission are hard at work on a recommendation,” said Barbara Roper, director of investor protection at the Consumer Federation of America. “We are pleased that there appears to be progress in the making.”

The SEC action has so far taken something of a back seat to the Department of Labor’s (DOL) ongoing efforts to increase consumer protections in the retirement plan investing domain. The DOL proposed its reworked fiduciary rule in April, and even with considerable industry backlash, the DOL is much farther along in its project. Like the DOL, the SEC says its rulemaking is meant to tamp down on a variety of investor abuses and service provider conflicts of interest believed to be harming millions of investors inside and out of retirement plans.

“Sales-based financial professionals perceived and relied on as advisers by retail customers are exempt from the fiduciary duty that would otherwise apply to investment advice in a relationship of trust,” Roper said. “In seeking to close the loopholes in its definition of investment advice, the DOL is grappling with many of the same issues that the SEC will face as it undertakes rulemaking—although the DOL’s jurisdiction is, of course, different. It’s not limited to securities. It covers issues in the retirement plan context, where the SEC does not have authority.”

The hearing featured DOL officials and others testifying on a variety of related issues. Roper highlighted a series of questions the SEC should now be working to answer: “How do you make a best interest standard real in business models that are laden with conflicts of interest?” she asked. “How do you apply the standard in certain areas, for example with regard to sales from a limited menu of products? How do you deal with the issue of the ongoing duty of care?”

NEXT: DOL officials weigh in on why now

For its part, the Department of Labor decided it was time to readdress the fiduciary standard “because the retirement landscape has changed in the past 40 years,” said Judy Mares, deputy assistant secretary at the Employee Benefits Security Administration (EBSA) at the DOL. “Today, there is $7 trillion in IRAs, $5 trillion in defined contribution (DC) plans and only $3 trillion in defined benefit plans. An individual’s need to plan and execute their retirement savings path has become critical, and the regulatory landscape hasn’t adapted to that shift.”

This is especially true as 10,000 Baby Boomers will be retiring every day over the next 17 years—adding another $2 trillion to IRAs, she said. “We think it is important to provide more consumer protections,” Mares said. Investors suffer $17 billion a year in investment losses and higher fees, she said.

Extending protections to IRA investors should be a significant component of both DOL and SEC rulemaking, said Timothy Hauser, deputy assistant secretary for program operations at EBSA. “If you are a fiduciary under ERISA, you automatically have an obligation of prudence, loyalty and a whole array of reporting disclosures—and you are also subject to a set of prohibited transaction rules,”­ he suggested. “In the IRA context, only the prohibited transaction rules apply.” He went on to agree with Mares that today’s investment advice marketplace is very “conflicted” and could benefit from thoughtful rule changes.

He said the DOL’s proposal is flexible and workable: “If we were to impose our overarching fiduciary structure on the marketplace without granting an exemption, a whole range of practices that right now are commonplace would be prohibited. We don’t think that would work. We think that has unintended consequences. So, we have revised our basic definition of who is a fiduciary, and what can be permitted through prohibited transaction exemptions, to enable many of these common compensation streams to move forward in a way we think honors the statute’s intents and mitigates conflicts of interest.”

NEXT: DOL says it is open to changes

Hauser said the DOL is receptive to the comment letters it has received and will be holding a three- or four-day hearing the week of August 10. “Get your applications in if you want to testify,” he suggested, adding that the hearing will be followed by an additional comment period.

Hauser also indicated that while the DOL firmly believes the fiduciary rule is necessary, it is open to amending the rule further: “We have identified what we believe are demonstrable injuries that flow from the current compensation structure and the current way advice is delivered to retirement investors. We are committed to doing something to fix that problem, but we are not wedded to any particular choice of words or regulatory text. We have gotten a lot of helpful comments, and there will be changes.”

That said, Hauser added that the DOL believes the carve-outs it created in the proposed fiduciary rule are helpful. “There is a carve-out for sophisticated plan investors; large plan investors can readily proceed on a non-fiduciary basis. The lengthiest portion of the rule describes what would be non-fiduciary education and what would be fiduciary advice. There is a carve out for platform providers that is particularly important in the small plan market, where the provider is really just marketing a platform of options and not giving individual investment advice to the plan.”

DOL officials told the SEC they believe exemptions included in the latest version of the fiduciary rule are equally helpful, particularly the best interest contract exemption that permits broker/dealers to give advice that results in greater compensation—as long as the B/D formally commits via contract to act in the customer’s best interest, Hauser said.

Hauser acknowledged that many of the comment letters DOL has received are against the best interest contract exemption, and he vowed that the Department is “completely open to suggestions” on this matter.

NEXT: A broker/dealer says the rule is unworkable

Jerome Lombard, president of the private client group at Janney Montgomery Scott, also testified before the SEC. He said 80% of the firm’s net revenues comes from individual investors, with one in three of their accounts being an individual retirement account. The private client group offers clients the choice of fee-based fiduciary relationships as governed by the ’40 Act or brokerage relationships as governed by the ’34 Act. Sixty percent of the group’s fees come from commissioned brokerage accounts, and 40% from fiduciary accounts, Lombard said.

“Janney believes investors deserve to have their interests placed first,” Lombard said. “We have been supportive of a higher standard of care since 2009 when SIFMA provided the SEC a roadmap of a standard of care for broker/dealers, an effort that Janney contributed to. However, my firm does not believe the approach being taken by the Department of Labor of applying the ERISA standard to the IRA and small retirement plan marketplace is the right approach to achieving that higher standard of care for investors.

“Rather, we see the proposed rule as confusing, burdensome, increasing costs to retirement investors, practically eliminating many of the choices those investors enjoy today—and likely eliminating access to investment advice and education for the smallest retirement savers,” Lombard continued. “It will result in endless litigation, in our opinion, and even FINRA sees the rule as difficult to navigate and enforce.”

In order to comply with the proposed rule, Janney would need to move its numerous commission-based accounts to fee-based accounts in order to avoid the need to qualify for a prohibited transaction exemption, Lombard said. Or, it could attempt to use the best interest contract exemption in order to permit clients in commission-based accounts to stay there, he said.

Janney has no intention of using the best interest contract exemption because of its “onerous reporting requirements—on top of the many reports we already provide clients,” he said. “The legal, compliance and surveillance costs would increase dramatically and ultimately be passed on to clients. It would also create new legal liabilities.”

If the DOL rule were to go into effect, Janney’s only solution to provide advice to clients in its IRA accounts and small retirement plans would be to act as a fee-based registered investment adviser—and those fees are 50% higher than brokerage costs, Lombard said.

He concluded by saying that Janney Montgomery Scott favors SIFMA’s best interest standard and hopes that the SEC moves forward on that front.

NEXT: A rebuttal from the CFP Board of Standards

Marilyn Mohrman-Gillis, managing director of public policy for the Certified Financial Planner (CFP) Board of Standards, testified last, challenging Lombard and other broker/dealers’ claims that they cannot operate under a fiduciary standard.

She began by echoing the remarks by Roper and the DOL officials that consumers are in desperate need for advice that is truly in their best interest because they are “unable to distinguish between a fiduciary adviser and a non-fiduciary adviser.” While there are many scrupulous advisers, they are many who are not, she said. “We believe more than ever that consumers need competent and ethical advice, and that’s why this rule is so important.”

Mohrman-Gillis said that those advisers and broker/dealers who fear that the fiduciary standard of care will force them out of business are misinformed. The CFP Board decided to adopt a fiduciary standard of care for its CFP professionals in 2007, again, against a great deal of grumbling in the industry, she said.

“We heard many of the same arguments that are coming forward today in response to the DOL rule, and I am here today to tell you that based on our experience, the sky did not fall,” Mohrman-Gillis said. “In fact, since 2007, there has been more than 30% growth in CFP professionals.”

In its comment letter to the DOL, she said, the CFP Board explains how the Business Model Council it established in 2007 was able to work with CFP professionals to educate them on how they could apply the fiduciary standard to their practice, regardless of whatever business model they operated under.

The DOL will see, she said, that the fiduciary standard of care did not force CFP professionals to “abandon service to small saves, to the middle class.”

She concluded by saying that the CFP Board believes it bears the responsibility to “help the Department of Labor get to a rule that is more workable, that addresses some of the issues that are raised by the opposition, so that the rule can actually work across business models.”

A video stream of the SEC Investor Advisory Committee hearing can be viewed here.