Long-simmering regulatory change is afoot in the investment world, and it’s causing a significant amount of consternation and backlash among the establishment-brokerage universe. It appears as though securities brokers who provide investment recommendations for pension or retirement accounts may finally be held to the same fiduciary standard required of Registered Investment Advisors (RIAs). The fiduciary standard says that advisors must make investment recommendations based solely on the best interests of their investor clients. The goal is to eliminate conflicts of interest that have lined brokers’ pockets while weighing on client investment returns. Nobody likes too much change, especially when the status quo has been in place for many decades. But this is one by-product of the financial crisis that that should be greeted positively by investors large or small. But first a little background.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which was signed into law in 2010, contained a provision whereby the SEC was required to conduct a study to determine whether the current regulatory standards adequately protect retail retirement investors. In the wake of the financial crisis, the Fed and other regulatory and legislative entities were naturally concerned that securities brokers and dealers have too many conflicts of interest that can result in sub-optimal account performance, at best, and outright fraud in the worst cases. Upon completion of its study, the SEC indeed ruled that the current regulatory framework is unsatisfactory, and it recommended that, according to the Congressional Research Services (CRS), “brokers and dealers be subject to a uniform fiduciary standard that is no less stringent than the standard to which investment advisers are subject.” Armed with the SEC’s recommendations and President Obama’s support, the Department of Labor introduced a new rule, on the brink of being finalized, which is expected to effectively result in the inclusion of broker-dealers as fiduciaries in the management of pension/retirement accounts.
In its October, 2015 report entitled “Department of Labor’s 2015 Proposed Fiduciary Rule: Background and Issues”, the aforementioned CRS, which is a non-partisan agency within the Library of Congress that provides policy and legal analysis to Congress, described the proposed change:
“Securities brokers and dealers who provide services to retirement plans and who are not fiduciaries under current regulations are not required to act in the sole interests of plan participants. Rather, their recommendations must meet a suitability standard which requires that recommendations be suitable for the plan participant, given factors such as an individual’s income, risk tolerance, and investment objectives. The suitability standard is a lower standard than a fiduciary standard. Under DOL’s proposed regulation, brokers and dealers could be considered fiduciaries when they provide recommendations to participants in retirement plans.”
So, at issue is whether securities brokers and dealers, in advising for retirement accounts, should be held to the suitability standard, which is imposed by the industry’s self-regulatory body called the Financial Industry Regulatory Authority (FINRA), or to the much more stringent fiduciary standard that is required of Registered Investment Advisors by the Employee Retirement Income Security Act of 1974 (ERISA). Under the suitability standard a broker can recommend an inferior fund with a higher fee (that pays him and his company more) as long as it is “suitable” for the client’s situation. The fiduciary standard requires he recommend the best fund with the best fee regardless of how much he will earn.
To me this seems like a no-brainer. Are lobbyists for the brokerage industry really fighting a proposal that, according to the CRS, requires that “individuals who are held to fiduciary standards are required to act solely in the interests of plan participants and beneficiaries?” It’s hard to argue with a new rule for which the primary goal is to protect retirement investors. But it shouldn’t come as a huge surprise that there has been intense opposition to this new rule by the brokerage industry. In fact, following the DOL’s first proposal to change the definition of fiduciary in 2010, the DOL received 316 public comments in response to the proposal. And according to The Wall Street Journal, “some financial trade groups are preparing a possible lawsuit to try to block it from taking effect.”
We should get the final ruling within the next few weeks. As a Registered Investment Advisor who has been subject to the fiduciary standard since we opened our doors in 1996, I am hoping that the new ruling will finally level the playing field through implementation of common-sense regulatory oversight for all advisors, not just us RIAs. It is stunning that elected officials continue to support any regulation that permits licensed financial representatives to NOT act in the best interest of the client.