April 2, 2007
Pittsburgh--A federal appeals court has struck down the Securities and Exchange Commission’s broker-dealer exemption, stating that the SEC lacked the authority to grant brokers broad exceptions to rules that apply to investment advisors. Though the suit was filed by the Financial Planners Association (FPA), the ruling impacts all brokers and advisors that come, or potentially come, under the Investment Advisers Act of 1940 (IAA), not just financial planners.
I believe the decision click to view document 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 is not about whether fee-based accounts should be overseen by the 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 sizeable 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 advisor” in a meaningful way so that the public can discern the difference between a traditional broker, a money manager, and an investment advisor.
To clearly state my position: The FPA deserves a standing ovation for its courage and tenacity in challenging the SEC. The exemption was not in the public’s best interest or the investment industry’s best interest. 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 advisors. 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 fundamentally, and forever, been changing.
Our current regulatory structure is based on the IAA, a law that was passed sixty-seven years ago when the industry consisted of traditional transaction brokers and money managers, and the public knew the difference between the two. That all changed some thirty years ago when a number of factors triggered an evolutionary process:
The first was the passage of ERISA 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 enabled investment advisors to operate under an RIA model, instead of a broker-dealer. This facilitated the investment advisor’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 Fidelity, Schwab, TD Ameritrade, and Pershing, which could facilitate the trading and custody of no-load products and managed accounts.
The fourth factor was the introduction of the PC; loaded with investment planning tools that, before, had to be run on main-frame computers. This significantly lowered the investment advisory industry’s barrier to entry, and made it possible for a small local investment advisor to provide the same level of service as a major brokerage firm.
The next factor was the move towards 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 putting assets under management and the creation of fee-based accounts by brokerage firms: a move that was, in fact, in the best interest of clients.
As a result of these factors, the “investment advisor” has evolved into a new industry – the investment advisor is neither an “investment adviser” (as defined by the IAA, the term being intended for money managers) nor a broker, but something in-between. The investment advisor 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 advisors there are, but the number is estimated to be well in excess of one hundred thousand.
Neither the regulations of the SEC nor the NASD seem appropriate to describe the role of the investment advisor. In fact, the preponderance of compliance rules are meaningless and don’t adequately address competence or objectivity, the very attributes clients expect most from investment advisors.
Because of the trust and confidence clients put in investment advisors, they are fiduciaries, whether they acknowledge it or not. Often, their clients also are fiduciaries, and depend upon the investment advisor for help in managing their own fiduciary roles and responsibilities.
What are the implications of vacating of the broker-dealer rule? Perhaps now Congress and regulators will announce that it’s time for a change—that it is time to acknowledge that a new industry has emerged and that our current regulatory structure does not 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 advisors; don’t put us in the position of being a product salesperson.” It’s time to acknowledge the importance of the role of investment advisors in helping to manage our nation’s liquid investable wealth, and the significant impact investment advisors can have on our country’s fiscal health.
Donald B. Trone, AIFA®
CEO, Fiduciary360