A single word change has upended wealth management. By substituting an "and" for an "or" in a footnote last week, the SEC watered down the meaning of investment advisors’ fiduciary duty to clients. The change prompted sharp criticism from multiple quarters, including the commission’s own investor advocate, and left industry insiders bewildered.
"It guts the RIA industry," says Brian Hamburger, founder of MarketCounsel, a regulatory compliance consulting firm. "RIAs are not fiduciaries anymore."
A Registered Investment Advisor (RIA) is a person or firm who advises high-net-worth individuals on investments and manages their portfolios.
As part of the Regulation Best Interest rules package, the SEC revised its interpretation of an RIA’s fiduciary duty. Previously, advisors had to seek to avoid conflicts of interest and make a full disclosure of all material conflicts of interest. The SEC changed the "and" to an "or."
That alteration "weakens the existing fiduciary standard by suggesting that liability for nearly all conflicts can be avoided through disclosure," SEC Investor Advocate Rick Fleming said in a statement critiquing the rule-making package.
"I do not believe this is what an investor would reasonably expect from a fiduciary, nor does it align with the ways that real-world investment advisors tend to view (and describe) their fiduciary obligation," Fleming said.
The broader implications could be far-reaching. If, over time, the fiduciary downgrade erodes the quality of service provided by the RIA industry, as numerous experts predict, it could depress the value of all RIAs. Client assets for RIAs, including hybrids, grew at a compound annual rate of 8.6% from 2007 to 2017 compared to 4.1% for broker-dealers, including independent broker-dealers and insurance advisors, according to Cerulli. Many industry insiders credit this fast growth as stemming from the high legal standard the commission has required of RIAs. But the SEC’s revision could undermine independent advisors’ advantage in the marketplace.
The commission has rendered the definition of fiduciary "meaningless," says Barbara Roper, director of investor protection at the Consumer Federation of America. In his own statement, the one commissioner who dissented from the majority in the vote, Robert Jackson, writes that, "the commission today concludes that investment advisors are not true fiduciaries."
Chairman Jay Clayton, who along with two other commissioners voted for the change, asserts otherwise, describing the new guidance as "reaffirming — and in some instances clarifying — the fiduciary duty investment advisers owe to their clients." "This rule-making package," Clayton says in the SEC’s announcement, "will bring the legal requirements and mandated disclosures for broker-dealers and investment advisers in line with reasonable investor expectations, while simultaneously preserving retail investors’ access to a range of products and services at a reasonable cost."
Indeed, the overall rules package passed last week, which included Regulation Best Interest and Form CRS, placed a heavy emphasis on disclosure.
The inescapable problem with disclosure, long demonstrated in academic studies, is that it does not protect investors from advisors bent on harming them, experts say.
"We all know consumers read glossy sales literature and not disclosure documents that are dozens and hundreds of pages long with dense language written by lawyers," says Ric Edelman, co-founder of Edelman Financial Engines, one of the largest RIAs in the country with about $200 billion in client assets under management. "Clients accept the verbal assertions of their advisor rather than reading prospectuses. It is therefore essential that the advisors be required to behave as fiduciaries, rather than disclose away behaviors that are not in the best interests of their clients."
Edelman calls the commission’s revision Orwellian. "This is doublespeak and this is very worrisome that the government has overtly created a confusing landscape that will only serve to harm investors," he says.
In response, the SEC provided the following statement: "Our rules and interpretations are designed to enhance the quality and transparency of retail investors’ relationships with investment advisors and broker-dealers, and preserve access (in terms of choice and cost) to a variety of types of advice relationships and investment products. Our fiduciary interpretation in no way weakens the existing fiduciary duty; rather, it reflects how the commission and its staff have applied and enforced the law in this area."
The commission did not elaborate when asked how a change that makes the mitigation of conflicts of interest voluntary either preserves or strengthens RIAs' fiduciary duty.
Marc has 36 years in financial services and 6 years in teaching.
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