Wednesday, January 26, 2011

Uniform Fiduciary Standard For Retail Investment Advisers And Broker-Dealers Is Unworkable

From the SEC "Study on Investment Advisers and Broker-Dealer" as required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act:
The Staff [of the U.S. Securities and Exchange Commission] therefore recommends establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers. The recommendations also include suggestions for considering harmonization of the broker-dealer and investment adviser regulatory regimes, with a view toward enhancing their effectiveness in the retail marketplace.
The full staff report is available here.

Fiduciary Standards Are A Pandora's Box Of Legal Problems For Retail Stock Brokers

Investment advisers perform a different function than retail stock brokers.

Investment advisers have specific investment objectives, an investment style, that they use to identify the way they invest or that their clients asked them to follow. For example, an investment adviser may be told by his client, or may identify his investment style in his promotional literature, as one that maximizes dividends and income while preserving capital. Another may identify himself, or be asked by a client, as seeking to maximize capital appreciation; an aggressive investor in small drug and biotech companies with the greatest potential for developing a blockbuster drug; for finding companies with extraordinary gains in profitability over the previous year, or for investing and trading in foreign currencies.

Fiduciary duty compliance for an investment adviser requires fair dealings without conflicts, with transparency and adherence to investment objectives.

Investment advisers and their clients have a mutual, agreed to understanding of investment goals and objectives for the money under advisement. Even if investment policy is never discussed, there is tacit acceptance of the policy by the customer just by going to an adviser who holds himself out to be a particular type of investor manager or adviser.

A retail stock broker, who does not currently by law, regulation or industry practice, have a fiduciary duty to a customer, is a salesperson. Salespeople in all other walks of life generally do not have fiduciary relationships with buyers. Does you supermarket have an obligation to tell you that their store brand is made by the same company you are buying and costs a few cents less? or that you should buy a few more cans of soup this week because prices are going up tomorrow?

Brokers can only sell to a retail customer investments, stocks, bonds, mutual funds, etc., that are on the brokerage firm's approved list. Is a retail broker with a fiduciary obligation required to tell you that the fees or transactions costs for the same investment are lower at another firm?

Are retail brokers with a fiduciary obligation obligated to tell a customer for a mutual fund that mutual fund managers cannot consistently beat an index fund? or that their firm's stock analyst cannot pick winning stocks any better than a someone who randomly picks a stock?

Will brokers be forbidden from selling commodities such as gold and silver to clients because they have a zero correlation with a market investment portfolio and therefore will not over time increase the value of the portfolio?

The functional difference between an investment adviser and a retail broker makes the application of a fiduciary standard impossible to implement effectively.

Imposition of a common fiduciary standard on advisers and brokers will lead to an enormous increase in lawsuits and arbitration claims against retail stock brokers and their firms. It will force the SEC to enact a very limited definition of fiduciary and that will create unmet retail broker client expectations, untold customer confusion and resentment by retail customers.

Let the lawsuits begin.


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