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SEC Fiduciary Duty Rule Must Protect Investors

By Lev Bagramian

There are plenty of indications that the SEC is earnestly working to propose a fiduciary duty rule for broker-dealers.   Last June, essentially as his first act as the Chairman of the SEC, Mr. Jay Clayton requested information to better inform and facilitate the staff’s efforts in drafting a fiduciary duty rule proposal.  Last month, we wrote to the Commission offering our thoughts on  how the SEC can craft this proposal to better protect investors from the powerful and prevalent conflicts of interest that influence so many broker-dealers and other advisers who offer personalized investment advice to investors. 

When these advisers push self-serving recommendations that produce maximum commissions and fees for themselves and their firms, individual and institutional investors suffer immensely.  In 2016, the Department of Labor produced an exhaustive economic analysis to support its fiduciary duty rulemaking under ERISA, showing that conflicts of interest are costing investors tens of billions of dollars every year in lost retirement savings.  The DOL’s estimate was extremely conservative, since it only examined the impact of conflicts of interest on one type of account (IRAs) and one type of investment (front-load mutual funds). Were the analysis expanded to encompass all types of investment accounts (retirement and non-retirement alike) and all types of securities products (from other types of mutual funds, to individual securities, to variable annuities, to non-traded REITS), the magnitude of harm would be even more staggering.

In our letter to the SEC, among other items, we focused on the following key points:

  • The rule must establish a true best interest standard.  Section 913 of the Dodd-Frank Act established a clear and high standard for any new rule promulgated by the SEC that fortifies the fiduciary duty under the Advisers Act and applies it to broker-dealers providing investment advice.  Merely tinkering with the suitability standard developed by FINRA or relying principally on a disclosure regime will betray the letter and spirit of the law.
  • The final SEC rule must ban certain practices that intensify conflicts of interest and require advisers to mitigate conflicts of interest.  A strong fiduciary standard must be complemented with other provisions that flatly prohibit certain practices, such as sales quotas and other compensation incentives that inevitably induce advisers to provide recommendations based on their own financial interest rather than the best interest of the client.
  • The rule must address the long-standing use of misleading titles that sow widespread confusion and induce the misplaced trust of unsuspecting investors.  For years, too many advisers have deployed promotional devises, including advertisements and titles, that deceive investors and lull them into believing that they are dealing with an adviser who has their best interest at heart.
  • The final SEC rule must ensure that investors have meaningful private remedies with which to enforce the new fiduciary duty rule, including the right to participate in class actions. Private remedies will be an essential feature of any rule.  
  • The SEC should not be swayed by arguments that a genuine fiduciary duty would be unworkable or that it would limit the availability of investment advice to small investment account holders.  New products and business models are emerging, including many innovative firms that rely on a combination of technology and human advisers to make fiduciary advice available under very low fee structures.  Financial planners have for years been able to thrive under the fiduciary standard while serving large and small accounts alike.

If the SEC keeps investors foremost in mind when drafting the rule, not only will it protect investors but it will also serve the SEC’s other two mission objectives: promoting  fair and efficient markets and facilitating capital formation.  The rule will promote more efficient allocation of capital, eliminating the distortions that conflicts of interest cause through the diversion of funds from a broad swath of investors to a concentrated population of financial industry advisers.  The rule will also promote fair competition by eliminating the obviously uneven regulatory requirements under which different sets of advisers operate.  And finally, it will promote capital formation by restoring and elevating investor confidence in the capital markets and by reducing fees and commissions, thus ensuring that investors have more money for investment in companies rather than the enrichment of their advisers.

The SEC has an extraordinary and perhaps once-in-a-lifetime opportunity finally to correct a long-standing regulatory failure: Due to the SEC’s inaction for decades, broker-dealers have been permitted to render conflict-ridden investment advice to retail and institutional investors without adhering to the fiduciary standard.  The result has been incalculable harm to millions of investors who can ill-afford the sometimes catastrophic but always corrosive losses arising from the sale of overpriced, under-performing investments recommended by many broker-dealer representatives who are not required to act in their client’s best interest.

The stage is set for the SEC to move forward, and no obstacles stand in the way that cannot be overcome when the relevant facts, legal principles, and investor protection considerations are taken into account.

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