On September 30, 2014, SEC Commissioner Michael Piwowar, speaking to the National Association of Plan Advisers, questioned whether creating a uniform standard of care for securities broker-dealers and investment advisers who provide personalized investment advice to retail investors can be justified. Although Commissioner Piwowar made clear that he has not yet reached a conclusion on whether or what new obligations should be imposed on financial services professionals, using a cost-benefit analysis he challenged principal arguments that have been made in support of a uniform fiduciary duty applicable to both stockbrokers and investment advisers. The establishment of a uniform fiduciary duty would, ostensibly, raise the level of responsibility of securities broker-dealers to that already in place for investment advisers in their client relationships. It has been the subject of vigorous debate and a congressionally mandated study that has yet to produce any changes in the regulations applicable to broker-dealers and investment advisers. Commissioner Piwowar concludes that it is not clear that the regulatory structure in place has resulted in legal or regulatory gaps or shortcomings in the protection of retail customers relating to the standards of care for providing personalized investment advice and recommendations. His analysis will be important as the full Securities and Exchange Commission considers whether to proceed with rulemaking to establish a uniform standard.
A Congressional Mandate on Perceived Disparate Standards
In the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), Congress addressed the perceived disparity in standards of conduct governing client relationships of investment advisers on the one hand, and securities broker-dealers on the other, in regard to “personalized investment advice” provided by both. The
Dodd-Frank Act directed the Securities and Exchange Commission (SEC) to study the effectiveness of existing legal or regulatory standards of
care for securities broker-dealers, investment advisers and persons associated with them, and expressly authorized the SEC, in its discretion, to establish a “fiduciary duty for brokers and dealers” when providing personalized investment advice to retail customers. The stated objective for establishing a fiduciary duty for broker-dealers is to match the standard of conduct already owed by investment advisers to their clients, because today both broker-dealers and investment advisers provide investment advice on an ongoing basis, and the historic dividing line between services provided by each has become blurred.
The SEC completed, and in January 2011 submitted to Congress, the study mandated by the Dodd-Frank Act. The study recommended that the SEC adopt a uniform fiduciary standard for broker-dealers and investment advisers when providing personalized advice about securities to retail customers. The practical effect is generally seen as imposing a new, higher level of responsibility on broker-dealers. The perceived difference in applicable standards of care that currently set apart investment advisers from broker-dealers is an established “fiduciary” duty that applies to investment advisers, which is generally characterized as a duty to act always in a client’s best interest. The duty of stockbrokers in making investment recommendations, on the other hand, has generally been described in terms of the “suitability” of investment recommendations. The stockbroker’s suitability-based duty is perceived as being at odds with the broader “fiduciary” duty by which investment advisers are obliged to act in the best interest of their clients, and to serve them with undivided loyalty, in rendering investment advice. But the perception may not match reality. Fiduciary principles have in fact long been applied in the relationship between stockbrokers and their customers as part of the regulatory regime
specifically applicable to broker-dealers. In his recent remarks, Commissioner Piwowar said that it is not at all clear that changes in regulations applicable to broker-dealers and investment advisers are necessary, including the adoption of a uniform fiduciary duty.
In the wake of the congressionally mandated study, the SEC did not proceed with rulemaking to establish a uniform fiduciary duty. Instead, in March 2013 the SEC requested comments, data and information on various approaches to the standard of care issue. That process is continuing, and as Commissioner Piwowar told his audience, the Commission will use all of the comments and information being received to assess whether to proceed with rulemaking on a uniform fiduciary duty.
A “New” Fiduciary Duty for Stockbrokers?
As noted above, and as commonly perceived, the impact of establishing a uniform fiduciary duty standard for broker-dealers and investment advisers would be to raise the standard for broker-dealers. Although a
simple enough proposition given the widespread perception of a significant difference between standards as they currently exist, such that an investment adviser is a fiduciary and a stockbroker is not, Commissioner Piwowar noted that the claim that a broker-dealer’s duties have less “teeth” than investment adviser’s overlooks the specific regulatory regime applicable to broker-dealers --the “robust regulatory scrutiny to which broker-dealers are subject.” Broker-dealers are regulated under the Securities Exchange Act of 1934 and SEC rules under it, which impose significant requirements, and which also established a self-regulatory organization to add a level of principles-based regulation. There is no self-regulatory counterpart in the investment adviser regulatory structure.
The relationship between a stockbroker and customer has long been viewed by regulators and courts as one involving trust and confidence placed with the broker. Fiduciary principles have been applied in policing the relationship so as, for example, to prevent a broker from acting adversely to the best interests of the customer in dealings with that customer, and to require disclosures and other procedures designed to assure that customers make informed decisions with respect to their transactions. Although in the debate over creation of a uniform fiduciary standard for brokers and investment advisers has focused heavily on characterizing the existing broker duty in terms of “suitability,” a broker’s duty to customers has never been defined solely that way. To the contrary, it has always been described in decidedly fiduciary terms. In a broker disciplinary case, the SEC itself said long ago:
Our findings... are based in large part on the premise that the relation of a securities dealer to his clients is not that of an ordinary merchant to his customers. Even apart from the relationship of agency which may exist, the status of a dealer in relation to an uninformed client is one of special trust and confidence, approaching and perhaps even equaling that of a fiduciary.
Courts as well have recognized that in holding itself out to be competent to advise customers regarding investments, a broker implicitly represents that it will deal fairly with the customer. Courts have not shied from describing a broker’s duty in broad fiduciary terms -- a duty of loyalty or due care, for example, depending upon particular facts and circumstances. In certain circumstances, where a broker is entrusted to exercise discretion as an investment manager for a customer, the duty has always been accepted as a fiduciary duty. That said, the ongoing debate over establishing a unified fiduciary standard to raise the level of responsibility of a broker-dealer to that already in place for investment advisers has focused on a perceived gap that is defined by the absence of a duty requiring brokers who make investment recommendations to act in the best interest of their customer without regard to the financial or other interest of the broker. It is said, given the current duty construct built only on a suitability responsibility, that a broker’s objectivity and good faith in making an investment recommendation may at least be colored, if not compromised outright, based on compensation associated with a particular “suitable” recommendation versus one equally suitable but less costly for the investor.
In his September 30 remarks, Commissioner Piwowar questioned the notion that the extant duty of broker-dealers to deal fairly with their customers pursuant to SEC and self-regulatory organization
(FINRA) rules is cabined by the suitability obligation, which he characterized as an important aspect of the broker-dealer’s baseline duty of fair dealing. There are other important aspects, as for example, the duty of a broker to disclose material conflicts of interest to the customers when making an investment recommendation. His point was simply that broker-dealers are subject to “robust regulatory scrutiny” that should not be overlooked in the debate about the need to superimpose a uniform fiduciary duty.
He also questioned whether investor confusion or lack of understanding of the difference between the duties of broker-dealers and investment advisers should be the driver in the debate.
Investor Confusion as a Driver
A RAND Corporation study commissioned by the SEC in 2008 found that retail investors are confused about the differences between investment advisers and broker-dealers -- particularly as to the legal duties owed regarding the services and functions each performs. Among other things, the RAND Report concluded that services and marketing by broker-dealers and investment advisers have become increasingly indistinguishable. As Commissioner Piwowar noted in his recent remarks, the study concluded that investors were confused, but that despite their apparent confusion about titles, duties and fees, investors expressed high levels of satisfaction with the servicers they receive from their own financial service providers. He agreed that based on the RAND Report, and the SEC’s own study mandated by the Dodd-Frank Act, investors are confused, and do not understand the differences between the duties of broker-dealers and investment advisers. That said, he responded: “However -- and this is a big however -- it is not clear that changes in the regulations applicable to broker-dealers and investment advisers are necessary, including the adoption of a uniform fiduciary duty.”
Despite confusion, and given that there are different standards of care, Commissioner Piwowar questioned whether SEC action is warranted. He offered, for example, that it is not clear that a uniform fiduciary duty would eliminate or even substantially ameliorate investor confusion. In fact, he stated, given distinctions between the regulatory regimes applicable to broker-dealers and investment advisers, even with the adoption of a uniform fiduciary standard it likely that investor confusion would continue. Only broad regulatory harmonization going beyond a standard of care may be the answer but, as Commissioner Piwowar noted, that topic has not been part of the ongoing debate. In
any event, he urged that a cost-benefit analysis was need before the SEC takes further action.
A Cost-Benefit Assessment
In his September 30 remarks, speaking only for himself, Commissioner Piwowar offered certain cost- benefit conclusions on the matter of adopting a uniform fiduciary standard for investment advisers and broker-dealers:
- He could cite no evidence that retail investors are systemically being harmed or disadvantaged under one regulatory regime as compared to the other;
- A uniform fiduciary standard of care may not result in clients getting any different investment advice than they receive today;
- It is not clear that a uniform fiduciary duty would eliminate or even substantially ameliorate investor confusion, and that in fact, as discussed above, it is likely that investor confusion would continue without a broad harmonization of the regulatory requirements applicable to broker-dealers and investment advisers without regard to a uniform standard of care;
- A uniform standard of care could actually harm retail investors by potentially limiting financial advisory options, or locking out investors from receiving investment advice altogether; and
- Based on data currently available, the potential benefits to establishing a uniform fiduciary standard seem “elusive” and the potential costs “sky-high.”
Citing a “real world” example demonstrating the need for caution in considering changes to standards of care, Commissioner Piwowar pointed to the experience in the United Kingdom following introduction in 2013 of a measure that significantly limited how financial advisers could be compensated. The negative effects were substantial -- much worse than predicted -- as millions of people turned away from services offered by financial advisers because they became too expensive, and also that there was a reduction of more than 44 percent in bank advisers and 20 percent in independent financial advisers after the change was implemented.
In the end, Commissioner Piwowar endorsed a “measured and deliberative” approach to deciding whether a uniform fiduciary standard for broker-dealers and investment advisers is actually warranted. Such an approach should determine whether retail customers are systemically harmed or disadvantaged because of different standards, and whether adoption of a uniform standard would adversely impact retail investor access or availability to personalized investment advice and recommendations. This approach is taken in a bill (the Retail Investor Protection Act) passed by House of Representatives last year, on which Commissioner Piwowar favorably commented.
In the wake of the Dodd-Frank Act and the vigorous debate over a uniform fiduciary standard for broker- dealers and investment advisers that led up to the congressionally mandated and authority for the SEC to adopt such a standard, many have predicted that the SEC will indeed do so. Conceptually, a one-size-fits- all uniform “fiduciary” standard of conduct for broker-dealers and investment advisers could be fashioned if it is specifically focused on common functional characteristics of broker-customer and adviser-client relationships, and is framed in terms of a baseline obligation that gives some meaning to acting in the “best interests” of a customer or client. However, Commissioner Piwowar’s September 30, 2014, remarks demonstrate that this is no easy task, and that there are good reasons to ask whether it is necessary at all. The fact that the SEC has not yet acted suggests that there are significant challenges yet to be considered, and resolved.