Uncivil War: States Wage Campaign Against SEC Over Fiduciary Standards

(Illustration by RIA Intel)

(Illustration by RIA Intel)

Reg BI backlash is intensifying.

This past June, the Securities & Exchange Commission (SEC) laid out rules intended to put the industry debate around fiduciary standards to bed, once and for all.

For broker-dealers, which employ three out of every five financial professionals, the new Regulation Best Interest (Reg BI) appeared to be an easy fix to a thorny problem. Public resistance to the termination of the Department of Labor’s fiduciary rule created an industry black eye. Why, many consumers asked, shouldn’t my advisor be expected to always work without conflicts of interest?

The CFP board defines the fiduciary standard as providing a level of care that requires a financial adviser to act solely in the client’s best interest when offering personalized financial advice.

Reg BI, with its user-friendly name, and seemingly firm language imposing stricter standards of client care, was aimed at spoon-feeding a calming dose of assurance for consumers.

Focusing on areas such as enhanced compliance and disclosure, best practices to avoid conflicts of interest, and the exercise of reasonable care when making recommendations, the new rules restored a veneer of “client first” relationship management.

Within hours of industry passage, though, Reg BI elicited howls of protest from various corners of the industry. And the initial outcry has led to a series of lawsuits, separatist movements by states, and in all likelihood, an extended fight for the industry’s future standards of client care.

Consumers often fail to grasp the difference between investment advisors, regardless of their registration or what kind of firm they work for. Many do not realize that advisors, especially at broker-dealers, often focus squarely on portfolio management, whereas RIAs also tend to incorporate financial planning into their investment advice to clients. Yet as industry thought leader Michael Kitces noted in a blog post this past summer, the two “would still be held to two very different standards when it comes to acting as a fiduciary” once Reg BI has been fully adopted next June.

Recall that the Dodd-Frank legislation of 2010 was aimed at leveling the playing field, ensuring that the standards of care for clients were uniform throughout the industry. As Kitces went on to note in that blog post, Reg BI “creates, literally, a double-standard for the delivery of financial planning advice.”

His firm, the XY Planning Network, went on to a file a lawsuit against the SEC this past September, noting that “Congress has repeatedly prescribed that the delivery of financial advice must be delivered under a fiduciary standard of care.” Reg BI, in the view of Kitces and others, treats financial planning that is conducted by SEC-registered broker-dealers as being “incidental” to investment management, and therefore held to a different (and lower) standard.

Yet an arguably greater challenge to Reg BI is coming not from interested parties like XY Planning, but from state-level regulators. In early December, Massachusetts Secretary of State William Galvin proposed a new regulation that would impose a uniform fiduciary conduct standard on broker-dealers, agents, investment advisors and investment advisor representatives when dealing with their customers and clients in the state.

“I am proposing this standard because the SEC has failed to provide investors with the protections they need against conflicts of interest in the financial industry with its ‘Regulation Best Interest’ rule,” Galvin noted in a press release.

That move comes just three months after a collection of seven other states (New York, California, Connecticut, Delaware, Maine, New Mexico and Oregon) jointly filed a similar lawsuit in the U.S. District Court for the Southern District of New York.

Of course, a patchwork of state regulations is bound to lead to utter confusion for consumers. But that’s not the end game for the states.

“Once more states start to push for their own standards, it’s going to become essential that national standards are harmonized with them,” says John Cataldo, chief legal counsel at Integrated Partners, a national RIA with roughly 140 advisors and $6 billion in managed assets.

Evelyn Zohlen, founder of Huntington Beach, CA-based RIA Inspired Financial, and current president of the Financial Planning Association (FPA) for 2019, concurs, predicting more states will take their own initiative, following the lead of Massachusetts and others. And that will likely get the attention of lawmakers in Washington.

“We haven’t heard the last from the SEC on this,” predicts Zohlen. “Commissioners are motivated to create a framework that protects consumers while not restricting business.”

The SEC could not be reached for comment.

Yet it may be hard to square those competing interests. For that matter, there may be no turning back when it comes to the issue of fiduciary standards (or their absence), as far as consumers are concerned. Cataldo says “the horse is out of the barn,” adding that “the investing public is becoming much more savvy on this issue.”

“Gone are the days when the industry tells clients what they should want,” says Cataldo.

“Clients are now more forcefully telling the industry what they want.” Zohlen says that Reg BI “muddies the waters from a consumer perspective. How do consumers even know what it all means?” she asks.

Still, Cataldo cautions that it will be hard for broker-dealers and hybrid firms to readily embrace fiduciary standards. “It will require a massive change in their culture.”

The FPA has a challenging balancing act to play in the debate, as the organization represents RIAs, hybrid advisors, and brokers. Providing advocacy for all members entails the organization to do “a delicate dance,” says Zohlen. While the FPA is leery of alienating any parts of its membership, “we feel strongly that planning should always be done under the fiduciary standard of care.”

The FPA’s message to broker-dealer and hybrid members is clear: “It’s only a matter of time before the industry fully embraces fiduciary standards, and we want to help all of our members get there,” says Zohlen.

Even if an industry shift towards a full embrace of fiduciary standards is inevitable, change will take time. Zohlen says it may be years, not months, before the SEC and other regulators come around to the view of various state regulators and industry advocates like Kitces.

Unless, of course, we get another industry black eye from a Bernie Madoff-style level of fraud.

“Another horrible breach of trust could be the catalyst to move things along a lot more quickly,” says Zohlen. “I sure hope it doesn’t come to that.”

Allan Roth, founder of Colorado-based Wealth Logic thinks that a full embrace of fiduciary standards may still fall short of the industry ideal. He notes that the Certified Financial Planner (CFP) board firmly backs fiduciary standards, but rarely enforces them with its members.

Compared to advisors that don’t even bother to hold themselves out as fiduciaries, “it’s even worse to tell you that I am a fiduciary but then don’t act as one.” Says Roth. “Consumers assume that by working with a fiduciary, they will trust that they will be served well, though they have no way to know that.”

To be sure, the growing battle between the states and the SEC is intended to trigger a showdown—and an eventual resolution—regarding the role of fiduciary standards on the financial planning industry. State-level actions will need to find workarounds to the fact that only the SEC can regulate its own registrants (including all those advisors that manage at least $100 million in assets).

Massachusetts, as one example, has argued that a lack of fiduciary standards can lead to dishonest and unethical business practices, which are subject to state-level regulatory oversight.

And while the SEC parries with the states, it will also be dealing with relentless pressure from finance industry lobbyists. The Financial Services Institute (FSI), for example, has adopted a curious strategy, suggesting that fiduciary standards “restrict investor choice and access.”

The FSI says that challenges to Reg BI will only increase consumer confusion on the subject. The CFP board vehemently disagrees. Its website states that “adoption of a uniform fiduciary standard will bring substantial practical benefits and additional investor protections for consumers of all incomes.”

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