'Buyer beware' is no basis for a fiduciary rule

What is the purpose of disclosing a conflict of interest? The answer depends on whether a financial adviser is a fiduciary. If you are a fiduciary, a disclosure of a conflict is a notification of an exception to the relationship governed by trust and loyalty. If you aren't a fiduciary, the disclosure provides notification that conflicts are inherent to the relationship. Opponents of the fiduciary standard in the insurance and broker-dealer industries are attempting to get the Securities and Exchange Commission to accept a non-fiduciary form of disclosure for advice to retail investors under the new rules required by regulatory reform. In comments submitted by the Securities Industry and Financial Markets Association to the SEC for its study of the obligations of broker-dealers and investment advisers, SIFMA urged the SEC to adhere to a principle: “Where products and services involve material conflicts of interest, broker-dealers and investment advisers should be able to provide disclosures to clients in a pragmatic way to clearly and effectively communicate, and receive consent to, these conflicts of interest.” SIFMA calls for this disclosure to be provided at the outset of the relationship, rather than on a case-by-case basis. This can't work if the fiduciary standard is extended to all who give advice to retail investors. If there is a need for these blanket conflict disclosures, the fiduciary standard won't exist as we know it, at least for advice provided to retail investors. Form follows function. The form of conflict-of-interest disclosures must be aligned either to the function of rendering advice to clients as a fiduciary or to the function of facilitating transactions as an agent of a financial services company. In fiduciary relationships, clients rely upon the superior knowledge of an adviser. The adviser must serve the best interests of the client by honoring a singular duty of loyalty. This places the onus on the adviser to produce clear and concise disclosures that are brought to the attention of the client in those rare unavoidable circumstances when fulfillment of the duty of loyalty could be less reliable because the adviser could benefit at the expense of the client. Non-fiduciary relationships in-volve inherent conflicts of interests because the broker has divided loyalties. The broker's obligation to clients is to offer investments that are suitable for the client, even though they may not be the best fit for the client's needs. Brokers are also permitted to serve their self-interests and the interests of their employers by recommending products that will be more lucrative to them, or their employer, so long as the suitability requirement is met. Disclosing this only at the outset places the onus on investors to understand that their interests are compromised with the interests of the broker and the financial services firm. Under this “buyer beware” ap-proach, the investor is presumed to not need an adviser who is subject to full fiduciary accountability, be-cause the investor is sufficiently knowledgeable about investments and alert to conflicts. When retail investors seek advice, conflicts must not be disclosed away at the outset of the relationship simply because it is pragmatically easier for insurance and brokerage firms to do so by virtue of their experience in providing transactional services. Such disregard for the investor's interests is a clear breach of the singular duty of loyalty of a fiduciary. It also undermines the duty of due care because the ability to perform the thorough due diligence required of a fiduciary is threatened at the outset as a result of conflict-ridden variable-incentive compensation structures that are built into products that require these disclosures. And it is diametrically opposed to the fiduciary duty of utmost good faith that requires full and fair disclosure to specific exceptions to the rule of unconflicted advice that is assumed in fiduciary relationships. No one likes disclosures. They are a burden for financial services companies to prepare, their representatives to explain and investors to interpret. Nevertheless, when they are necessary, they should serve their intended purpose. In its rulemaking to harmonize the regulatory structure of brokers and advisers, the SEC must recognize that trustworthy advice is the purpose to be served. Therefore the SEC's focus should be on the avoidance or mitigation of conflicts by advisers. Fewer conflicts mean fewer disclosures. This is the truly pragmatic solution and the only way to preserve the integrity of the fiduciary standard. Blaine F. Aikin is chief executive of Fiduciary360 LLC.