SEC on a fiduciary fishing expedition

On March 1, the Securities and Exchange Commission took a highly unusual — perhaps unprecedented — action. The agency issued a “request for data and other information” in advance of proposing a rule. Specifically, the commission requested input under the subject heading “Duties of Brokers, Dealers and Investment Advisers” with the stated intention to use the information to “[inform] our consideration of alternative standards of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.” That the SEC finds itself unable or unwilling to formulate a rule on this issue is troubling. The SEC was created nearly 80 years ago, and regulatory oversight of broker-dealers and investment advisers as a means of protecting investors is core to its mission. The approach the SEC now has embarked on is an amorphous exercise in information gathering, un-bounded by a clear purpose and core principles. As such, the process presents real problems for anyone wishing to provide meaningful input. Answering questions regarding the range of hypothetical scenarios posed by the commission necessarily entails making assumptions beyond those the SEC chose to state explicitly. For example, several scenarios posited by the SEC are premised on the idea that fiduciary principles reasonably could be considered optional, or at least highly malleable, in the area of financial advice. That premise, and the scenarios that depend upon it, must be rejected. In the Supreme Court case SEC v. Chenery (1943), the court's finding that the directors of the corporation were fiduciaries was fundamental to its decision. In his majority opinion, Justice Felix Frankfurter asserted: “We reject a lax view of fiduciary obligations and insist upon their scrupulous observance. But to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obligations? And what are the consequences of his deviation from duty?” This line of inquiry is ideally suited to the issue at hand.

A FIDUCIARY FUNCTION

Should a broker or investment adviser who provides personalized investment advice about securities be considered a fiduciary? On this question, the consensus answer is yes. Virtually by definition, personalized investment advice is a fiduciary function. Even brokerage industry trade associations now acknowledge that this should be the case. To whom is he or she a fiduciary? The clear answer is retail investors. What obligations do advice providers owe retail investors as fiduciaries? All fiduciaries must fulfill the duties of loyalty and care. These overarching duties are associated with serving the clients' best interests, avoiding conflicts of interest when possible and fully disclosing all material conflicts that cannot be avoided, and acting with prudence and diligence, among other things. To recap, we have a known goal — protect retail investors. We have known parameters — advice providers should be recognized as fiduciaries when they provide personalized investment advice to retail investors and, as such, be obligated to fulfill the duties of loyalty and care. These answers provide a firm foundation to propose a rule to extend the fiduciary standard to all advice providers. Only two related questions posed by Mr. Frankfurter remain for further analysis. What currently permissible business activities deviate from fiduciary obligations, and what are the consequences of these deviations? The SEC should focus upon these two questions. In the course of the SEC's 72-page exploratory expedition for information, there are questions about current business activities and the consequences of changing standards of care but there is no context for proper analysis. A proposed rule with investor protection firmly established as the core purpose of reform — and the fiduciary standard acknowledged as central to that goal — would establish the necessary framework. In particular, this framework would make clear that costs and benefits to investors associated with a higher and more consistent standard of care are what matter. Costs and benefits to the financial services industry are also relevant, but only to the extent that they translate into an impact on investors. In short, industry practices should be adapted to uphold the fiduciary duties of loyalty and care, not the other way around. Blaine F. Aiken is president and chief executive of fi360 Inc.