The DOL’s Fiduciary Rule is Dead. Can the SEC Clear Things Up for the Consumer?

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In June, the U.S. Fifth Circuit Court of Appeals confirmed a March decision to strike down the Labor Department’s (DOL) fiduciary rule which was originally released on April 6, 2016 . The rule held investment professionals to what is called a “fiduciary standard.” A fiduciary standard requires financial advisers to put their clients’ interests ahead of their own self-interest. The rule applied to anyone providing advice on retirement accounts – IRAs, Roth IRAs, 401(k)s, etc. The rule was to become effective the beginning of 2018 but was delayed pending the outcome of the court decision.

It sounded like a good rule. Many Americans probably thought all advisers were already held to a fiduciary standard. Registered Investment Advisers have always been held to the fiduciary standard, but Registered Representatives (brokers/financial salespeople) were not. The court ruling did not say a fiduciary standard is a bad idea. The court overturned the rule because the DOL exceeded its authority by trying to regulate advisers.

What’s Next? The SEC’s Proposed “Advice Rule”

The issue is now being taken up by the Securities and Exchange Commission (SEC), which does have the authority to regulate advisers. In April, the SEC issued a proposal which has been referred to as the “Advice Rule”. The proposal does not hold all financial advisers to a fiduciary standard. Instead, it attempts to provide more clarity between financial professionals working under a fiduciary standard (working solely in the client’s best interests), and brokers/salespeople who work under the less stringent “suitability” standard (suitable based on risk tolerance, financial needs, goals).
The SEC Advice Rule would create a new term “Regulation Best Interest,” which requires brokers to act “in the best interests of the retail customer at the time the recommendation is made, without putting the financial or other interest of the broker-dealer ahead of the retail customer.” A broker-dealer will have acted in the best interest of the customer if:

  1. It discloses in writing prior to a recommendation the material terms of the relationship between the broker and the customer, as well as fees and charges and material conflicts related to the recommendation (the “Disclosure Obligation”).
  2. It exercises reasonable diligence, care, skill and prudence to evaluate the recommendation and conclude that it is in the best interest of the customer (the “Care Obligation”).
  3. It establishes, maintains and enforces policies reasonably designed to identify and disclose or eliminate material conflicts of interest related to the recommendations and related to the financial incentives of the broker-dealer and its associated persons (the “Conflict of Interest Obligation”).

What Critics are Saying

Critics say the SEC’s Advice Rule fails to adequately account for the different legally binding standards of care that advisers and brokers owe their clients. SEC Chairman Jay Clayton acknowledges the distinction in the services that brokers and advisers provide their clients, but argues that the proposal extends the spirit of the fiduciary duty to the broker sector. Advocacy groups for fee-only advisers are asking the SEC to modify its proposed rule package to spell out the differences — in black and white — the business model for fiduciary advice from that of the brokerage world.

No Mention of “Fiduciary”

The term “fiduciary” cannot be found anywhere in the Advice Rule draft. More importantly, there is no concrete definition of what constitutes a client’s best interest. A fiduciary standard of care consists of a duty of loyalty and care, and simply means that the adviser must act in the best interest of his or her client, or disclose when it is not doing so. The adviser must do his or her best to make sure investment advice is made using accurate and complete information. Acting as a fiduciary requires avoiding conflicts of interest and disclosing any potential conflicts to placing the client’s interests first. Fiduciary standard advisers seek best execution of clients’ trades. This might include using due care when selecting trading venues and periodically evaluating the quality of execution being provided.

Undefined Regulation Best Interest Standard

The Regulation Best Interest standard is vague and undefined. Some critics believe it is nothing more than the existing suitability standard. The suitability standard only details that brokers have to reasonably believe that any recommendations made to clients are suitable in terms of the client’s financial needs, objectives, and unique circumstances. The Financial Industry Regulatory Authority (FINRA) regulates brokers holding them to the suitability standard. FINRA considers suitability to include making sure transaction costs are not excessive. An example would be excessive trading or churning the account simply to generate more commissions. Disclosing potential conflicts of interest is not as strict a requirement for brokers under the suitability standard. A key distinction between the two standards of care, in terms of loyalty, is that a broker’s duty is to the broker-dealer he or she works for, not necessarily the client served.

Jim Davis, president of the advocacy group’s board of directors, says that brokers sell securities and insurance products and receive commissions for their sales. That likely means that in addition to the client, they are also working with—and arguably for—the issuers, creating an inherent conflict that sets brokers apart from fee-only advisers. They are in a relationship of three. Mr. Davis believes the relationship is similar to pharmaceutical sales representative and a doctor.

“Consumers shy away from asking for prescription advice from a pharmaceutical salesperson — they know that a trained medical doctor can help them make an informed choice,” Davis says in a statement. “The SEC can best serve the public by making the differences between a financial salesperson and a fiduciary advisor crystal clear.”

The SEC proposed Advice Rule will be in the comment phase on August 7, 2018.

If you are looking for advice that is always in your best interest, we are a Registered Investment Adviser (RIA)3. We are required to act as a fiduciary at all times. Contact us to find out more.

Rick’s Tips:

  • The appeals court overturned the DOL’s Fiduciary Rule because the DOL exceeded its authority by trying to regulate advisers.
  • The SEC’s proposed “Advice Rule” attempts to provide more clarity between financial professionals working under a fiduciary standard.
  • The Advice Rule does not use the term fiduciary or provide a definition of what constitutes a client’s best interest.

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