Earlier today, The Institute for the Fiduciary Standard held a panel on financial advice.  I served as the moderator for three fantastic panelists, Donald Langevoort, James Cox, and Ann Lipton.  As part of my role, I opened the panel with a summary of the current landscape for financial advice.  Hopefully this helps others who are trying to understand the current state of play:

In the past, American retirements had often been supported by three different sources of retirement income: an employer-sponsored, defined-benefit pension; social security; and personal savings.  Today, few Americans have all three sources of support.  Employers have largely shifted to offering defined-contribution retirement plans, allowing participants to contribute a portion of their salary to a 401k plan or similar plan, which the employer may or may not also make some contributions to.  At the same time, Americans, on the whole, generally lack financial sophistication, and often struggle to navigate our increasingly complex financial landscape.  In short, Americans need access to competent, trustworthy advice to make decisions.

 

Sadly, far too many Americans struggle to access high-quality and trustworthy financial advice.  Our fragmented regulatory system makes this even harder.  A person holding themselves out as a financial adviser might actually be a stockbroker, a registered investment adviser, an insurance salesperson, something else entirely, or some combination of the forgoing!  Unsurprisingly, investors often do not understand the system.  One survey found that about half of investors over the age of sixty either didn’t understand how they paid for financial advice or mistakenly assumed that financial advisers work for free.  And you can’t blame them.  It’s dizzyingly complex with a mixture of different federal and state laws coming into play.

 

A variety of reforms have been implemented, struck down, and proposed.  I’ll attempt to sketch the current state of play by breaking the persons giving financial advice into categories.

 

Let’s start with stockbrokers.  The broker-dealer industry is primarily regulated by the FINRA, the Financial Industry Regulatory Authority.  It’s a self-regulatory organization sitting somewhere in between a trade group and part of the federal government.  Although funded by member dues, its rules are approved by the Securities and Exchange Commission.  FINRA had long required brokers to give advice that was “suitable” for investors.  These brokers receive transaction-based compensation.  In essence, they collect commissions for selling financial products.  This creates a rather obvious conflict of interest to sell the product which pays the most—so long as it remains suitable.

 

Earlier this year, the SEC supplanted the suitability standard with Regulation Best Interest, which requires stockbrokers to “act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker. . . ahead of the interest of the retail customer.”  If you’re not quite sure what that means, you’re not alone.

 

Let’s turn to the second category of persons giving financial advice. Registered Investment Advisers have long owed a fiduciary duty under the Advisers Act.  The duty was recognized by the Supreme Court a famous case called Capital Gains. 

 

These fiduciaries generally do not sell products on commission and are paid for their advice.  Historically, the fiduciary duty owed by Advisers has been understood as requiring them to put their clients’ interests first. 

 

When it issued regulation best interest, the SEC also issued a new interpretation of an advisers duty of loyalty.  Now, the SEC says that “the duty of loyalty requires that an adviser not subordinate its clients’ interests to its own.”  If you’re not quite sure what that means, you’re not alone.

 

The SEC also issued a new regulation calling for brokers and advisers to distribute a short customer relationship summary describing their duties.  Early testing revealed that many ordinary humans struggled to understand the system even after receiving the SEC's template.

 

Adding to the confusion, insurance salespeople also give financial advice and sell complex financial products.  The states have historically regulated their sales practices, but their duties have not been as clear.  In 2016, the Department of Labor issued a Fiduciary Rulemaking under the Employee Retirement Income Security Act, which would have affected all three categories of advice-givers. In short, the rulemaking would have applied a tough fiduciary standard to advice about assets held within retirement accounts.  It would have also applied to insurance sales.  In a case filed by Eugene Scalia, the Fifth Circuit struck down Labor’s fiduciary rulemaking.  Later, President Trump appointed Scalia to run the Department of Labor, which recently proposed a new fiduciary rulemaking—largely unwinding the changes and proposing to generally defer to the SEC’s standards. 

 

But wait, there is more.  Private self-regulatory groups also offer their own standards and certifications.  Investors who struggle to understand this system may simply choose to work with an adviser who holds the right badge or certification.  The largest such group is the CFP Board which certifies financial planners.  In October of 2019, it updated its standards and requires its representatives to act in the best interest of clients, properly disclose conflicts, and to manage conflicts.

 

As you can see, it’s a complex environment.  We have three panelists here to help talk about these developments and what they mean.  My brief introductions . . .