SEC Commissioner Hester Peirce conducted a deep rhetorical dive in exploring the meaning and differences between the terms “fiduciary” and “best interest” in the context of recently proposed standards for investment advisers and broker-dealers providing investment assistance to investors. In remarks titled What’s in a Name? Regulation Best Interest v. Fiduciary, the commissioner reached the following bottom line conclusions: (1) both terms can have multiple meanings; (2) there are only two major differences in the standards implied by the terms; and (3) the impact on retail broker-dealer customers could be dire.
A fiduciary. In April 2018, the SEC considered the appropriate standards that should apply between investors and investment advisers, as well as between investors and broker-dealers. With respect to investment advisers, the Commission issued an interpretive release clarifying certain aspects of the fiduciary duty that an investment adviser owes to its clients under Section 206 of the Advisers Act. The Commission stated that the duty of loyalty component of an adviser’s fiduciary duty requires the adviser to acquire “informed consent” from its clients to any material conflict of interest that could affect the advisory relationship.
Commissioner Peirce, however, questions whether the Commission got that interpretation right, noting that “the Commission cites, not a court decision or other weighty legal precedent, but an Instruction to Form ADV.” She also observes, “The term “fiduciary” has become such an oft-repeated mantra that I worry it will have the perverse effect of harming investors. Investors are told repeatedly that all they need to ask is one simple question about their financial professional: Are you a fiduciary?” Commissioner Peirce concludes, “In short, the term fiduciary duty is not easy to define even within the advisory context.”
Regulation Best Interest. Proposed Regulation Best Interest was also released in April of this year, and it addressed the standards applicable to broker-dealers. In short, the regulation requires a broker-dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, 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-dealer ahead of the interest of the retail customer.
Commissioner Peirce, in her remarks, critically observes: “As with the fiduciary standard … one has to ask: regardless of how nice it sounds, what does “best interest” actually mean? The Commission spent hundreds of pages describing the new “best interest” standard, but it is not clear that people understand it.” Peirce also notes, “A bigger concern for me is that the best interest standard suffers from the same problem the fiduciary standard does—a term that is wonderful for marketing purposes, but potentially misleading for investors.” She continues, “Just as “fiduciary” has been used to lull investors into not asking questions about their financial professional, so “best interest” runs the risk of becoming a term that encourages investors simply to rely on the fact that their best interest is being taken care of.”
Practical differences. According to Peirce, when comparing the proposed Regulation Best Interest standard (as well as a broker-dealer’s other requirements under the securities laws) to an adviser’s fiduciary duty as described in the proposed interpretive release, only two differences stand out. She observes, “First, an adviser generally has an ongoing duty to monitor over the course of its relationship with its client, while a broker-dealer generally does not. Second, a broker-dealer must either mitigate or eliminate any material financial conflict of interest it may have with its client. An adviser is required only to disclose such a conflict.”
With some irony, Commissioner Peirce concludes that proposed Regulation Best Interest arguably would subject broker-dealers to an even more stringent standard than the fiduciary standard for advisers outlined in the Commission’s proposed interpretation.
Potential impact on retail investors. Pierce also points to the Commission’s acknowledgement that the imposition of a new higher standard of conduct on broker-dealers could result in retail customers losing access to advice they receive through recommendations from broker-dealers, and customers that do not have the option of moving to fee-based accounts would in effect be unable to obtain investment assistance. Peirce asserts that, “At a minimum, their costs of obtaining such assistance might rise markedly. Although we tried to be cognizant of these access concerns, given the relative balance of the two standards, I fear that more and more broker-dealers will decide to become advisers that offer only fee-based accounts resulting in many Americans being shut out from receiving any investment advice.”
Commissioner Pierce also asserts that we are already seeing this dynamic at work, noting: “Brokers are taking a hard look at the existing regulatory framework coupled with FINRA arbitrations in which sometimes a fiduciary standard is applied. Then they look over the fence to the adviser world with its principles-based fiduciary standard, less frequent exams, absence of arbitration, and predictable revenue streams.” On this point she concludes, “Having engaged in this comparative exercise, many firms and individual financial professionals say farewell to FINRA, hop on the fiduciary bandwagon, and never look back. Regulation Best Interest could exacerbate this trend.”
Commissioner Peirce, however, questions whether the Commission got that interpretation right, noting that “the Commission cites, not a court decision or other weighty legal precedent, but an Instruction to Form ADV.” She also observes, “The term “fiduciary” has become such an oft-repeated mantra that I worry it will have the perverse effect of harming investors. Investors are told repeatedly that all they need to ask is one simple question about their financial professional: Are you a fiduciary?” Commissioner Peirce concludes, “In short, the term fiduciary duty is not easy to define even within the advisory context.”
Regulation Best Interest. Proposed Regulation Best Interest was also released in April of this year, and it addressed the standards applicable to broker-dealers. In short, the regulation requires a broker-dealer, when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, 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-dealer ahead of the interest of the retail customer.
Commissioner Peirce, in her remarks, critically observes: “As with the fiduciary standard … one has to ask: regardless of how nice it sounds, what does “best interest” actually mean? The Commission spent hundreds of pages describing the new “best interest” standard, but it is not clear that people understand it.” Peirce also notes, “A bigger concern for me is that the best interest standard suffers from the same problem the fiduciary standard does—a term that is wonderful for marketing purposes, but potentially misleading for investors.” She continues, “Just as “fiduciary” has been used to lull investors into not asking questions about their financial professional, so “best interest” runs the risk of becoming a term that encourages investors simply to rely on the fact that their best interest is being taken care of.”
Practical differences. According to Peirce, when comparing the proposed Regulation Best Interest standard (as well as a broker-dealer’s other requirements under the securities laws) to an adviser’s fiduciary duty as described in the proposed interpretive release, only two differences stand out. She observes, “First, an adviser generally has an ongoing duty to monitor over the course of its relationship with its client, while a broker-dealer generally does not. Second, a broker-dealer must either mitigate or eliminate any material financial conflict of interest it may have with its client. An adviser is required only to disclose such a conflict.”
With some irony, Commissioner Peirce concludes that proposed Regulation Best Interest arguably would subject broker-dealers to an even more stringent standard than the fiduciary standard for advisers outlined in the Commission’s proposed interpretation.
Potential impact on retail investors. Pierce also points to the Commission’s acknowledgement that the imposition of a new higher standard of conduct on broker-dealers could result in retail customers losing access to advice they receive through recommendations from broker-dealers, and customers that do not have the option of moving to fee-based accounts would in effect be unable to obtain investment assistance. Peirce asserts that, “At a minimum, their costs of obtaining such assistance might rise markedly. Although we tried to be cognizant of these access concerns, given the relative balance of the two standards, I fear that more and more broker-dealers will decide to become advisers that offer only fee-based accounts resulting in many Americans being shut out from receiving any investment advice.”
Commissioner Pierce also asserts that we are already seeing this dynamic at work, noting: “Brokers are taking a hard look at the existing regulatory framework coupled with FINRA arbitrations in which sometimes a fiduciary standard is applied. Then they look over the fence to the adviser world with its principles-based fiduciary standard, less frequent exams, absence of arbitration, and predictable revenue streams.” On this point she concludes, “Having engaged in this comparative exercise, many firms and individual financial professionals say farewell to FINRA, hop on the fiduciary bandwagon, and never look back. Regulation Best Interest could exacerbate this trend.”