Why Harold Evensky believes that a FINRA-as-devil attitude is counterproductive

Harold is as close as they come to being an industry statesman. The reconciliation of brokerage regulation with the formulation of advisory services regulation by definition is in contradiction of the key defining issues of each. Is it possible? Like Harold we all would like to think so. But as Ron Rhoades has clearily established in the previous article, it is simply not possible. As much as I respect and admire Harold, particularily his sentiment for a unified regulatory authority within which everyone can work, unless FINRA completely retools itself which is unlikely, advisory services regulation under FINRA would be conter productive to the best interests of the investing public and those providing personalized investment advice to retail clients. Though I wish Harold was right, the fact that FINRA (the former National Association of Securities Dealers) has demonstrated time and again over the past 70 years that it has worked at cross purposes against advice, advisors and advisory services—that makes it extremely unlikely that they would be diligent, effective and even handed in weighing the competing interests of the broker and the advisor. Given its history, FINRA is viewed as the proverbial fox guarding the hen house for good reason.

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While this may come as a surprise to some, I concur with Harold’s astute observation that the RIA community should “work, to whatever extent we can, with the SEC and a future fiduciary regulator to educate them regarding the unique nature of principals based advice and support their efforts.” Even if this “future fiduciary regulator” is FINRA, which as Harold suggests we are well down the path of seeing. (The lack of SEC self-funding in the final legislation likely hits the nail on the head, in this regard.)

However, I share Steven’s concern that FINRA will be unable to change. Fiduciary standards are upheld – and strengthened – when the regulatory organization is composed of individual members – professionals – bound together by a bona fide fiduciary standard of conduct. I foresee a future where, under FINRA’s ambit, the fiduciary standard is slowly eroded by the “particular exceptions” which Justice Cardoza so long ago warned against.

Already we have seen this, in FINRA leadership’s call for a “new uniform federal fiduciary standard,” the path for wholesale erosion of the fiduciary standard. Yet, current federal law – the Advisers Act – applies a uniform standard across all 50 states. And in all my research into state common law, I have never discerned any material difference in how state courts apply the fiduciary standard to the delivery of investment and financial advice. (There are slight differences in WHEN it is applied, but once applied the fiduciary standard is surprisingly uniform in what it requires, across the many states.) Given the fiduciary law’s principles are already uniformly applied, by and large, why do we need a new standard?

Hence, given FINRA’s actions and recent advocacy efforts, I remain skeptical that FINRA embraces a TRUE, bona fide fiduciary standard. Rather than accept the restrictions on business conduct which a fiduciary standard necessarily imposes, I believe FINRA seeks to frame the debate as one in which the fiduciary standard must be conformed to existing BD / investment underwriting business practices. Hmmm … I always thought that business practices should conform to the law, not the other way around.

The ’34 Act governing registered representatives, and the ’33 Act, are rules-based regimes. These Acts apply enhanced levels of disclosure to what are otherwise arms-length relationships between product providers (issuers, brokers, dealers) and the customer. By contrast, the IAA has, for seven decades, applied a principles-based regime to the advisor-client fiduciary relationship. There is a HUGE gap between fiduciary relationships and arms-length relationships. “Suitability” obligations and enhanced disclosure obligations come nowhere near closing such a gap. Many learned judges and legal scholars have long accepted the fact that a true fiduciary cannot wear two hats.

Denigration of the fiduciary relationship, by particular exceptions over time, or through the adoption of a “new federal fiduciary standard” which is anything but a fiduciary standard, will no doubt occur under FINRA’s watch – and have Justice Cardoza turning over in this grave. Indeed, thousands of attorneys will likely rebel if something is called a “fiduciary standard” – when in fact it is only an enhancement to the already-existing disclosure obligations of BDs.

For this reason, I will continue to suggest that together the RIA community must find a way to advocate for an much-needed alternative to FINRA – and to suggest further that FINRA should have no role in market conduct regulation (even for BDs). As Harold notes, the chance of winning this particular battle may be very small. But in my mind the long-term ramifications are huge. I doubt a true profession for investment advisers and/or financial planners can be formed if FINRA is the overseer. Hence, in my view this is a battle worth pursuing.

But even a strategic asset allocator might hedge sometimes. Hence, I fully support Harold’s engagement of FINRA and others involved in regulation, by providing them with education and insights about the fiduciary standard. If, in the end, we can’t beat FINRA, then – perhaps inevitably – we must join with them – and seek to influence FINRA’s application of the fiduciary standard, in order to preserve it as a true fiduciary standard.

Kudos to Harold for bringing these perspectives forward, and to his continued work in advancing the fiduciary standard and the profession.

It’s intimidating “debating” with friends I consider heads and above two of the most knowledgeable professionals on the subject of fiduciary duty. So, given my respect for their opinion, let me set the record straight. I too am concerned. Although inherently an optimist, I’ve also been in this business long enough to have a healthy level of skepticism. My point is not that I would prefer FINRA, but rather that I believe in dealing with reality. Based on my perception of reality, I believe our efforts will be more effectively spent not on name calling but rather on educating and persuading the SEC, FINRA, the public, the public media and any other interested parties that the RIGHT thing is to insure that any and all investment advice offered to the public comes with the commitment to meet the Committee for the Fiduciary Standard’s Five Fiduciary Principles:

 Put the client’s best interest first;
 Act with prudence; that is, with the skill, care, diligence and good judgment of a professional;
 Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts;
 Avoid conflicts of interest;
 Fully disclose and fairly manage, in the client’s favor, any unavoidable conflicts.

Harold is that rare industry statesmen whose counsel is not wisely dismissed.

The most positive outcome of regulatory reform is the industry is modernizing requiring regulators and broker/dealers to either come along or lead the charge. We do not know if FINRA will be completely be retooled so that its advice voice will be as strong as its brokerage voice particularily when those voices are in conflict. We do not yet know which broker/dealers if any, will seize the day to win marketshare based on the dept and breadth of the counsel they support. I believe it is in the best interest of the industry, consumer and the adviser for the SEC to advance rules based regulation rather than principles based regulation because it quickly establishes a uniform level of counsel and innovation that can not be achieved with generalized principles. Principles based regulation requires case by case interpretation that would slow innovation and thwart the proper resourcing of advisers which would serve the best interests of the consumer, because everything is a matter of oppinion.

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