Proposed Fiduciary Rule Changes Signal Heightened Due Diligence Requirements for Brokers, Advisors

Attorney Advising Disclaimer

FINRA, the SEC and the US Department of Labor are considering, and/or proposing changes to fiduciary standards for brokers and advisors as the agencies strive towards a new "culture of fiduciary responsibility," in the words of fi360 president and CEO Blaine Aikin.

The dutys owed by a financial professional to a client depend on whether the professional serves as an Associated Person (broker) of a FINRA-registered Member Firm (brokerage firm) or as an "Investment Advisor" at a Registered Investment Advisory. Brokers at broker-dealer firms are governed by FINRA rules which hold them to the olbigation to recommend only "suitable" investments to their clients. An Investment Advisors working at a Registered Investment Advisory is held to a fiduciary standard, acting only in his or her client's best interests.

State law varies from state-to-state whether brokers are held to a fiduciary standard. Cases in California hold that brokers are fiduciaries. Other states do not impart such a standard. In FINRA arbitration cases, brokerage firms consistently argue against a fiduciary standard and try to import whichever cases and statutes they believe best support their point.

The conflicting duties owed to clients is something that the financial services industry does not like to discuss. The recent attention by the SEC, FINRA, and Department of Labor sheds some light on the problems.

Borrowing principles and language generally associated with the concept of fiduciary duty, FINRA updated its suitability rule this summer, moving into an arena of greater scrutiny intended to better match incurred risk with a customer's actual risk tolerance and objectives.

For instance, FINRA's new suitability rule requires brokers to "have a reasonable basis" before recommending products, basing such recommendations on individual customer's investment profiles, as opposed to using a cookie-cutter risk tolerance questionnaire, which researchers have said is unstable and oversimplified.

Moving closer to a fiduciary standard, FINRA expanded the range of criteria used to judge risk tolerance and suitability—e.g., time horizon and liquidity—while continuing to investigate allegations of unsuitable recommendations and failures to conduct adequate due diligence.

The SEC, meanwhile, has stated its intention to crack down on smaller violations in order to stop large violations later on, joining the Department of Labor in an approach to expand fiduciary advisors' responsibilities by next year, at the earliest.

Driving the point home, SEC Chair Mary Jo White said in early November that a uniform fiduciary standard for brokers and advisors is of "high priority…[we] obviously realize the concerns about consistency and the impact their rule making can have on the broker-dealer model."

Meanwhile, the Department of Labor expects to expand the definition of "fiduciary" to cover advisors that work in the retirement plan segment. The American Society of Pension Professionals and Actuaries and the National Association of Plan Advisors are against the measure, which has delayed the rule proposal and corresponding vote.

Regardless of the varying and sometimes conflicting standards currently at play, financial professionals are generally obligated to perform some level of due diligence and determination of suitability or appropriateness of an investment recommendation.

Brokerage firms are fighting at every point to prevent being held to a fiduciary standard. Charles Schwab & Co. claims it will cost customers $1 billion if a fiduciary standard is put in place. Yet, this same firm aggressively marketed to its clients its "Yield Plus Fund" as a safe alternative to money market funds, but in fact was laden with long-term toxic mortgage backed securities. In 2008, the Fund imploded costing Schwab's clients billions of dollars.

Many brokerage firms push certain mutual fund families or proprietary securities over other products. This often is a result of the proprietary products being more profitable for the firm in the form of hidden fees and commissions related to the creation and maintenance of the products sold. This obvious, yet extremely lucrative, internal conflict would be eliminated by the implementation of a clear fiduciary standard.

Today, brokerage firms bombard customers with advertising promising unbiased advice, superior knowledge of the market, and the skill to outperform the market. Watch any televised sporting event and the financial services advertisements are non-stop. But when called to mandatory arbitration, away from the public spotlight, every broker's and firm's Statement of Answer contains stock-boilerplate language arguing the trusted broker and firm should only be considered "order-takers." The once vaunted financial professional is argued to having provided the same level of service as a clerk at a fast food restaurant. Cognitive dissonance is alive and well.

If you have invested with a broker or financial advisor whose failure to conduct adequate due diligence, unsuitable recommendations, breach of fiduciary duty, misrepresentations and/or omissions of material fact have proven harmful to your investments or interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.

News: Schwab Impact: Fiduciary Rule Changes at SEC, FINRA and the Department of Labor (Financial Planning)

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