July 24, 2018
First, I applaud the provisions of IA-4889 and the clarity it adds to the standards of the IAA of '40 rules.
In response to the three interpretation aspects of the fiduciary duty under section 206 of the Advisers Act for which you requested comments:
- Does the Commission's proposed interpretation offer sufficient guidance with respect to the fiduciary duty under section 206 of the Advisers Act?
I believe the proposed interpretation does offer good guidance however, the ability to "disclose away" conflicts of interest remains unclear. I was dually registered with a broker-dealer/investment adviser for over a decade and the underlying conflicts of interest were subtle and pervasive, yet were not, in my opinion, adequately disclosed. The broker-dealer offered incentives for the sale of certain products and some of those products added to credit for attendance at functions for which the broker-dealer paid. Additionally, it was generally understood that retention as a representative of the B-D/IA firm and the percentage of "pay-out" of IA fees one received was based at least in part of the volume of customer purchases of some of those products through the IA. It was also understood and published that after selling a commissioned product there was only a limited number of years (generally two) until the product could be moved into an investment advisory account where the adviser and selling representative could begin drawing significant fees for "advising" on the previously sold product. This practice was commonly, if informally, referred to as a "revenue enhancer." I see no restriction on any of those practices in the guidance.
- Are there any significant issues related to an adviser's fiduciary duty that the proposed interpretation has not addressed?
For a dually registered adviser or adviser representative, the inherent conflict between the "caveat emptor" relationship of the broker and customer and the fiduciary relationship of the investment adviser is not addressed. While I recognize and support the Commission's "Best Interest" proposal, there remains a fundamental difference between the fiduciary duty for loyalty and avoidance of conflicts and the broker's self-interest and inherent conflicts of interest. Brokers and their representatives are drawn to the highest commissions and other compensation which are often well hidden in voluminous prospectuses while a fiduciary adviser is held to the simple standard of acting in the advisee's best interest while avoiding conflicts of interest wherever possible.
As an example, while attending the Morningstar Investor's Conference this year I sat across the table at a meal from a group of "advisors" who were openly boasting of their success of advertising their firm as an "SEC Registered Investment Adviser" then selling high commission variable annuities to the members of the public with whom they had meetings. Their methodology was to advertise fiduciary advice as an adviser, to speak of their independence at a seminar, then to sell high commission products when meeting with the members of the public. They boasted that their commissions and rewards from their broker-dealer had dramatically increased since adopting the strategy. When I asked if they had any concern about the violation of fiduciary duty, one replied that since they never established a fiduciary relationship with the customer they were not at risk. Another of the group then commented that two years after the sale, the variable annuity could be moved into an advisory account and they could "earn" 1.5% fees per year "forever."
I am of the opinion after many years of observation of this type of practice at multiple broker-dealers prior to our forming an independent RIA and severing our ties with the B/D community that a clear delineation should be made between IA and BD relationships. Again, in my opinion, a given relationship should be either a B/D relationship based on that set of rules under FINRA or a fiduciary IA relationship under section 206 of the Adviser's Act. Conversion of accounts and/or products from the B/D relationship to an Advisory relationship should be carefully policed and limited to situations where the representative was doing a business conversion of his or her "book" of business. The process of sale followed by conversion to advice to enhance revenue should be strictly prohibited.
Further, I am of the opinion that holding forth as a fiduciary investment adviser or a representative thereof should bind the person or organization doing so to the standards under section 206. Advertising in any format should be clearly either as an investment adviser or as a broker/dealer with a clear delineation between the relationship types for those who respond. In essence, that would mean that a given representative would need to hold forth as one or the other and then, once the relationship was established, hold to that standard.
- Would it be beneficial for investors, advisers or broker-dealers for the Commission to codify any portion of our proposed interpretation of the fiduciary duty under section 206of the Advisers Act?
I believe it would be beneficial for investors, advisers and broker-dealers for the Commission to codify the customer/client relationship procedures for dually-registered entities and persons to effect a clear delineation between the two standards.
While I was dually registered and in the process of establishing what would eventually become a purely IA relationship with my existing customers, I attempted to determine if there was an established standard for converting brokerage relationships to IA relationships. The CCO and the attorney for the B/D-RIA with which I had a relationship told me that FINRA policed sales and the SEC policed advice but the transition was a "no-man land" where neither looked. They further advised me that the SEC did not "look back" to see where the advisory products originated in a B/D sale but restricted themselves to actions after the IA relationship had been established. I was advised too that such conversions were in the best interest of the B/D-RIA as it increased annual revenues.
Thank-you for the opportunity to offer these comments. I am available to further discuss these issues if you wish to do so.