The SEC Loses and You Win.

From time to time, Delia Fernandez will author a guest post on our blog. [Disclosure:  There is no express or implied relationship or financial ties between Delia's practice and Tredway, Lumsdaine & Doyle, LLP.] You will see her guest posts from time to time under the aptly named category "Financial Advisories By Delia." Enjoy her wisdom.

Or How the Investment Industry Struggles with the F Word

 A ruling that allowed stock brokers to call themselves investment advisors without being required to act in their clients’ best interests as fiduciaries when giving investment advice has been overturned, giving a big win to all consumers.

 This was a bizarre exception to an important law. Under the Investment Advisors Act of 1940, all investment advisors are fiduciaries. That simply means that we’re required to act in our clients’ best interests when giving investment advice. So if a client consults an advisor and the best thing for them to do is pay off their credit cards and build up a savings account for emergencies, that’s what an advisor is obligated under law to tell them.

 That means that advisors are not allowed to sell you an investment that might enrich the advisor (and yes, which technically might be suitable for your age and financial circumstances, which is what you might get from a broker), but which isn’t in your best interest. I have to believe it’s what many consumers think they have working for them when they sign up for an investment account.

 Unfortunately, up until Friday morning, that was not the case. The brokerage industry managed to carve out an exemption for itself under the law, claiming that aspects of their business weren’t within the intent of the Act, so they didn’t have to register as advisors or abide by the law and the fiduciary standard. 

They just got to call themselves investment advisors to their clients, which to a lot of us in the industry was a huge injustice to the investing public. 

Like a lot of legal issues, this one turned on a technicality. Brokers and dealers of securities are exempt from registering under the Act if, in fact, the investment advice they give is “solely incidental” to their work as a broker/dealer, which is buying and selling securities. 

However, many broker/dealers are claiming to be investment advisors in full-page ads and are also being paid for that investment advice, in the form of regular fees. That would seem to call for them to register as the law is written, but the SEC had said that they were exempt due to a section of the law that says the SEC can exclude others “not within the intent of [this paragraph].” This exemption was commonly referred to in the industry as the “Merrill Lynch Rule” and many broker/dealers took advantage of it and didn’t register as advisory firms. Instead, they had to warn clients in their contracts and agreements that they were not required to act in the clients’ best interests, so the client was duly warned. 

But the court ruled against the SEC, saying that the catch-all phrase describing others not within the intent of the law was for newcomers not foreseen at the time of the writing of the law in 1940, and that broker/dealers had clearly been identified in the Act when it was written and therefore had been already addressed.

The heroes of this story include the Financial Planning Association, which is the entity that sued the SEC in 2004 and that just won the suit on Friday. Other heroes include T.D. Ameritrade, which is the one brokerage firm that spoke out against the SEC decision and supported the FPA in its suit. 

We don’t know what will happen next. It’s possible that the SEC will appeal the decision, which we hope they won’t. Or it could be that those broker/dealers who want to continue to call themselves advisors will step up to the fiduciary standard and register under the Investment Advisors Act. 

In any case, I think consumers have been well served by this decision, and we all should celebrate. And I hope you’ll become better informed about the people who want to give you investment advice, and whether they consider themselves fiduciaries. 

Do keep in mind that there is a professional association of advisors who are fiercely proud of their fiduciary standing, and that’s the National Association of Personal Financial Advisors, or NAPFA. You can find out more about this organization of fee-only planners and fiduciaries, and find a fee-only planner in your area, by contacting www.napfa.org. To learn more about the importance of working with a professional fiduciary, go to here. 

The ruling of the U.S. Court of Appeals for the District of Columbia Circuit and the legal briefs filed in the case can be reviewed online.

You can also view the FPA’s statement to the SEC.

Delia Fernandez, MBA, CFP®
Fernandez Financial Advisory, LLC
delia@fernandezllc.com
562-594-4454