Although the potential for a uniform fiduciary duty on all financial advisors has been a major industry discussion over the past decade, defining fiduciary status — when it should apply, and what it means — long predates the recent Department of Labor’s fiduciary rulemaking process.
In fact, the basis of a fiduciary duty, and the recognition that one person may act as an agent and steward for another,
Accordingly, “trusted advisors” in most professions, including law and accounting, have some form of a code of ethics that require a fiduciary (or at least a fiduciary-like) duty to act in the client’s best interests. Similarly, doctors take a Hippocratic oath to support their patients.
In the context of the financial services industry, it was recognized long ago that there is a need for certain individuals in a unique relationship of trust and confidence to be regulated as fiduciaries (now known as Registered Investment Advisers under
In fact, the entire framework for regulation for financial advisors today, still, is that RIAs are subject to a fiduciary duty for their investment advice, but a broker-dealer is not subject to the fiduciary duty (meaning he or she is not required to register as an investment advisor and become subject to fiduciary duty) as long as their advice is “
In other words, the regulations recognize that (registered) investment advisors give advice, while brokers sell brokerage products. Thus, the
The caveat, of course, is that the world has come a long way since the Investment Advisers Act of 1940 and the original separation between brokerage sales and advice. Compensation for the sale of brokerage products and services has been repeatedly undermined over the years.
First, the
Instead, registered representatives of broker-dealers are now financial advisors, financial consultants, wealth managers, etc., and their registered representative status as a broker is (often literally) just a footnote.
Yet the expansion in the scope of advice delivered by a broker (and/or insurance or annuity agent) is precisely why the Department of Labor decided to begin the process over the past eight years to modify its ERISA-based fiduciary rule.
Because not only had the marketplace shifted from defined benefit plans (the ERISA plans of old) to defined contribution plans (including both 401(k) plans through employers, and now a multi-trillion-dollar IRA industry that exists outside the scope of ERISA), but the brokers who served those accounts were increasingly operating not as salespeople, but as advisors. Even though they were still compensated as salespeople (predominantly or exclusively through commissions), which has long been recognized as a fine way to compensate salespeople but a highly conflicted way to compensate advisors.
Accordingly, the Department of Labor shifted from its original five-prong test to determine fiduciary status (which applied primarily in the context of investment consultants serving defined benefit plans, as that was the typical retirement advisor relationship of the time) to one that more broadly encompasses the ways that retirees today receive advice (on both their defined benefit plans, and their defined contribution plans of various types).
Which means that while in the past, a fiduciary relationship only occurred to “investment recommendations made on a regular basis, based on a mutual understanding that is the primary basis for investment decisions, and individualized to the needs of the plan”, now fiduciary advice would occur any time “investment advice is given, in an advice relationship, to a retirement investor [for compensation]”.
And “investment advice” was itself broadly construed to include recommendations regarding:
- The advisability of acquiring, holding, disposing of, or exchanging, securities or other investment property;
- rollovers, transfers, or distributions from a plan or IRA, including whether, in what amount, in what form, and to what destination such a rollover, transfer, or distribution should be made; and,
- how securities or other investment property should be invested after the securities or other investment property are rolled over, transferred, or distributed from the plan or IRA.
The notable shift in
In essence, the DoL simply took the brokerage and insurance agent industry at their advertising word, that given the way they now hold out to the public as being in the business of “advice” (for which brokerage services are often literally just a footnote), then those firms would be regulated the only way “advice” has ever been regulated once a special relationship of trust and confidence forms: as a fiduciary.
Given these dynamics, a number of major organizations that represent the product distribution (i.e., sales) portion of the financial services industry banded together to fight the DoL’s fiduciary rule. Because the reality is that actually imposing a full-blown fiduciary duty on sales activities is, in fact, very disruptive.
Accordingly, the Financial Services Institute (representing independent broker-dealers), SIFMA (representing the broader securities industry) and the Insured Retirement Institute (representing the annuity industry and annuity agents) joined together to file suit against the Department of Labor. Their premise: brokers and insurance agents should not be regulated as fiduciaries… because they’re not actually advisors in the first place (business cards notwithstanding!). They’re simply salespeople in the business of selling investment and annuity products to consumers in a non-advisor capacity.
Thus, in their
Of course, it’s almost impossible to have a modern-day communication between even a financial services product salesperson and a customer not at least have some mention of advice, but the brokerage and annuity industry brief pointed out that while:
“Brokers may provide some financial advice when assisting investors with a sale… this by itself does not convert them into an adviser — much less a fiduciary. As the Advisers Act makes clear, an ‘investment adviser’ does not include ‘any broker or dealer’ who provides advice that is ‘solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.’” -FSI & SIFMA in representing their brokers to the court.
Indeed, the
And it went on to point out that:
“Relationships that lacked that special degree of ‘trust and confidence’ — such as everyday business interactions — were long-recognized as non-fiduciary. For this and other reasons, ‘a person acting as a broker ordinarily is not a fiduciary’ and similarly that an agent who receives a commission on the sale of a product is not paid for ‘render[ing] investment advice… She is paid for effecting the sale.’”
In fact, the product distribution industry emphasized that the commissions that brokers and annuity agents earn cannot be compensated for advice, stating that “the payment is for effecting the sale, not for any advice, [which] is clear from the fact that agents are paid only if they make a sale, regardless of how much ‘advice’ they provide in connection with it.”
In essence, the crux of the argument from the product distribution industry was that the Department of Labor was overreaching by applying the fiduciary rule to salespeople beyond its original purpose… which was only to apply the fiduciary rule to actual advisors in a relationship of trust and confidence. And the product distribution industry insisted that their salespeople are not in a special relationship of trust and confidence acting as advisors, and that their brokers and annuity agents don’t receive commissions, 12b-1 fees, etc., to compensate them for their advice. They receive those payments merely for effecting the product sale.
Similarly, the
“The Department [of Labor] conceded that it can regulate such advice only if the parties to the sales are in relationships of trust and confidence. Yet [the DoL] failed to identify substantial evidence that sales of these [annuity] products actually take place in such [trusted advice] relationships.”
IALC went on to lament that the DoL fiduciary rule was overly broad because “A one-time sales pitch could thus render a person a fiduciary and trigger the prohibited transaction provisions.”
Notably, they weren’t criticizing the consequences of a one-time advice engagement, but a one-time sales pitch, in their own words. Because, as they note, “Congress imposed restrictions on advisers who actually occupy a position of trust and confidence. The question here is whether those who provide advice incidental to sales of fixed annuities occupy positions of trust…” which IALC contends their annuity salespeople are not, and thus why they shouldn’t have been subjected to the DoL’s fiduciary duty.
This argument was further reiterated by
And the court agreed,
After all,
The court then went on to note: “Stockbrokers and insurance agents are compensated only for completed sales, not on the basis of their pitch to the client. Investment advisers, on the other hand, are paid fees because they ‘render advice’.”
In other words, the financial product distribution industry successfully persuaded the appeals court that the original distinction between sales and advice that has existed for decades should have continued to apply in the context of the DoL’s fiduciary rule, allowing an exemption from the fiduciary rule for the product salespeople in brokerage firms and operating as annuity agents who aren’t in the business of giving financial advice.
In fact, the court stated that “transforming sales pitches into the recommendations of a trusted adviser mixes apples and oranges” and explicitly stated that:
“The rule expressly includes one-time IRA rollover or annuity transactions where it is ordinarily inconceivable that financial salespeople or insurance agents will have an intimate relationship of trust and confidence with prospective purchasers.”
In other words, the financial product distribution industry is hailing it as a great success that it convinced two out of three Appeals Court judges that it’s “inconceivable” that a broker or insurance agent could actually be functioning as an advisor with an intimate relationship of trust and confidence with a client.
Nevermind, of course, that most of those firms use the advisor title, market themselves as advisors, convey that advice is what clients will be getting, may have already delivered a comprehensive financial plan, or could already be giving other ongoing fiduciary advice before this particular “one-time” IRA rollover event. (E.g., for the existing client who is now retiring and rolling over a retirement plan to consolidate with the client’s other accounts already with that advisor.)
Fortunately, at least one judge did recognize this reality. As
In essence, the dissenting judge was emphasizing that it wasn’t the Department of Labor’s rule that was causing brokers and annuity salespeople to be caught up in the fiduciary duty. It was their own actions in providing investment advice and specific client recommendations — on which their clients might rely in making an investment advice — that were triggering their fiduciary status!
In the near term, the immediate ramifications of the appeals court’s decision remain unclear. While the court itself moved to vacate the DoL fiduciary rule in its entirety — finding that the Department of Labor fundamentally overreached by extending the fiduciary duty away from advisors and onto non-advisor salespeople as well —
Which means the lawyers will now begin to debate whether the 5th Circuit ruling should trump the 10th Circuit’s, or whether there is a split decision that needs to be re-heard by the full 5th Circuit (as the initial ruling was from just three judges, and not the entire 5th Circuit panel of judges), or whether a split decision in the appeals courts could even go all the way to the Supreme Court (where, ironically, the financial product distribution industry would have to lobby even harder to make the case that their brokers and insurance agents do not give any advice). In the meantime, there is
In a world where the Department of Labor was still trying to sustain its fiduciary rule, a 5th Circuit re-rehearing, or a subsequent appeal of the split decision to the Supreme Court, would have been likely, as the DoL fought to defend its rule. But the path is less certain given that
In the meantime, though, further delay of the fiduciary rule may also stir more states to act. After all, Nevada has already passed its own state fiduciary rule (which they acknowledged was done in part to protect their citizens after the DoL fiduciary rule was delayed), and
Notwithstanding that two-out-of-three 5th Circuit Appellate judges believed the industry’s claims that they’re only salespeople and not in the advice business,
Ultimately, technology will continue to undermine the classic product sales model and compel brokerage and annuity salespeople to give more advice as a value-add to justify their cost. Accordingly,
In fact, viewed through this lens, fiduciary regulation is not actually a cause of industry change at all; it is an effect, a result of technology shifting the financial advisor value proposition and leading everyone — whether at an RIA, a broker-dealer, or an annuity agency — to increasingly give advice. Leading regulators update the regulations to reflect this reality.
That being said, it’s worth recognizing that there is still a role for pure product sales transactions in the marketplace today. After all, while most financial advisors only see the role that we as financial advisors play — giving advice, and making recommendations pursuant to that advice — the role of the brokerage industry overall is broader.
When a do-it-yourselfer has a direct relationship with an online brokerage account, but needs to make a call for assistance to place a trade, that is a broker … and one clearly not in the role of giving advice.
And the process of companies issuing stock in an initial (or secondary) public offering, or raising capital by issuing a bond — for which originating brokerage firms and their brokers have to literally sell the stock or bond to investors to distribute the offering — is a sales-based transaction that is essential to our economic system’s capital formation process.
Sometimes, the public just wants to talk to a salesperson to help them effect a sales transaction. After all, when I walk into a clothing store in the mall, I’m not looking for a personal fashion consultant; sometimes I just want a salesperson to help me complete the process of buying what I want, and giving me the relevant product information I need to make the decision.
In this context, it is arguably fair to suggest that perhaps the DoL’s rule really didn’t leave much — or enough — room for the kind of non-fiduciary truly-non-advice sales transactions that do happen in the brokerage and annuity industries.
As Judge Stewart did note, the rule arguably left room for a pure order-taking broker, who simply acts on the client’s instructions and does not provide anything that even might be construed as a recommendation. But at the same time, there was not exactly a clear “seller’s exemption” for those operating in a sales capacity with the general public (though notably there was actually a seller’s exemption to protect sales pitches to plans with greater than $50M of assets, that were presumed to be sophisticated enough to understand the nature of the sales-not-advice relationship).
Perhaps if the Department of Labor had provided a clearer seller’s exemption, that would have allowed brokerage and annuity salespeople to clearly avoid the fiduciary duty — and the need for the best interests contract exemption — there would have been less of an objection from the industry in the first place, as the entire basis of their (now successful) lawsuit would have been rendered largely moot.
For instance, what if DoL had included an option that salespeople were exempt from their fiduciary obligations as long as they:
- Clearly communicated to the public that they were a salesperson and not an advisor (i.e., reforming the use of titles);
- Didn’t give advice that was more than solely incidental to the sale of their products (conforming to the SEC’s existing framework under the Investment Advisers Act of 1940); and,
- Were not already in a separate or ongoing relationship of advice and trust (i.e., salespeople who were selling a product after delivering a financial plan, or providing other advice, such that an ongoing advice relationship would have already been established at the time of sale).
In other words, while I’m not personally convinced that the Department of Labor “overreached” by simply
In point of fact, this is why
Accordingly, I can only hope that going forward, either the DoL will maintain its rule but add in a retail seller’s exemption, or the SEC will take up the issue of titles — and specifically, what titles imply about whether the broker is breaking the “solely incidental” exception.
It seems patently absurd that a broker can literally market “financial advisor” as their primary job function on their business card, yet maintain in the appeals court that their advice was solely incidental to the sale of products.
Consumers should have the choice between advice and sales… once advisor and broker titles are clear.
In the end, it’s not really about the “right” standard — suitability versus fiduciary — to apply across financial advisors and the brokerage industry. It’s about recognizing that brokers and annuity agents fulfill a sales role that is functionally different than actual advisors. Job titles and disclosures should accurately reflect the nature of those relationships.
Once the distinction between advice and sales is truly clear, let consumers make their choice.
So what do you think? Has the product distribution industry now denied that it is in the business of giving consumers advice? Will the Department of Labor or SEC end up creating a retailer seller’s exemption? Should sales be separated from advice rather than creating a uniform fiduciary standard?
