Moreover, FINRA stands to play a significant role in the fiduciary arena in any case if the standard is extended to broker-dealers providing investment advice. Presumably, anyone providing investment advice would be governed by the Investment Advisers Act of 1940, but broker-dealer requirements under the Securities Exchange Act of 1934 and FINRA rules would also require fine-tuning to ensure better continuity and consistency across the federal securities laws and regulations. Whereas the SEC's oversight of investment advisors is based on fiduciary principles, FINRA's operates under specific rules, and the differences in approaches may present particular challenges. The SEC may have to assert its experience in applying the principles if it wants to police the fiduciary standard to counter FINRA's rules-based regulation of broker-dealers.
Fiduciary Application And Harmonization
Ultimately, the application of the fiduciary standard to all investment and financial advisors will have serious practical implications for how the investment industry as a whole operates. The primary goal of regulatory reform has been to enhance investor protection, which is one of the reasons regulators want to more broadly apply the fiduciary standard. To that end, Schapiro spoke earlier this year of harmonizing the SEC's rules, but support for the concept has largely been mixed because of varying views of what harmonization ultimately means.
Certain members of the brokerage industry have used the idea to argue for new (and perhaps diluted) standards of care that would accommodate varying business and service models. These proposals have been sharply criticized because they place greater emphasis on appealing to special interests and promoting concepts of fair dealing rather than concepts of loyalty and trust. The standards created under this concept of harmonization could also introduce more instability into the regulatory system if there were uncertainty about how the standards would be interpreted and applied over time.
A more practical approach to harmonization would be to use rules to complement and strengthen fiduciary principles. Schapiro and Walter have both supported the application of a consistent fiduciary standard of conduct and have noted the importance of adopting rules to address the roles and functions of different financial intermediaries-an approach consistent with the way fiduciary roles have traditionally been defined through law. Under such a regulatory scheme, the principles-based fiduciary standard guides professional conduct and enhances enforcement, while clear and strong rules draw lines for behavior and prevent abuse.
The harmonization of the two spheres, however, will take time and will not necessarily cure all regulatory issues. As a starting point, the SEC must respond to any new legislation enacted in the fiduciary arena. Moreover, as it seeks to bring more clarity and consistency to the obligations of financial intermediaries, the SEC will be required to contemplate distinctions between investment service and product providers.
Regulators, for example, will have to tailor their guidance to better define when brokers are exempt from a fiduciary standard because their advice is "solely incidental" to their brokerage business. Regulators will also have to set requirements for inherently conflicted brokerage activity such as sales activity for initial public offerings. And regulators must determine whether brokers' interactions with institutional and retail clients warrant similar treatment.
None of these issues have easy solutions, and ideally Congress would enact legislation this fall codifying the existing definition of fiduciary and setting clear boundaries for regulatory policy-making and oversight. However, as lobbying efforts by special interests increase in the coming months, we run the real risk that legislators and regulators will get caught up in a game of semantics and lose sight of investor protection goals. The solution ultimately lies in helping lawmakers understand that investors are under a serious misconception about the duties of investment professionals. Legislators must also understand that the existing fiduciary standard is already rooted in a strong foundation of trust, loyalty and due care that will significantly boost investor protection if it is properly recognized and applied to all investment advice providers.
Kristina Fausti is director of legal and regulatory affairs for fi360, a firm that offers training, investment education and Web-based tools for fiduciaries and those who serve them. Before joining fi360, Kristina served for more than four years as a special counsel in the Office of Chief Counsel of the Division of Trading and Markets at the U.S. Securities and Exchange Commission and specialized in broker-dealer regulation.