Harmony—Such A Beautiful Word
The word “harmonization” has such a soothing feel to it. It conjures up images of combatants laying down their weapons, putting aside differences, and working hand in hand to find that common ground that would allow them to live in peace forever, world without end, amen.
For that reason, it is the perfect banner for the brokerage industry to raise as it continues its efforts to avoid being held to a true fiduciary standard when brokers give personalized investment advice to clients. It is a beautiful smoke screen—a dangerous deception.
If you care about the integrity of the current fiduciary standard, avoid the temptation to jump on the harmonization bandwagon. It is a trap. To appreciate how artfully the trap has been laid, we need to quickly trace the evolution of fiduciary regulation of brokers and advisors.
An Eye-Opening Walk Down Memory Lane
When Congress enacted the Investment Advisers Act of 1940 (Advisers Act), it made a distinction between brokers and advisors. Those who provided personalized investment advice to clients, with some exceptions, were subject to the Advisers Act. Brokers were one of the exceptions. If the advice provided was “solely incidental” to their work as brokers, and they received no “special compensation,” brokers were not subject to the Advisers Act.
This distinction made sense. Brokers sold securities. Advisors gave advice. In 1940, life was simpler. Everyone could tell the difference. Sure, in selling securities a broker might say something that sounded like advice. “Mrs. Jones, XYZ company stock is a great opportunity and we are recommending it to all our clients.” But if those statements were “solely incidental” to selling securities and the broker received only a standard commission in connection with the transaction, that advice did not turn the broker into an advisor under the Advisers Act.
The Advisers Act does not explicitly impose a fiduciary duty on advisors. But in 1963 the Supreme Court ruled that advisors subject to the Advisers Act had a fiduciary duty to their clients. Since that case, it has been clear that, under federal law, advisors have a fiduciary duty to their clients and brokers do not. Brokers are subject to the lesser “suitability” standard, arising under the Securities Exchange Act of 1934 (Exchange Act) and associated regulations.
By the 1990s life was not so simple. The lines between brokers and advisors had blurred. SEC Chairman, Arthur Levitt, formed a committee in 1994 led by Dan Tully, the chairman and CEO of Merrill Lynch. The committee’s mandate was to take a hard look at the brokerage industry and make recommendations or managing its conflicts of interest. In 1995, the committee issued the “Tully Report,” which recommended, among other things, that brokers should use asset-based fees, rather than commissions, to reduce conflicts of interest.
Fee-based brokerage accounts proliferated. At the same time brokers increasingly operated using titles like “financial advisor.” A broker calling himself a financial advisor and charging an ongoing fee looked an awful lot like a fee-based advisor who was subject to the Advisers Act.