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Discussion surrounding the implementation of the “fiduciary rule” — which calls on financial advisers to act in the best interest of their clients — has thrown into sharp relief the disparity in protection investors receive from different types of advisers.
Joseph Brenner, chief counsel of the Securities and Exchange Commission’s Division of Enforcement, told a public meeting of investment lawyers in March that financial advisers who are held to a fiduciary standard face greater scrutiny for negligence than others in the field.
Registered investment advisers (RIAs) are regulated by the SEC and held to a fiduciary standard, whereas broker-dealers — governed by the Financial Industry Regulatory Authority, an industry self-regulator — are held to a less stringent “suitability standard”. Broker-dealers need only show that their recommendations are suitable for clients and not necessarily in their best interests.
As of June 9, under a new US Department of Labor rule, certain broker-dealers are also held to the higher fiduciary standard when advising on retirement accounts.
“A greater scrutiny for negligence is one of a number of benefits the fiduciary standard has for investors,” says Barbara Roper, director of investor protection for the Consumer Federation of America, a lobby group. “Being a financial adviser implies a careful process. Advisers should be competent to determine what’s in their clients’ best interests. And if advisers embrace a fiduciary standard they would likely have a better defence against claims of negligence.”
Whether the extension of the more onerous standard leads to more or fewer advisers being challenged on the suitability of their investment recommendations remains to be seen.
Several recent SEC rulings have considered whether advisers were negligent. Most involve either an investment adviser who was aware of something — such as a conflict of interest — that should have been disclosed to the client but was not, or the adviser did something that was inconsistent with what they had represented to their clients.
For instance, in a case against the Robare Group, a Texas advisory company, the SEC proved on appeal last November that the adviser knew there was a potential conflict of interest but neglected to disclose details to its client.
Advisers can be negligent without realising they did anything wrong. When charging an adviser for negligence, the SEC does not need to prove they had any bad intention towards their client. Negligence simply compares the adviser’s actions to the standard of care they owe their clients.
“In a negligence case the defendant’s state of mind — their intent or lack thereof — is not pertinent to the analysis,” says Alan Wolper, a partner in the Chicago office of law firm Ulmer & Berne.
Civil litigators representing defendants and plaintiffs alike are reticent to talk about individual negligence cases and public records are few since most cases are settled out of court. However, Brian Hamburger, founder of Hamburger Law Firm, says negligence claims are a risk for financial advisers of all stripes.
He says the best defence for advisers is simply to act like a fiduciary in all relations with clients and provide full disclosure. “The first step is to be completely aware of all conflicts of interests — and if you can’t avoid or minimise them, you must disclose all of them,” says Mr Hamburger.
But he warns that disclosure alone does not satisfy the requirement that an adviser has acted in the client’s best interest.
Mr Hamburger says investors need to be engaged in the process and have a full understanding of all products and decision-making.