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Daniel Razvi argues in Advisor Perspectives that no method of compensation is “better or worse” for fiduciary advice. He states, “Methods of compensation or conflicts of interest” … are not relevant to the “core concept of fiduciary.” This interpretation defies the origins of the law and Supreme Court that opined otherwise.
Razvi also makes the point that an advisor who looks in the mirror and sees an advisor who is “Trustworthy … honorable … knowledgeable … and gives good advice” … and he believes, “puts the client’s needs ahead of his own, “the Advisor is definitely a fiduciary.” This is fantasy, in my opinion.
He then claims proponents of a “new regulatory fiduciary standard argue strongly that an advisor’s manner of compensation is extremely important.” This is actually backward.
It is proponents of the original federal legislation in 1940 who took this stance, and it has been echoed by scholars, jurists, and policy experts today who stress the harmful impact of conflicted compensation to fiduciary advice.
The foundation of federal securities laws for investment advice and the importance of fiduciary duty derives from the Investment Advisers Act of 1940 (IAA). “Fundamental to the Act is the notion that an adviser is a fiduciary,” noted Robert E. Plaze, former deputy director of the Division of Investment Management of the SEC. A 2016 Fiduciary Institute paper discusses the importance of fiduciary duties and avoiding conflicts with the IAA.
Rutgers University Law Professor Arthur Laby writes on the history of the Advisers Act that “the Advisers Act grew out of study and reflection” and one of the main concerns “bedeviling advisory firms,” were tipsters. Laby explains (see page 2):
The first (reason) was that so-called “tipster” organizations were disguising themselves as legitimate advisory organizations. Certain firms providing advice were affiliated with investment banks or brokerage firms and, therefore, had a vested interest in recommending particular securities.
The main reason for the IAA, according to Laby, was to differentiate so-called tipsters from legitimate advice firms. The importance of differentiating advice from sales in regulation is clear.
The Supreme Court affirmed this rationale. In the 1963 Supreme Court landmark case, SEC v Capital Gains Research Bureau, SCOTUS affirmed the fiduciary duty of investment advisers.
The Court notes in its decision an SEC report:
The report reflects the attitude – shared by investment advisers and the Commission –that investment advisers could not ‘completely perform their basic function –furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments, unless all conflicts of interest between the investment counsel were removed. (page 5)
The importance of avoiding conflicts of interest to rendering unbiased advice is clear. Yet the Court still reiterated a few pages later the importance of an investment adviser not engaging in sales, and also the importance of only receiving compensation in “professional fees fully disclosed in advance.”
… Two fundamental principles upon which the pioneers in this new profession undertook to meet the growing need for unbiased investment information and guidance were, first, that they would limit their efforts and activities to the study of investment problems from the investor's standpoint, not engaging in any other activity, such as security selling or brokerage, which might directly or indirectly bias their investment judgment; and, second, that their remuneration for this work would consist solely of definite, professional fees fully disclosed in advance. (page 7)
The background of the Investment Advisers Act of 1940 reveals preserving “disinterested advice” was the priority of regulators and industry leaders in 1940. It remains so today. Disinterested advice requires avoiding conflicts, “not engaging in other activity” and only receiving fee compensation “fully disclosed in advance,” according to the United States Supreme Court.
Razvi makes statements that are incomplete, misleading, or just plainly wrong. He is joined in similar views by broker-dealer organizations like the Financial Services Institute. As a point of fact, the IAA was enacted in 1940 because “other activity such as security selling” … that “might bias their investment judgment” was common. Transparent fees were believed far superior.
Razvi suggests that established law affirmed by the United States Supreme Court, and reflected in subsequent case law, essentially no longer matters. Instead of looking to the law, advisors are urged to look to themselves and ask if they feel like fiduciaries. This is no way to inspire confidence from consumers.
There is much serious discussion about the “rule of law” today. This discussion is good and should be applied to the affective meaning of fiduciary today. Pressures from the brokerage and insurance industries over the past 20 years have effectively nullified the clear purpose of the IAA and the Supreme Court decision in 1963.
Knut A. Rostad is a co-founder and the president of The Institute for the Fiduciary Standard, a not-for-profit organization dedicated to furthering fiduciary principles in investment advice through education and advocacy.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
