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On March 1, two unrelated Securities & Exchange Commission actions set out the state of its thinking on enforcing the “best interest” and “fiduciary” standards.
The SEC released a video of Chairman Gary Gensler speaking on why “ESG” should be defined much like “fat-free” milk. The chairman stressed that investors need to understand core terms, and that attaching the ESG label to a product must have meaning, just as real as ingredients in dairy products sold to consumers.
Then, the SEC lambasted the RIA of a prominent broker-dealer for fiduciary failures in a lawsuit filed in U. S. District Court for the Southern District in Iowa. The SEC alleged that it, over the course of several years, “defrauded its advisory clients and/or repeatedly breached its fiduciary duty.”
These unrelated actions foretell what’s to come at the SEC with regard to protecting consumers’ interests against non-fiduciary brokers.
On its website, the firm talks about its “integrity” and industry “high standards.” Investment News named the firm “broker-dealer of the year” 13 times.
BDs and their RIAs give their reps flexibility and “freedom” to run their businesses. But that freedom went beyond allowing its reps the ability to customize their business to best serve their clients.
The SEC alleged widespread fiduciary duty breaches in five primary ways:
1. It failed to disclose material facts of conflicts when investing in more expensive no-transaction-fee (NTF) mutual funds and sweep funds, “while less expensive options were available that did not provide additional compensation.”
2. It failed to disclose conflicts associated with “wrap account clients purchase (of) NTF mutual funds” that were not in the clients’ best interest.
3. It “repeatedly violated its fiduciary duty.” The firm failed to provide “full and fair disclosure” when converting traditional accounts to wrap accounts. Instead, It provided “false and misleading information regarding the necessity of the conversion.”
4. It failed to “adequately disclose to clients” its program of forgivable loans for adviser reps – and its associated conflicts.
5. It failed to “adopt and implement written policies and procedures” on, among other things, recommendations in the “best interest of advisory clients.”
According to Investment News, the firm will “vigorously” fight the charges.
According to the firm, The SEC’s lawsuit is similar to pending complaints filed by the SEC against other firms. But that is a “middle school” defense, like saying something is acceptable because the other kids are doing it.
The lawsuit seeks to enforce a fiduciary standard by penalizing alleged flaws or omissions in disclosures. Chairman Gensler seeks to establish and enforce a higher standard of fiduciary care when it comes to investing and ESG product labeling.
In the video noted above, the chairman asked for the criteria and data behind claims that ESG funds are “green” or “sustainable.” He asked, “Where’s the data?” After all, as Gensler noted, we know what’s behind the claim of “fat-free” milk. It’s on the carton for the world to see.
With ESG, Gensler returned to his inaugural theme at the 2021 FINRA conference. He spoke bluntly and elicited smirks and grins by saying truth telling is good and ambiguity is bad.
Gensler’s disdain for “searching for some ambiguity in the text or a footnote” was plain. Asking “if something is over the line” is asking for trouble; it “may not be consistent with the law and its purpose.”
Gensler’s message to FINRA: “Best interest means best interest” and “The ’33 Act was called the Truth in Securities Law. Telling the truth matters.”
The audience eye-rolling and smirks from his language were profound. No one in the financial industry believes a regulator enforces “truth telling” and stamps out ambiguity. But this raw skepticism is a huge Gensler asset.
Gensler’s call to regulate ESG represents the best of fiduciary law. Law professor emerita Tamar Frankel explained that fiduciary law “can accommodate new situations and changes in social morals and norms, yet maintain its core values.”
Best interest in the context of Reg BI also merits definition so investors can understand the criteria that constitute its definition. From Reg BI’s release in June 2019, consumer advocates, have said so. That includes Barbara Roper, formerly of the Consumer Federation of America, and now a senior advisor to the SEC chairman. Roper called for the SEC to define best interest.
The SEC clobbered this firm for fiduciary breaches, as it could have done to many others. Professor Frankel wrote of “core values”; Chairman Gensler said that “telling the truth matters.” Replace “ESG,” “green” or “sustainable” in the ESG video with “best interest.”
The SEC chairman has launched a counter offensive of guidance and enforcement to raise conduct standards. We are in unchartered waters. Prepare for the unexpected that will come.
Knut A. Rostad, MBA, is the co-founder and president of the Institute for the Fiduciary Standard, a nonprofit formed in 2011 to advance the fiduciary standard through research, education and advocacy.
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
