Insights from the experts in investment fiduciary responsibility.

Fiduciary Hedge Clauses, Mary Jo White, and the Pending Rule

Posted by Duane Thompson on February 14, 2013

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>>>>The Investment Advisers Act of 1940 has long prohibited so-called “hedge clauses,” provisions in an advisory agreement that waive compliance with any provision of the Act. In terms of the advisor’s fiduciary duty, any effort to waive it would be folly – unless you are Congress or the SEC.

In its own inexplicable wisdom, Congress chose to narrow the parameters of the fiduciary duty under the Dodd-Frank reform act by limiting investment advice to retail customers, and curtailing the duty once advice is dispensed. The prognosis for preserving the traditional fiduciary standard isn’t much better at the SEC, unless the putative new SEC Chairman, Mary Jo White, proves to be a wild card.

Form has overtaken substance in the fiduciary debate, with opponents conceding the reality of a fiduciary duty but still resisting its traditional application to “investment advice.” Wall Street is merely playing the old shell game, by shifting  the old battle over “solely incidental” investment advice -- advice exempted from fiduciary oversight under the Merrill Lynch rule -- to investment advice exempted under Dodd-Frank. 

If SIFMA, Wall Street’s advocacy group, had its way, the new fiduciary duty for securities brokers would be limited to advice on individual securities transactions and portfolio management. This may seem to be a big concession, given the broad activities that one associates with investment advice on stocks and bonds and in managing portfolios. Unfortunately, SIFMA also served up novel arguments on why traditional fiduciary activities associated with these activities, such as development of asset allocation strategies, the use of financial planning tools, asset balance reminders to clients with non-discretionary accounts, and needs analysis of investment objectives, were not really investment advice.

In early January, SIFMA went on to predict that a fiduciary rule, or concept release requesting information on costs and benefits, would be forthcoming in the first quarter of this year. After more than a year of regulatory impasse, even this rosy forecast had to be moved back to the second or third quarter of 2013. This was undoubtedly due to the Administration’s surprise announcement of Mary Jo White, a former prosecutor, to chair the SEC, thereby placing acting Chairman Elisse Walter in a caretaker role until the Senate approves the nomination.

As someone who has made a career of writing legal briefs for the courts but not dense policy prose, Mary Jo’s stature looms large but uncertain in the fiduciary debate.  Recent reports from inside the SEC show continued gridlock, and in some quarters, a lack of interest in adopting a fiduciary standard.  Even the Commission staff remains divided over a principles versus rules-based approach, illustrated by one incident in which some SEC staff wanted to gloss over compliance problems in a release seeking comment over  a temporary fiduciary rule granting streamlined principal trading for broker-dealers.  If this is the proverbial canary in the coal mine, then the prospects do not look good for a broader rule.

Another sign of threats to the traditional fiduciary standard is a controversial approach reportedly under consideration by the Commission in seeking public comment.  This approach would be to release for public comment an unorthodox proposal, one focused not on a final rule, or the cost-benefits of a fiduciary standard, and arguably, not even a proposal.  Instead, the SEC would be putting the proverbial cart before the horse by soliciting suggestions on ways of harmonizing broker and adviser rules under a fiduciary standard.  More importantly, this would allow the Commission to avoid making assumptions on the shape of a fiduciary rule in a concept release, which often gives insight into the Commission’s thinking.   One can argue that this completely undermines the purpose of  the rulemaking process, and thereby the Administrative Procedure Act, by not providing assumptions of what the fiduciary standard might look like.  In what amounts to a regulatory sleight of hand, when the final fiduciary rule was released for public comment, comments would be focused on what would be, in practical terms, a series of harmonized rules comprising a fiduciary standard, not on a fiduciary standard alone.  Only the imposition of a fresh perspective, in the form of Mary Jo White, could derail this approach.  Of course, until the Senate confirms her nomination, Mary Jo will offer no hint of her position on the shape of a fiduciary rule, or anything else for that matter, except an emphasis on enforcement.

One would like to think that President Obama had Wall Street in mind when he announced Mary Jo as his choice for SEC Chairman.  Noting her diminutive size as she stood next to him at the podium, he added after his formal remarks, “You don’t mess with Mary Jo.”  It will be up to Mary Jo, in turn, to keep her own agency from messing with the fiduciary standard.

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