How Manipulative Language Muddied the Meaning of Advice

On September 22, Rutgers Law professor Arthur B. Laby will be honored with the Institute for the Fiduciary Standard Frankel Fiduciary Prize. Laby is renown in securities law for his research and writing on investment adviser and broker-dealer regulation and fiduciary advice. Two articles are particularly noteworthy.

Fiduciary Obligations of Broker-dealers and Investment Advisers. In this 2010 law review article, Laby drilled down on adviser and broker differences.

Laby addressed an issue that few do. It is the cultural and business differences – specifically what he called the “fundamental characteristic” – between advisors and brokers. Broker-dealers acting as principals, according to Laby, “cannot readily act in their customers’ best interest. Advisers are poles apart. Other than negotiating a fee, advisers are typically not in an adversarial position with their clients.”

Laby’s latest (2020) article, Advisors as Fiduciaries, should be a required primer. He includes a review of the classic advice professions and describes how advice is unique, important and necessitates client trust. Laby defines advice as to “give one’s opinion” as to the best course of action in a context of “close personal communications.” Laby’s premise is that advice is a human act delivered by competent, expert professionals who are loyal to clients.

Laby’s scholarship articulates the classical view of 40 Act investment advice in broad strokes. This includes the Supreme Court’s nod of approval in 1963 In its landmark case, Securities and Exchange Commission v. Capital Gains Research Bureau, Inc., et al. This view dominated until recently.

Today the SEC describes advice very differently. It can include sales, product recommendations, investment advice, planning, digital services. Digital engagement and behavioral nudges may soon follow.

Two changes stand out in the SEC’s new view of advice: redefining “best interest” and “conflict of interest”:

• The term “best interest” has long been associated with fiduciary care. Yet, in April 2018 the SEC proposed that the broker-dealer standard, Reg BI, be called a “best interest” standard. That is false and wrongheaded. The SEC admitted as much when it used awkward wording, ”not putting the interest of the BD or rep ahead of the customer,” to describe this lower broker-dealer standard.

• The Reg BI standard permits the interest of the broker or BD to be alongside the interest of the customer, while the fiduciary best interest standard “requires an investment adviser to put its client’s interests first.” This difference is stark. The Reg BI version replicates BD talk that proclaims customer, broker and BD interests are routinely in alignment.

• In the June 2019 final Reg BI rule, the SEC did not define “best interest” and argued that not defining the BD best interest is in the customer’s best interest.

• In the June 2019 final rule, the SEC redefined the meaning of conflicts of interest. Conflicts used to mean what the 40 Act framers said; a brokerage or sales incentive that impairs objectivity and is often not transparent to the customer. The point of the SEC’s Tully report on compensation practices under Chairman Arthur Levitt was to move the BD industry away from commissions and conflicts.

• Today, however, conflicts mean something completely different. According to the SEC staff in its August 3 staff bulletin, conflicts of interest can be distilled to, “an economic incentive (to make recommendations) that provide more revenue.” This conflates a business interest with a conflict of interest and means merely getting new business is a conflict.

• The SEC staff redefined conflicts with clarity; they described mitigation with ambiguity. The SEC staff stated that “appropriate” mitigation measures depend on the nature of the incentive, which depends on “some factors (that may include) …. sources of compensation … the extent to which the firm uses incentives … (variable) compensation … (or if) dually registered (reps).”

• In March 2022, under the Biden Administration SEC, the word “fiduciary” was effectively banned from form CRS. In June, the first major Reg BI enforcement case enforced the suitability standard. Then the staff bulletin redefined conflicts to make them meaningless.

The meaning of advice has been fundamentally altered through manipulative language. “Best interest” and “conflicts of interest” have been re-defined and reapplied by the SEC to advance its implicit goal and vision for a federal regulatory sales standard with minimal fiduciary care. Its strategy is underway. The SEC staff has said so, by declaring that fiduciary status is “extraneous.”

Join one or several Fiduciary September 2022 panels. Join our campaign. Nothing can be more important than fiduciary advisors helping ‘preserve, protect and defend’ fiduciary principles.

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.

More Fiduciary Rules Topics >