If You Want Something Done Right

But the securities industry also has a firm grasp of another, equally essential point: The Achilles heel of the independent advisory world is costs. The independence of independent advisors has, at least historically, translated into small businesses with limited resources: resources that are further limited by revenues that come solely from the clients, rather than being subsidized by the highly lucrative product distribution end of the financial industry. Consequently, most independent advisory firms are extremely sensitive—and vulnerable—to increases in costs, such as the costs of regulation. One way to force independent advisors back into the securities industry fold would be to increase regulation, which not coincidentally is FINRA’s forte.

This agenda was not lost on Mercer Bullard. An experienced securities lawyer, Professor Bullard is a former assistant chief counsel at the SEC, and currently sits on the Commission’s Investor Advisory Committee. As a former regulator, he realized early in the process that led to Dodd-Frank that despite all the hoopla surrounding a fiduciary duty for brokers, when it came time to implement whatever was finally decided, independent advisors would be at a severe disadvantage; they had no cohesive organization to step up. This situation was exacerbated when the CFP Board-led Coalition for Financial Planning decided to focus its efforts on establishing a regulator for financial planners, effectively taking itself out of the RIA game.

To fill this void, Bullard and his law students have created an alternative called the Self-Regulatory Organization for Independent Investment Advisors, or SROIIA. It would be an SRO for the currently 34,000 or so independent RIAs only—no registered reps or dually registered advisors; Bullard & Co. will leave their regulation to FINRA. If accepted by the SEC as an SRO for RIAs, SROIIA would create rules and standards (presumably with approval by the SEC), enforce those rules, and conduct regular examinations. There would, of course, be membership dues and fees to cover the costs of all this. But because the organization would be owned and controlled by independent RIAs themselves, the costs could be managed in accordance with the needs of small businesses, which virtually all independent RIAs are.

To fulfill Dodd-Frank’s mandate that the regulation of brokers and investment advisors be “harmonized,” Bullard envisions SROIIA would need to become involved in the same areas that FINRA now regulates: Customer communication, advertising, supervision, licensing, continuing education, registration, arbitration, book and records, and relationships with finders and solicitors. The difference would be SROIIA would approach these issues from a “principles” perspective based on a fiduciary duty to clients, rather than FINRA’s rules-based approach, which currently appears to be more concerned with creating defensible safe harbors, rather than actually doing the right thing for the client.

Of course, SROIIA would also set rules and standards for a fiduciary duty to the clients. These would cover the content of brochures, and when and how they are delivered, how conflicts would be disclosed, and setting acceptable basis for investment recommendations. The timeline for SROIIA depends largely on the SEC and Congress: First, the SEC needs to recommend to Congress that RIAs need an SRO. Then Congress would have to authorize the SEC to approve the SRO. Then the SEC would accept applications to become an SRO for investment advisors. Given its recent posturing, FINRA undoubtedly would apply, as would SROIIA. Once the SEC grants approval for any or all of the applicants, RIAs could then sign up.

If the current rate of progress on the SEC’s Dodd-Frank mandates is an indication, we’re probably looking at much later rather than sooner for any new advisor SRO. The way things are going now, I’m guessing that’s just fine with many independent RIAs. Unfortunately, change in their little corner of the world appears to be inevitable—the only real question is whether it will be change they can live with. Like many supporters of a uniform fiduciary standard, I’m dismayed that the reregulation of investment advisors seems to have been shoehorned into the equation. In fact, FINRA’s recent actions make one wonder whether this was the plan all along.

At this point, with reduced funding rendering the SEC unlikely to remain as the regulator for RIAs, Mercer Bullard and his team appear to be right: The best outcome that independent advisors can hope for is to establish their own alternative to FINRA. At least that way, they could create a genuine fiduciary standard, be evaluated and regulated by their peers, and exercise control over the costs of all this new regulation—which holds the potential to put the entire industry out of business. It is indeed unfortunate that none of the independent advisory world’s current organizations have the ability or the vision to fill this role. I suspect that for years to come, we’ll be speaking of Mercer Bullard and his University of Mississippi law students in the same reverential tones as we currently do when remembering the founders of the old ICFP and IAFP, and their efforts to launch a profession of independent advice.