Preliminary Solicitation of Public Comments: Fiduciary Conduct Standard for Broker-Dealers, Agents, Investment Advisers, and Investment Adviser Representatives

June 26, 2019 – XY Planning Network

Subject: Fiduciary Rule comment
From: Michael Kitces

RE: Preliminary Solicitation of Public Comments regarding Proposed Fiduciary Rule

Dear Secretary Galvin:
We are writing to voice support for the Massachusetts Securities Division (MSD) proposal regarding a fiduciary standard for all investment advice provided in the state of Massachusetts.

We represent XY Planning Network, which provides business support services to 990 advisor members currently providing fiduciary financial planning advice in states across the country. All of our members currently operate solely as fiduciaries, registered as investment advisers. Our focus is to provide fiduciary financial planning advice to Gen X and Gen Y consumers, without any asset minimums and without any product sales (as all of our members are Fee-Only and none of our members are FINRA-registered).

At XYPN, we believe that all financial advice should be delivered under a fiduciary standard, as the very essence of what it means to provide "advice" is to provide "guidance or recommendations offered with regard to prudent future action", which inherently is framed as the appropriate future action for the recipient of the advice (i.e., in their best interests). Thus, when the Supreme Court enshrined a fiduciary duty for Registered Investment Advisers in the case of SEC vs. Capital Gains Research Bureau, it acknowledged that "the [Investment Advisers Act of 1940], in recognition of the adviser's fiduciary relationship to his client, requires that his advice be disinterested."

However, we believe and recognize that broker-dealers to play a vital function in the capital formation process, and the ability to investors to access and participate in (secondary) capital markets, as well as the broader distribution of financial services products (alongside insurance/annuity agents), which are inherently sales and not advice-based fiduciary functions.

As a result, we do not believe that it is appropriate to apply a uniform fiduciary standard to all RIA and broker-dealer (and insurance/annuity agents) entities operating in the state of Massachusetts, which risks impairing the important roles that broker-dealers and insurance/annuity agents play.

Instead, we believe a more effective approach is to establish a clear bright-line division between advice and sales activities, and to regulate all advice-based activity (or the act of holding out as providing such advice) as fiduciary, while allowing firms a choice to engage in non-advice-based product sales and other non-advice-based brokerage activities (with marketing and titles that are commensurate with that purely-sales-based role). Which in turn preserves a choice for consumers between engaging with an advisor for advice, and a sales representative for a transactional purchase – with a clear understanding of the nature of the relationship by regulating the titles used and how advisors and brokers hold out to the public, effectively requiring a clear enumeration of whether the provider is being engaged as a (fiduciary) advisor or a (non-fiduciary) salesperson.

The (Failed) Regulatory Separation Of Sales And Advice
The core framework of the separation between brokers and investment advisers – and the separation of sales from advice – dates back to the origin of the Investment Advisers Act of 1940, which occurred after the Securities Exchange Act of 1934, and specifically created a new class of (registered) investment advisers to whom additional and higher standards of care would apply, and from which only a delineated segment of broker-dealers may be carved out.

Specifically, the '40 Act declared that an investment adviser included:

"…any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to …the advisability of investing in, purchasing, or selling securities…․"

In turn, to ensure that consumers still have the choice of engaging with an investment adviser or a broker-dealer, Congress specifically carved out the Section 202(a)(11)(C) exception for broker-dealers, stating that the "investment adviser" term did not include:

"…any broker or dealer whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor…" (emphasis mine)

The Merriam-Webster dictionary defines "incidental" as:
1) being likely to ensue as a chance or minor consequence; or
2) occurring merely by chance or without intention or calculation

In this context, "solely incidental" advice would constitute advice that occurs either: a) by chance; b) as a consequence of product sales (i.e., that the sale would precede the advice, and not the other way around, such that the advice was a consequence and not an antecedent); or c) without intent to give advice.

Notably, this language implicitly suggests that Congress fully anticipated that there would be broker-dealers whose level of advice did arise to the point that it necessitated investment adviser registration, such that broker-dealers giving any level of advice could avoid it only if they received no special compensation and the advice was no more than solely incidental to the delivery of brokerage services.

In fact, in its 5th Circuit Court of Appeals brief regarding the Department of Labor's fiduciary rule, the Financial Services Institute (FSI) and the Securities Industry and Financial Markets Association (SIFMA) pointed out that:

"Relationships that lacked that special degree of "trust and confidence"—such as everyday business interactions—were long-recognized as non-fiduciary. For this and other reasons, a person acting as a broker ordinarily is not a fiduciary" and similarly that "an agent who receives a commission on the sale of a product is not paid for "render[ing] investment advice… She is paid for effecting the sale." -FSI & SIFMA in representing their brokers to the Court (emphasis mine)

In turn, the 5th Circuit agreed that:

"Stockbrokers and insurance agents are compensated only for completed sales, not on the basis of their pitch to the client. Investment advisers, on the other hand, are paid fees because they 'render advice'." -5th Circuit Court of Appeals Decision on DoL Fiduciary (emphasis mine)

The caveat, however, is that while the brokerage industry has (correctly) made the case that transactional sales relationships are not fiduciary advice relationships of trust and confidence, their marketing belies that relationship.

In 2017, the Consumer Federation of America reviewed the marketing of 25 major brokerage firms and insurance companies, and found in a study entitled "Financial Advisor or Investment Salesperson? Brokers and Insurers Want To Have It Both Ways" that all of them were using titles and marketing services that were advice-centric, including referring to their financial professionals not as salespeople but as "financial advisors", referring to their services as investment "advice" and retirement "planning" (not investment and retirement product sales), and "they market those services with messages whose clear intent is to convince retirement savers that they should trust that their advisor will be looking out for their best interests"… despite relying on a broker-dealer exemption that they are acting primarily as salespeople for which any advice is "solely incidental" to the sale of brokerage products.

Similarly, in its Comment Letter objections to the Department of Labor's fiduciary rule, SIFMA raised concerns that the proposed fiduciary rule would "limit access to advice" from broker-dealers… even while relying on the broker-dealer exemption that they are not in the business of advice, and that any such advice was/is "solely incidental" to their sale of brokerage products and services.

How Regulation Of Advisor Titles And Holding Out Can Remedy Consumer Confusion While Preserving Choice
Nearly 80 years ago, Congress enacted a bright-line separation between sales and advice, effectively separating the capital formation, capital markets, and product distribution sales functions of broker-dealers (and insurance agents) from the investment advice functions of actual advisors.

Unfortunately, though, the SEC over time has been increasingly lax in its enforcement of the "solely incidental" exemption, and this lax enforcement of the separation of sales from advice, and the appropriation of advice-centric titles and marketing by sales organizations (while relying on the solely incidental exemption), has resulted in investor confusion about the distinct roles of broker-dealers versus investment advisers, both in Massachusetts, and states across the nation. 

Nonetheless, we ultimately believe that the fundamental separation of advice from sales, as enumerated by Congress in the Investment Advisers Act of 1940 is an appropriate approach to preserve the relevant services that broker-dealers (and insurance agents) do provide, while applying the appropriate fiduciary duty to the delivery of advice, both nationally and within Massachusetts.

Accordingly, we believe that the Massachusetts Securities Division can relieve investor confusion with an enforcement approach that applies a fiduciary duty based on whether the firm holds out as being in the business of advice, and/or uses titles to imply an advice relationship, and/or actually delivers more-than-solely-incidental advice services (relying on a stricter interpretation of "solely incidental" than the SEC's lax enforcement), while allowing brokerage and insurance agent salespeople to avoid fiduciary obligations in the state of Massachusetts by clearing marketing and communicating that they are salespeople (and not in the business of advice). And we believe that this is a superior approach over applying a uniform fiduciary relationship to all investment advisers and broker-dealers, at the risk of disrupting the key capital formation and capital markets functions that a narrower but important subset of broker-dealers still play (as was their original regulatory-sanctioned purpose).

In the end, by separating the regulation of sales from advice, and holding firms accountable based on the services they promise (through their use of titles and consumer marketing), choice is preserved, both for consumers (who have a straightforward choice between a salesperson or an advisor), and for firms (that have a choice about whether to be subjected to a fiduciary duty or not based on whether they choose to communicate that they're in the business of [fiduciary] advice, or solely in the business of product sales [with titles and marketing that clearly communicate such sales-based services]).

Fiduciary Regulation Of Advice Will Not Limit Consumer Access To Advice
While certain detractors of various state (and Federal) fiduciary proposals have raised concerns that a fiduciary duty will make it 'impossible' to do business in the state, and/or that Massachusetts (or other states') consumers will lose access to financial advice, we feel it is crucial to point out that XY Planning Network has quickly grown over just the past 5 years to a network of nearly 1,000 advisors, all of whom operate fully and solely under a fiduciary standard with a particular focus on Gen X and Gen Y consumers, and do so without any asset minimums or product sales. Instead, XYPN members simply charge a financial planning fee for services rendered. 

In other words, XY Planning Network has already actively demonstrated that it is feasible to serve the marketplace under a fiduciary standard, without asset minimums or product sales, simply by making fiduciary financial advice available to anyone who is ready to pay a professional for such advice. While some brokerage firms may suggest that it is not feasible to deliver advice to the middle market cost effectively, we are living proof – at a scale that already nears the size of a top-30 broker-dealer by advisor headcount, and growing at a pace of more than 30 new advisors per month. 

In addition, we are living proof, at nearly 1,000 advisors of scale and growing rapidly, to reject the notion that imposing a fiduciary standard creates untenable liability for advice professionals serving Massachusetts consumers. In fact, XYPN provides Errors & Omissions insurance directly to the majority of our members, and in 5 years have never had a single claim filed in any year against any member. And as a result of the extremely low litigation risk of fiduciary advice, E&O underwriters are able to price such insurance for our members at less than $100/month, far cheaper than typical E&O coverage at broker-dealers (whose claims rates are likely higher because of the attempt to deliver conflicted advice instead of fiduciary advice).

In other words, fiduciary advice to the middle market doesn't have to be prohibitively expensive; instead, we have demonstrated in practice that it can be delivered cost effectively, and when done with our high XYPN standards (including a ban on advisors with a problematic regulatory history, and a requirement of at least 3 years of experience and CFP certification before holding out to the public as an XYPN member), results in lower E&O insurance costs and legal liability contingencies to deliver fiduciary advice than the typical conflicted-advice brokerage model today. In other words, a fiduciary rule can actually lower the cost of advice, while also raising standards for Massachusetts investors.

Consequently, to the extent that brokerage firms and other opponents of the Massachusetts fiduciary proposal have suggested that they may abandon the state and/or find it untenable to serve Massachusetts consumers when held to such a standard, organizations like XY Planning Network and its soon-to-be-1,000+ advisors stand ready to serve Massachusetts consumers and provide investment advice on a fiduciary basis under the rule as proposed, without investment minimums or conflicted product sales.

Ultimately, we simply believe that consumers deserve a choice – between a salesperson or an advisor – and that Regulation Best Interest actually is an appropriate standard for (brokerage) salespeople (operating purely in a sales capacity), while a fiduciary rule is best for anyone who provides advice (or holds out and implies an advice relationship).

And so while we strongly urge Massachusetts to move forward with a fiduciary rule, we do suggest that broker-dealers be allowed to continue to provide brokerage-only services, as long as their marketing clearly conveys the limited non-advice scope of their services. To the extent that still results in any broker-dealers leaving Massachusetts, XYPN's substantial and growing base of advisors are ready and willing to provide fiduciary advice to Massachusetts consumers in their absence.

Respectfully,
- Michael Kitces, Co-Founder, XY Planning Network
- Travis Johnson, Director of Compliance, XY Planning Network