Ken Fisher Warns, Industry Responds: What Happens to RIAs in 10 Years?

Jane Wollman Rusoff is a New York-based freelance writer and contributing editor of Investment Advisor's sister publication, Research. She is the founder of Family Star Productions.

Ken Fisher Is Right About Demise of RIAs … and Wrong

By Ron Rhoades

(In response to ThinkAdvisor.com's interview with Ken Fisher that discussed in part the future of RIAs, Ron Rhoades posted comments on ThinkAdvisor.com that formed the basis of a full blog on the topic. Below is an edited version of his comments.—Ed.)

"All the features of the potential fiduciary standard, including mandatory arbitration elimination, are likely to backfire and blow back—maybe fatally—on the naïve RIA world. BDs will likely subsume and exterminate the RIA world because the BDs would like to take it over: Money has been coming out of BDs and going into RIAs for 40 years. The RIA world has been growing rapidly at the expense of the BD world. And the BD world hates that."—Ken Fisher

So is Fisher correct?

If the SEC, acting pursuant to Section 913 of the Dodd-Frank Act, imposes broad fiduciary standards upon broker-dealers (BDs) and their registered representatives (RRs) who provide "personalized investment advice," is this the death knell for RIAs?

In a sense, probably … yes. In another sense, no.

Since the 1970s, the SEC and FINRA have undertaken a series of wrong decisions that permitted brokers to transition from providing trade execution services to providing comprehensive financial and investment advice.

Yet, as will be seen, the SEC through its actions has diminished the fiduciary standard of conduct, and the BDs have already subsumed the reputation of all fiduciary advisors.

Whose "Best Interests" Are Being Looked After?

There is no question that BDs today are providing a large volume of personalized investment advice. And there is no question that the vast majority of consumers believe that they can trust their BDs and RRs to act in their best interests.

Yet despite assertions by BDs (and even by their industry lobbying organization, SIFMA, and by their membership "self-regulator," FINRA) that they do in fact act "in their client's best interests," nearly any objective observer would dispute such a conclusion. It is clear that most BDs and their RRs continue to sell expensive investments, often choosing products that pay them additional fees (through higher 12b-1 fees, payment for shelf space, receipt of soft dollar compensation and even payment for order flow, although this latter practice is de jure banned).

Indeed, BDs and RRs possess limited obligations to disclose the fees and costs of the products they sell. Their obligations to disclose and quantify their compensation are even more limited.

In essence, massive fraud occurs. While many BD firms and their RRs state that they act in their clients' best interests, the reality is that most act only in the self-interest of the BD firm and their RRs.

Contrasting Suitability and Fiduciary Standard of Care

The suitability standard is frequently applied to the provision of such advice, at least in many of the decisions of FINRA-approved arbitrators. This suitability standard relieves BDs and their RRs of the duty of care in recommending mutual funds and other pooled investment vehicles, a duty nearly all other service providers possess. Instead, their obligation under the very low suitability standard is, essentially, to not allow their clients to purchase products that are dynamite, i.e., "blowing up" each and every time. The weak suitability standard fails each and every day to protect consumer interests.

In contrast, the fiduciary standard requires extensive due diligence of the firm and individual providing advice. While a prudent investment portfolio is not required to be employed for every client, there must be clear disclosure of the fact that a particular recommendation is not prudent. Additionally, a full explanation of the risks, fees and costs are required of the fiduciary advisor.

Disclosing Away Fiduciary Obligation

In recent years we have seen the rise of the dual registrant: securities industry participants who are registered as both registered representatives and investment advisor representatives.

Under a strange and bewildering 2007 proposed regulation, the SEC permits BDs and their dual registrants to wear "two hats" at the same time, for the same client. This is permitted despite centuries of fiduciary law that indicate that the fiduciary obligation extends to the entirety of the relationship between advisor and fiduciary.

Moreover, the SEC also permitted in that 2007 proposed regulation dual registrants to "switch hats," seemingly at will. Of course, few clients understand such a change in role, and such a switch from a fiduciary role to a non-fiduciary role often occurs without the understanding and informed consent of the client.

Even worse, however, is the proposition seemingly accepted by the SEC (as evidenced by the questions posed in its March 2013 Request for Data in connection with Section 913 rulemaking) that "disclosure" of a conflict of interest is all that is required of a fiduciary advisor. Such a stance may come from a wishful (by BD firms and their legal counsel) misinterpretation of the SEC vs. Capital Gains decision.

Five Reasons I Concur With Ken Fisher

As Ken Fisher said in the ThinkAdvisor.com interview: "If you're an RIA, you'd better get un-naïve: The RIA world is at threat of being taken over by BDs in a regulatory sense. There's a good chance that the entire RIA world is gone in 10 years. The SEC doesn't seem to understand what it's doing."

In a sense, I concur with Ken Fisher. Why?

First and foremost, a huge lobbying effort is underway by Wall Street firms and insurance companies, and their many hired lobbyists, to sway not only Congress but the administration, the DOL, the SEC and other agencies to their views. Those who seek to lobby for the application of a bona fide fiduciary standard are outnumbered, in terms of visits to senators, congressmen and agency representatives, by a factor of at least 20 to one, and perhaps much more.

Second, Wall Street and the insurance industry are poised to pour a great deal more money at this issue. Wall Street knows that the application of a true fiduciary standard would destroy their highly profitable, high-intermediation-costs business model, and they will throw their full weight behind their opposition to a true fiduciary standard.

Third, the SEC's 2007 proposed rules and the SEC's lack of oversight and enforcement of investment advisory account practices today (particularly those housed with dual-registrant firms) have essentially bought into the proposition that one can negate the application of fiduciary standards through agreement with the client. In other words, the client can, by "consent" (which is altogether neither adequately informed nor evidencing of any real understanding by the client), waive a dual registrant's fiduciary obligations.

What we have now, in reality, is not a bona fide fiduciary standard at all. Rather, it is close to the "new federal fiduciary standard" touted by SIFMA and its many allies, who purport to "manage" conflicts of interest "through disclosure."

Fourth, FINRA, the big gorilla (who only wants to get bigger), lurks. Even if a bona fide fiduciary standard is restored, it remains highly likely that FINRA (with extensive lobbying by itself, as well as its member firms) will obtain oversight of RIAs. We cannot expect that an organization that has failed for over seven decades to raise the standards of conduct of its members will suddenly transform and embrace a true fiduciary standard. Rather, FINRA is an organization that serves not the public, but its member BD firms, and it will use its rule-making powers and influence at every turn to seek to prevent the application of the fiduciary standard, or so weaken it that the fiduciary standard becomes a meaningless footnote in the to-be-written history of securities regulation.

Fifth, what if the SEC does not apply fiduciary obligations upon BDs who provide investment advice, as is certainly possible? What is the result if two different groups provide the same services under different standards of conduct? As explained many decades ago by Nobel-prize winning economist George Akerloff in his paper, "The Market for Lemons," a "rush to the bottom" occurs. Simply put, those operating under a lesser standard of conduct are able to extract greater rents from their customers. As a result, securities industry participants who do not possess a strong personal ethos migrate to the non-fiduciary platform. The fee-only, fiduciary advisory community remains small in comparison.

A New Definition for 'BFFs'

Yet I foresee that fee-only and other true fiduciary advisors who seek to avoid (not simply disclose) conflicts of interest, and who receive much-deserved professional-level compensation for their expert advice, will still exist, even if all of the foregoing comes to pass.

True fiduciary investment advisors will have to work harder to distinguish themselves. In fact, they may need to call themselves "BFFs"—not "best friends forever" in the language of instant messaging, but rather "bona fide fiduciaries." Through interview checklists and educational materials these BFFs will continue to educate consumers, and they and the media will guide consumers in increasing numbers to true fiduciary advisors.

Still, forces may arise that will lead to the destruction of bona fide fiduciaries. As Fisher observed, Wall Street does not like to see its market share decline. Hence, Wall Street's captured regulator, FINRA, will likely (after gaining oversight of RIAs) issue a host of new regulations, making it difficult for any RIA-only firm to survive. As seen in recent years with the decline of smaller BD firms under the weight of FINRA's rules, smaller RIA firms will find it difficult to stay in business. The cost of entry for new RIA firms will reach an entirely new high as well, due to high regulatory costs and high capital requirements imposed by FINRA (even though many RIA firms will continue to not accept custody of client securities).

This, I believe, is the future that Ken Fisher observes.

We can only hope that Fisher's vision and the slide of RIAs toward oblivion does not occur, for the sake of all of our fellow Americans who both need and deserve truly objective, bona fide fiduciary, personalized investment advice. For the sake of capital formation unimpeded by dramatically high intermediation costs. For the sake of the future of the American economy, and America itself.

Ron Rhoades is assistant professor in the business department of Alfred State College, and is the owner and principal of ScholarFi Inc.

Why Ken Fisher Is Wrong About the Future of RIAs

By Bob Clark

In a candid interview with Jane Wollman Rusoff for ThinkAdvisor.com, the outspoken investment manager Ken Fisher suggests that the brokerage industry has managed to turn Dodd-Frank Section 913 on its head, with dire consequences for independent RIAs (the Fisher interview prompted much soul-searching and responses from advisors).

While Ken's a smart guy and not to be discounted out of hand, hopefully the best part of his current view is his depiction of the brokerage industry—and not his predictions of a dim future for RIAs.

Despite his belief that it ultimately will come out on top of the Dodd-Frank reregulation, Fisher isn't laudatory of the brokerage industry: "The BD world always has been the 'evil empire,'" he told Rusoff. "BDs will likely subsume and exterminate the RIA world because the BDs would like to take it over: Money has been coming out of BDs and going into RIAs for 40 years. The RIA world has been growing rapidly at the expense of the BD world. And the BD world hates that."

Then Fisher goes on to tell us exactly how the BDs will exact their revenge: The securities industry "is effectively posturing the regulators for their benefit in all this stuff coming out of Dodd-Frank pertaining to the interrelationship between BDs and RIAs[…]. All the features of the potential fiduciary standard, including mandatory arbitration elimination, are likely to backfire and blow back—maybe fatally—on the naïve RIA worlds."

Strong stuff, for sure. And yes, I'm well-aware that the independent advisory world has been hearing this threat at least as far back as the mid-1980s, when FINRA's predecessor, the NASD, was lobbying to "regulate" financial planners. Yet it's possible Fisher is right that this time is different: particularly since this time the SEC has a legal mandate—in the form of Dodd-Frank—to actually change existing regulations.

However, I can't help but feel that Fisher is wrong and that the tide of change is against the brokerage firms on this one. While it might achieve a temporary victory or two, ultimately it will have to accept that the brokerage business model it's tried so hard to defend under the guise of "business model neutrality" will have to upgrade into the 21st century.

Originally, say 100 years ago or so, the brokerage model made sense. Broker-dealers underwrote securities for American businesses and convinced investors to buy them. Those investors, being wealthy and sophisticated, understood how the game worked and so were not taken advantage of (although occasionally a few tried to claim they had been).

Then, starting sometime in the 1960s following the post-WWII economic boom, the middle class began to accumulate wealth, too: a trend that has continued through today, when the majority of wealth in the U.S. is now in the hands of the middle and upper-middle classes. Unfortunately, financial sophistication did not come along with this growing wealth. It's no coincidence that the independent advisory industry began to emerge in the late 1960s and has continued to gain momentum—and market share. Unsophisticated investors need more than brokers; they need independent advisors who are on their side of table to help them navigate the challenges of the financial services industry to meet their growing financial responsibilities and goals.

The brokerage industry is well-aware of this trend. After a brief period in the 1980s when it tried to outlaw asset management at financial planning firms, BDs have jumped on the middle-market bandwagon, opening their platforms to outside investment products, managing fee-paying retail assets and selling 401(k) programs.

But as Fisher noted, none of this worked. Independent advisors have been taking assets away from brokerage firms, in increasing numbers, for nearly a half century.

Will BDs finally buck this trend and put independent RIAs out of business through new regulations under Dodd-Frank? Not likely. I say that because in my view, the independent advisory industry has been gaining momentum for the past half-century. Why? Because it offers the one thing that Wall Street can't: independence to represent their clients—and only their clients—which is what investors, in growing numbers, want.

So to my mind, skyrocketing compliance costs won't put an end to independent advice. Heck, even FINRA regulation (as onerous as that would be) wouldn't end independent advice.

Either scenario would certainly change the independent advisory business, pushing RIAs into larger and larger firms (as Mark Hurley has been predicting for almost 15 years) with the financial muscle to both bear the costs of brokerage-like regulations and, more importantly, to stand up the brokerage firms in Washington on technology platforms and in the media. Of course, that's just my opinion: Ken Fisher might be right.

Bob Clark is the author of the Clark at Large column in Investment Advisor and his blog by the same name at ThinkAdvisor.com.

Ken Fisher's Backhanded Call to Arms

By David Tittsworth

Ken Fisher's recent interview with ThinkAdvisor.com certainly caught my attention. Given the fact that I've spent the last 17 years of my career representing SEC-registered advisory firms, my first reaction was defensive. But I've calmed down and now wish to address some of Fisher's more provocative statements. 

"The RIA world is at threat of being taken over by BDs in a regulatory sense."

Our organization has warned of the serious legislative and regulatory threats from the broker-dealer industry and FINRA (formerly NASD) for many years. As just one example, I distinctly remember testifying at the SEC's roundtable of advisory issues in May 2000 and discussing issues relating to fiduciary duty as well as the threat of a self-regulatory organization (SRO) from NASD.

More important, we've written numerous comment letters and met with SEC commissioners and staff. We have testified on Capitol Hill. We have worked with state securities regulators, and consumer and industry groups. We have urged our members and other advisory firms to get involved. I believe that serious threats still exist, but any objective analysis of the evidence would show that these threats have been out there for a long time.

"There's a good chance that the entire RIA world is gone in 10 years."

If Fisher is literally suggesting that the SEC-registered advisory universe will disappear, he's clearly wrong. All indications, including demographics in the U.S., show that the demand for advisory services will continue to increase during the next decade. Maybe what he is saying is that the current composition of the profession will disappear as more and more brokers appropriate the advisory profession.

I'm also not sure what Fisher means when he uses the term "RIA." His firm is registered with the SEC as an investment advisor and thus is an RIA. I doubt that he is predicting the demise of his own firm, so he may mean something else—perhaps smaller advisory firms.

I'll make two quick points. First, others have predicted the demise of smaller advisory firms and been proven very wrong—some of you may remember the infamous Goldman Sachs-Mark Hurley study in 1995 that basically predicted firms below $5 billion in AUM would go the way of the dinosaurs. Second, separating "RIAs" from larger investment advisory companies is one big reason that the investment advisory profession is not as effective at lobbying as the broker-dealer industry.

"The RIA world is naïve in thinking implementation of the fiduciary standard will be done in ways that will impede the BDs and help the RIAs."

I absolutely agree that a watered-down fiduciary duty for broker-dealers could lead to very bad results by allowing brokers to claim the mantle of fiduciary duty without subjecting them to core fiduciary principles. Fisher may be right, but I'm not giving up the fight. The SEC has not yet initiated a rulemaking under Section 913 of the Dodd-Frank Act and, if history is a gauge, any such rulemaking will be highly controversial. 

"The RIA world doesn't lobby very well; the BD world does."

I have always felt that we are outgunned by the broker-dealer lobby. SIFMA and other BD trade organizations are much bigger, better organized and more powerful, but it doesn't have to be that way. If all SEC-registered investment advisory firms joined forces, we would be very formidable.

The fact is that most advisors do not support organized efforts to respond to the potential threats that Fisher has identified. Some of this is due to the vast diversity among SEC-registered advisory firms. In spite of that, all advisory firms are in the same core business of providing advice about securities, are subject to the Advisers Act fiduciary standard, are subject to the same SEC regulations and face serious consequences for non-compliance.

All advisory firms similarly have a potential upside from working together more closely. All firms have a shared interest in preserving the principles-based framework of the Advisers Act, in opposing unreasonable and inappropriate regulations and in bolstering investor confidence.

"If there's one thing the BD world would love, it's to have the RIA world taken over by [FINRA]."

I agree that the biggest threat to the current regulatory framework is the potential role of FINRA as the SRO for advisory firms. On June 6, 2012, I testified in opposition to legislation sponsored by Rep. Spencer Bachus that would have subjected thousands of firms to FINRA oversight. Thanks to the efforts of a broad coalition, including state securities regulators, consumer groups, financial planning groups, we were able to defeat that initiative.

But Fisher is right: FINRA and its allies are regrouping for yet another assault. The question is simple. Will you stand with us when that time comes?

David Tittsworth is executive director of the Investment Adviser Association.