Practical Insights for Compliance Officers [Webinar] - Fiduciary Duty

Fiduciary Duty

Mr. Cipperman will assess the most impactful regulatory developments of 2016, review results of the recent CCS survey of financial industry C-Suite opinion leaders, and give you his take on the fluid regulatory environment.This webinar was co-hosted with Todd Cipperman of Cipperman Compliance Services on Nov 17th.

 You can download a full copy of the slides from this webinar.


Full video transcript available below:

One of the same things, and now we’re not talking about fiduciary rule. We are talking about here is the fiduciary duty.

As an investment advisor, all advisors have a fiduciary duty and when the SEC brings enforcement cases. Breach of fiduciary duty is always one of the allegations. I always get asked as a compliance professional and a lawyer, “Well, what is really meant by fiduciary duty?” I’m going to talk about a few of the practices the SEC says is in breach of that obligation. One of the big ones revolves around product and investment recommendations. I want to talk about share classes a little bit.

As you may or may not know in the last year, OC Launch was called the Share Class Initiative and basically what they said to RAs and other financial planners and broker dealers, “Are you recommending the lowest share class available? Do you have a fiduciary duty to give the cheapest share class available?” It’s very interesting because really in the suitability world of broker dealers so long as that share class is suitable it doesn’t have to be the lowest class. What they’re saying fiduciary is a higher standard. It has to be lower.

Where you get into problems is on a retrospective basis. Let’s say, for instance, that a broker and advisor recommended a B share, which has no upfront sales load as an ongoing say 12 people under service fees. Now, upfront that may be the right answer because it’s unclear how long someone is going to hold a share class. Over time, it may be more expensive to have a B share and looking backwards it might have been better to sell an A share which had an upfront load.

It really puts a lot of pressure on the advisorial front to make a determination what the right share class is. I can tell you you’d better have an ongoing review of client accounts to make sure you’re selling the right share class. Particularly stressing this analysis is if there is a trailer going to other people in the advisory firm, such as registered broker dealers like a 12B-1 that’s going back to a registered personnel because that even makes the breach of fiduciary duty look even worse.


Related to that the SEC has really taken aim in the wrap business, and that’s this idea of a one fee for a mutual fund wrap of mutual funds underlying one account. Big cases this year. By the way, when I mention names of cases, it’s not because I think poorly of these firms. A lot of firms have had enforcement actions, but I name the cases simply for ease of reference and this is public information, but there is certainly pejorative meant by naming names here. There was a case against Royal Alliance, a very large reputable broker dealer about the wrap program.

Essentially, the argument was that the Royal Alliance had not fully disclosed that the wrap program may not recommend the lowest class available. Well, it sounds pretty simple, but there is lots of reasons that a wrap program may not have the lowest share class, may not use A shares. For instance, very often wrap programs the technology can’t deal with the frontend loads. They have no way to handle the money. Very often, the third-party advisor and the client refuses to even pay a load.

They may not even want it but, at the end of the day, there has been a lot of stress on wrap programs and whether or not they’re using the lowest share class available. Now, in the Royal Alliance case, there was a revenue sharing back of 12B-1, which was disclosed, but the allegation was the disclosure wasn’t enough. It was very interesting in fiduciary cases and the idea of disclosure. There is a line of thought that disclosure cures all fiduciary problems. That’s really not true because if you look at the case law, there are lots of situations no matter how much seemingly disclosure there is enough the SEC says, “It’s not enough.”

Essentially, what they’re saying is it’s not allowed. That’s kind of what you are seeing in the wrap world. No matter much disclosure you have that you don’t have the lowest share class available it never seems to satisfy the SEC and, therefore, the end result is you’re going to be in trouble if you’re not using the lowest share class. One of the arguments in the Royal Alliance case, again, there was this reverse churning argument that I referenced, which is a lot of people would have been better off in a traditional brokerage account.

Now, of course, in all fairness to Royal Alliance, I’m not sure how they could know that going into the program. This has a significant impact. I will tell you what’s really changing. Revenue sharing with advisors is under siege and I think over time is going away. It’s very tough for an advisor to justify any kind of revenue sharing on a fiduciary basis. It’s also making it very difficult on dual registrants. The advisor or that broker dealer what’s their standard of care? I think the dual registrant model is sort of going away. That’s a prediction.

Related to the wrap programs is the idea of commissions. There is a bunch of cases this past year. Riverfront Bear or Bear Raymond James where the allegation there was trading away by the underlying managers in a wrap program for best execution reasons, but the SEC said that there was failure to disclose that impact to the wrap investors. In other words, they were paying more fees above the wrap fee and essentially, inadvertently, was benefiting the wrap sponsor because they didn’t have to commit to brokerage work.

This was part of a whole sweep so, again, when you combine the attack on the share classes along with how commissions are charged it’s become a situation where you really wonder if the wrap business is really under siege. That’s one place. In addition, it’s a breach of fiduciary duty in how you recommend products; particularly, if you recommend proprietary products. The JP Morgan case about a third to a half of their products recommended were proprietary products. The SEC felt that was excessive. Then you got the whole F-Squared issue.

For those of you who don’t know, F-Squared was charged with using misleading back tested performance data and trumping up the performance, but then the SEC brought cases against third-party advisors that use the F-Squared models that they broke/ breached fiduciary duty for not doing sufficient due diligence, which is sort of interesting. Can we change? Can we go to the next slide? Okay and then let’s go to the next slide. I want to stop here on Polling Question #2. Have your firms increased or decreased your product offerings because of enhanced fiduciary responsibility?

Have your firms increased or decreased your product offerings because of enhanced fiduciary responsibility?

Should we close the voting? Again, very interesting; changing enforcement culture, but firms haven’t really adapted yet. Okay. Let’s move on. There we go. Now, those are a couple of areas; wrap programs, product recommendation, share class, but there has been a lot of just sort of standard conflicts of interest that are deemed breaches of fiduciary duty. I’ll give you a couple of examples. Double dipping of fees; when you invest client fees in affiliated mutual funds, the Henry Gleisner Case. This goes to the dual registrant when you take both asset-based fees and commissions, Henry Valentine. I think the Conrad Case is really interesting. It was a hedge fund that sort of suspended redemptions in 2008, but allowed favored clients to get out even though others could not. Again, what’s interesting there is no particular harm to anybody there. No one actually got harmed. It was just favoring one client over another and that’s important in a fiduciary context. It’s not necessary that someone is actually harmed. It’s just that you’re not treating clients, putting all clients equally and putting them ahead of your firm.

The Hope Advisors Case was sort of a fascinating one. It was a two and twenty fund and they were using non-economics trades to sort of book increases so they could continue taking their performance fee benefiting themselves. It never actually hurt clients, but it could have. A lot of cases using friendly brokers for sham quotes to pump up valuations, recommending services with affiliates and investment allocations. There is a lot. There is still cherry picking where someone will do an omnibus trading and then allocate the trades at the end of the day, TPG Advisors, [inaudible 00:25:58] and James Kerry Asset Management.

Any kind of compensation that you don’t fully disclose it was in the First Southwest Case. It had to do with getting municipal underwriting fees, and any kind of overbilling and as well as misusing client’s information in terms of marketing. These are all sort of the self dealing conflicts of interest and then adding to that any kind of marketing or distribution statements actually that are misleading are considered a breach of fiduciary duty, whether it be that includes distribution in guise or marketing your strategy as low risk, trumping up your qualifications, using hypothetical back-tested performance.

A note on that; much like the product recommendations, a hypothetical back test performance technically speaking is not illegal; however, I’ve never been in a situation where the SEC came in and said, “You have enough disclosure to make it not misleading so, essentially, although not illegal I think it’s essentially outlawed because you can never disclose enough so that the back test performance is not misleading.” That’s where the SEC comes out on.

This webinar was co-hosted with Todd Cipperman of Cipperman Services LLC. To learn more visit

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