This week we celebrate the 250th birthday of the Declaration of Independence with celebrations around the country. Next month, the Investment Advisers Act of 1940 will turn 86 — and be ignored. That is a shame because the two foundational documents have much in common.
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The Declaration of Independence made a bold case for a then-radical form of government. The Advisers Act set out a bold concept for a new profession — registered investment advisors — for the 20th century. Each document is based on implicit or explicit fiduciary principles that, by and large, still resonate with the public. From the founders’ sensitivities to high standards of personal conduct to the Advisers Act’s explicit fiduciary purpose, their political and financial principles are aligned.
The declaration is rooted in centuries-old foundational values. In his book, “Revolutionary Characters,” historian Gordon S. Wood wrote that the leaders of the American Revolution “committed themselves to behaving in a certain moral, virtuous and civilized manner” — a manner deemed a prerequisite for political leadership. Furthermore, being disinterested, that is, “free of interested ties and paid by no one,” was a core value that formed the basis for the founders’ fiduciary principles.
READ MORE: The oldest RIAs are 85. How did they become a $144T industry?
‘Poisonous’ conflicts of interest
The Advisers Act directs SEC-registered financial advisors “to act in the best interest of the customer without regard to the financial or other interest of the broker, dealer or investment advisor providing the advice.”
Crucially, the act insists on duties of care and loyalty and that conflicts of interest be avoided, or be fully disclosed and consented to by the customer. In short, conflicts of interest are deemed a poison to be avoided at all costs. Fiduciary law scholar Tamar Frankel wrote that “a major rule, which is designed to prevent violation of fiduciary duties, is the rule prohibiting the fiduciaries from acting in conflicts of interest.”
READ MORE: DOL fiduciary rule ‘contorts logic, facts and common sense’
Death of ERISA?
The 1963 Supreme Court decision in Securities and Exchange Commission v. Capital Gains Research Bureau et al. noted that the Investment Advisers Act of 1940 reflects “a congressional recognition of the delicate fiduciary nature of an investment advisory relationship.”
But the “delicate fiduciary nature” of investment advice has taken a pummeling this past year. The greatest single example is, without doubt, the Department of Labor’s proposed fiduciary rule, which would decrease regulatory burdens and lower litigation risks for plan fiduciaries recommending alternative investments in 401(k)s.
The proposed rule is nothing less than a direct and open attack on ERISA and fiduciary principles. It invites conflicts of interest. If enacted and enforced as written, the rule would effectively mean the death of ERISA.
READ MORE: DOL rule could reshape 401(k) access to alternatives
‘Procedural’ over ‘substantive’ hinders alternatives scrutiny
Why? The rule would let plan fiduciaries complete a “procedural” process of reviewing six factors while not requiring a substantive investigation. The difference between procedural and substantive processes is like night and day. The procedural process does not require the independent investigation ERISA calls for.
Most alternative investments do not let a fiduciary access key product features — the most basic information fiduciaries need — to conduct a prudent analysis. That is, information on performance, fees/expenses, liquidity and valuations regularly accessible in the public markets, but not fully accessible in private markets.
The DOL’s proposed rule would effectively turn ERISA’s fiduciary investigation on its head and instead allow reliance on sponsor representations, marketing materials or industry narratives.
READ MORE: What Trump’s next administration will mean for financial regulation
‘Unprecedented’ flood of conflicts
This proposed rule arrives in a world that has witnessed an unprecedented flood of conflicts of interest around the executive branch seeking to normalize conflicts — a process that amounts to, as the late Sen. Patrick Moynihan famously wrote in another context, “defining deviancy down.”
Avoiding conflicts of interest has been a national preoccupation of enlightened American business and political leaders since our founding. It will be again. As Supreme Court Justice Harlan Stone wrote in 1934, “No thinking man can believe that an economy built upon a business foundation can permanently endure without some loyalty to [the fiduciary] principle.”
