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The Way Out of Our Regulatory Dilemma

Whenever I get around Ron Rhoades, I find myself nodding my head a lot. Rhoades heads the Alfred State College financial planning department and in his spare time thinks deeply about how advisors are regulated. He is a one-person think-tank for the profession when we look at how to frame our arguments about fiduciary issues.

I bring this up because Rhoades has written an important four-part series on RIA regulation, which is being serialized at RIA Biz. (Here's a link to Part I: http://www.riabiz.com/a/22918833/why-keeping-finra-from-ruling-rias-is-critical-to-these-firms-the-investor—-and-even-the-us-economy) Rhoades starts out by arguing, with surprising pursuasiveness, that FINRA should not just be denied in its efforts to regulate RIAs, but that it should be banished, disbanded or otherwise eliminated altogether. He argues that it has proven to be ineffective, it exists to benefit the very organizations that it should be regulating, and it has somehow buried the fiduciary standard that it once championed for its members. Each argument is elaborated on to the point of conclusiveness; any impartial observer would have to conclude that he's right.

I won't tell you about the other parts, except for the final recommendation. Rhoades thinks that the solution to our regulatory dilemma is not more SEC inspectors (the ones we have seem to be not just ineffective, but also strikingly unproductive, each visiting an average of 3-4 advisory offices a year), and not an SRO.

Instead, he recommends that the profession create a Professional Regulatory Organization. Its individual members would be qualified to practice financial planning or RIA activities (the CFP and PFS designations are not specifically mentioned), and everybody who is allowed to join would be required to live up to a bona fide fiduciary standard. The organization's primary mission would be to protect the public interest, and members would be regulated, in part, by a peer review process.

You are invited to imagine what the impact would be on the current regulatory debates. If the public knows that a member of the PRO is a professional and is held to the highest fiduciary standard, then all the mishmash of titles and credentials and consumer confusion about roles and obligations flies out the window. The brokerage firms can call their sales staff "advisors," "planners" or "demigods" on their business cards, but if they aren't members of this organization, then the public knows that they aren't professionals, just like they know that nurses are not doctors. If they ARE members of this organization, then they are living under rules which forbid them from recommending the house products and slyly recommending high-commission annuities for every financial circumstance.

All this debate about the fiduciary standard being imposed on brokers, or harmonizing it, also goes away. Who needs it? We know which professionals are required to live up to the highest standards of customer care, simply by whether or not they are members of the PRO. There's no need to ask the SEC chair, who until recently had served as the FINRA chair, to implement fiduciary rules on the brokerage firms. When brokerage firms lobby to impose sales-related regulation on members of the PRO, the PRO would have the lobbying clout and membership numbers to offer the obvious reply. (Is this intended to protect consumers, or the business practices of the brokerage industry?)

Rhoades suggests that the PRO would have to be created by an act of Congress, but the more I think about it, the more I think this is one instance where I shouldn't nod my head. Yes, if the PRO is to have regulatory teeth–the ability to collect fines and whatnot–then we'd have to engage in a messy Congressional battle. But I look back to the old ICFP (a precursor to the FPA for you younger advisors) as a bare-bones model for how the profession could create its own workable PRO. You couldn't be a member of the ICFP without the CFP credential, and members were required to live up to certain practice standards. If you grafted the CFP Board's practice standards onto a new version of the ICFP, and instituted peer review and required every member to sign certain documents which guaranteed that they would adhere to a bona fide fiduciary standard, the result would be a workable PRO. In time, Congress might be persuaded to give it legal sanction.

Could any of the current membership organizations be retrofitted into this role? The FPA's original founding vision was to become a professional organization whose membership would be confined to people with the CFP credential, and associate members who were not CFP-holders would have non-voting rights and limited privileges. However, the FPA has refused to follow that vision, I think to its detriment, and its home office seems to me to be in self-preservation mode rather than looking for ways to benefit the profession as a whole–despite constant and laudable prodding by its board of directors.

What about NAPFA? That's a more interesting possibility. NAPFA is redefining itself as you read this and recently committed to the CFP designation. (Leaving out the PFS designation, I believe, was a mistake, but that might be correctable.) NAPFA is a member, alongside the CFP Board, of the Financial Planning Coalition, and the two have more in common with each other than either has with the FPA as currently managed. The problem there is that many converted dually-registered advisors have sore memories of NAPFA getting a lot of press coverage and its board members talking openly about conflicts of interest. There may be perceptual hurdles to overcome.

I think the most likely possibility for a PRO is a revival of the old ICFP. Not in its earlier form, but as an organization made up purely of credentialed professionals with peer review and fiduciary guarantees in place. NAPFA could create this organization as a subsidiary, and I suppose it's possible that the FPA could create a subsidiary that finally meets its founding vision. FINRA could lobby for an SRO while the real professionals were creating an organization that is at once less conflicted and more focused on consumer protection–and as an important ancillary benefit, the scale of this PRO would allow it to become a real lobbying force in Washington.

Rhoades, in other words, seems to have created a way out of our dilemma, our world where the people with money don't seem to care about the consumer, and the people who care about the consumer don't have the lobbying money to grease the right palms in Washington. The PRO proposal should be taken seriously, sooner rather than later. Read his serialized arguments, and see if you don't find yourself nodding your head.