Will the SEC force your broker to behave?
- January 27, 2011
- 3 comments
- Posted in Government, Investing, Latest Posts
It’s too soon to put on the party hats. The investor protection community cheered this week, when the staff of the Securities and Exchange Commission recommended that stockbrokers take more legal responsibility for the financial advice they give. But we’re a long way from moving that proposal into an actual rule of conduct. Of the five SEC commissioners, two are Republican; they want the subject studied some more. The House of Representatives is hostile and pro-industry lobbyists – from brokerage firms and insurance companies — are out in force.
At issue is the question of “fiduciary duty,” for advisers who give you personal investment advice. If the advisers are fiduciaries, they have to put their client’s best interests ahead of their own. They’re not allowed to sell you expensive financial products in order to win a sales contest. The adviser also has to disclose all fees and avoid conflicts of interest.
At present, every registered investment adviser is a fiduciary. Brokers, however, don’t have to meet these requirements. Neither do planners or insurance agents who sell securities such as variable annuities. They can – and often do – put their own financial interests ahead of yours. They can sell you a high-cost strategy when a low-cost one would be better. They don’t have to list all the fees you pay (many fees are hidden) or tell you specifically about their conflicts of interest.
Did you know that when you buy a municipal bond from a broker, the markup is usually 2 percentage points? Probably not. The broker quotes you a “market” price and the cost doesn’t show up on the confirmation that the brokerage firm sends. Investors are also widely unaware of the costs of the variable annuities they buy.
A stockbroker’s only responsibility is to sell you something “suitable.” If a high-fee product could potentially meet your goals, it’s a legal sale – even though there were better options. If the broker gives you unsound advice and you take it, it’s your responsibility – you made the decision. Except in outrageous cases, it’s “investor beware.”
Many brokers think of themselves as fiduciaries and treat you fairly (consistent with their need to sell). If you run into the other type, however, you usually have no recourse. Brokers can also operate with two hats – sometimes as a broker (just buying and selling securities) and at other times, giving you advice.
It has never made sense for the legal and ethical rules of the road to differ, depending on which type of adviser you use (or which hat your broker is wearing that day). The Dodd-Frank financial reform law told the SEC to study the matter and make a recommendation. The staff released its report last Saturday, concluding that – if brokers and other financial salespeople want to give investment advice – they should be fiduciaries, too. All advisers should operate under the same standard of care.
Now the hard part starts. The SEC has the right to proceed to rulemaking, based on the staff report. The three Democrats on the commission – chairman Mary Schapiro, Elise Walter, and Luis Aguilar — have spoken in favor of bringing stockbrokers under the fiduciary rule. The two Republicans – Kathleen Casey and Troy Paredes – say there’s not enough evidence to warrant a change because it’s not clear that brokers’ customers are being harmed.
On a 3-2 vote, a new rule would win, but other pressures are also being brought to bear. Industry lobbyists are leaning on their favorite Congressmen, who hold the purse strings. They can threaten the SEC with budget cuts if it writes a rule that Wall Street doesn’t like. That has worked at other times, to water down investor protection and enforcement.
What does the industry want? A detailed definition of every aspect of “fiduciary duty,” including the meaning of “personal investment advice.” Ira Hammerman, general counsel for SIFMA, the financial industry trade association, says that “fiduciary” has varying meanings, depending on the state. Brokers need a specific, national rule so they will know exactly what to do.
But, but, but – advisers, including broker/advisers, have operated as fiduciaries for as long as 50 years, without needing definitions. “It’s a system based on principles, not rules,” says financial planner Harold Evensky, of the wealth management firm, Evensky & Katz in Coral Gables, Florida. Advisers know what it means to “put the client’s interest first” and “disclose all fees.” Detailed definitions could be fought over for years, he says. Worse, they could provide a road map for developing strategies that evade the rule.
If brokers have to be fiduciaries, their firm’s compliance department will set the standards. “They will change the culture,” Evensky says.
Your leverage in a dispute would change, too. For example, say that you asked your broker to diversify your retirement account, he picked four high-risk stock funds and you lost three-quarters of your money. In arbitration today, the broker could claim that you wanted growth and signed off on his risky strategy. You’d lose your claim. As a fiduciary, however, the broker would have to show that his picks were in your best interest. You’d probably win.
The primary reason to create a fiduciary rule is not to head off major scandals, it’s to stop the daily nickel- and-diming that costs investors millions of dollars a year.
Pending SEC action, investors should take advice only from a broker or planner willing to be a fiduciary. Ask him or her to sign the following statement: “I will act as fiduciary. I will put my client’s best interests first. I will act with prudence. I will not mislead. I will disclose all fees and important facts. I will avoid conflicts of interest and disclose those that I can’t avoid.” Maintain the relationship only if your adviser says “yes.”
Read More:
Investor Protection: Brokers and Insurance Companies Hope to Weaken Gains
Should You Trust Your Broker? No, and Here’s Why
Investor protection gets knocked out of the financial reform law
Tags: Fiduciary, investment advisers, Securities and Exchange Commission, stockbroker
This is an excellent article about an issue of great importance within the RIA community. Unfortunately, the general public still doesn’t understand what the big deal is – and frankly sometimes I wonder what the big deal is myself.
The problem is this subject is viewed (to the extent it is viewed at all) as shifting shades of gray by a public that generally doesn’t care how financial professionals are regulated. However, I find it interesting that other countries have recently been so worn down by financial advisor fraud, scandal, and abuse that they’ve finally decided to take real action – action that isn’t even on the radar screen in America. For example, within 24 months financial advisors in Britain must begin billing clients directly for services rendered and will no longer be allowed to accept commissions. In Australia they have 18 months to make the switch. Now this is what real reform and real consumer protection looks like. Meanwhile in America we endlessly debate the various meanings of the word fiduciary and who it does and doesn’t apply to and then wonder why no one cares.
Personally, I find discussions about fiduciary standards being applied to financial product salesmen as absurd as they are immaterial to the general public. A corrupt, transaction-based business model that breeds abuse from its very core cannot be legislated into a good business model. It’s a mystery to me as to why this is not self-evident and reflected in our current laws.
Perhaps the criminalization in other countries of the inexplicable business model used by the vast majority of American “financial advisors” will serve as an example of what real reform looks like and suggest to Americans that financial advice is in fact not “free,” that financial advisors are actually true professionals, and that it’s infinitely safer for your wallet and better for your peace of mind to be invoiced by your advisor and never have to wonder if you got good advice or just a good sales pitch.
Steven A. Weydert, CFP(r), MS
President
Weydert Wealth Management, Inc.
Steven — Many thanks for the information on Britain and Australia. I didn’t know about it. I agree that consumers shouldn’t have to think about who’s a fiduciary, it should just happen. Outlawing commissions is interesting — commissions are intended to bias judgment, and do. We might achieve something similar here if all payments to the broker were disclosed as if they were fees, under the prominent heading: You Pay …
Thank you for the information on what’s happening with leveling the playing field for investment professionals. If regulation is put in place for this purpose, then what is left between the investment professional and the client is a relationship based on the investment professionals expertise and their ability to communicate and educate the client as to why they stand out from the competition.