Investors need to know who is controlling their financial fate

Amidst political fanfare on Monday, President Obama formally announced his support of the Department of Labor’s attempt to hold more financial advisors to a fiduciary standard of care by broadening the definition of “investment advice” to include more service providers.

The effort has been stalled for the past five years as the brokerage industry has fought against any legal requirement for brokers to act in their clients’ best interests.

So the big question is: Why should brokers, who are providing investment advice, be subject to a fiduciary standard?

Larry Downing | Reuters President Barack Obama

Larry Downing | Reuters
President Barack Obama

The truth is that brokers are not different from any other service provider when performing the securities brokerage services for which they are registered. Where a broker is merely selling a financial product or furnishing access to capital markets, there’s really no need for them to be held to a fiduciary standard of care.

The currently applicable standard, that an investment be suitable, is sufficient to protect the interests of brokerage customers that are purchasing something from the broker.

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There are two complicating factors here, however. Chief among them is that the U.S. Department of Labor and the Securities & Exchange Commission have allowed brokers to act like investment advisors for decades.

They’ve allowed them to market and name themselves like investment advisors and even charge a fee based on assets just like investment advisors.

Even President Obama broadly referred to brokers as “financial advisors” in his speech. But something darker lurks within. That wolf in sheep’s clothing trades what investors think is advice for the professional sale of a product that often has additional costs and expenses or may have been motivated by the broker’s compensation arrangement.

In other words, consumers think they’re getting advice, but it’s actually a sales pitch for a suitable product. And because brokers are presently not required to register as investment advisors, they don’t have to disclose material conflicts of interests, including compensation incentives.

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There is an additional nuance that causes confusion among retirement investors, in particular. And that is the classic economic problem in which the buyer of services on behalf of these retirement accounts—the plan trustee—has different interests than its beneficiaries, the would-be retirees.

The buyer is looking for an inexpensive service provider that allows it to be operationally efficient and insulates the company from risk, whereas the investor is simply looking for high-quality investment options, and sound advice, all wrapped in a tax-favored account.

Brokerage firms deliver additional bells and whistles, such as training and education services, that for many seem like advice. But they’re not.

They are infinitely scalable risk-mitigation tools that reduce the broker-dealer’s liability. Personalized investment advice has marginal costs and requires supervision. Brokerage firms would prefer to deliver training and education.

So, despite the president’s claim, this problem is not about “bad advice.” It’s that investors either aren’t getting any advice or getting advice incidental to the sale of securities.

Perhaps most frustrating is that the solution has a simple fix.

“This problem is not about ‘bad advice.’ It’s that investors either aren’t getting any advice or getting advice incidental to the sale of securities.”

It requires no further rule making, legislation or executive orders aside from what’s already been proposed by the DOL. The SEC merely needs to enforce the “solely incidental” exemption for brokers under the Investment Advisers Act of 1940.

For a broker-dealer to offer investment advice that is not solely incidental to a brokerage transaction, they would first need to register as an investment advisor. The registration, however, is significant only in that the firm would immediately be held to a fiduciary standard of care and be required to mitigate or disclose all material conflicts of interest.

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The DOL could then rely upon their proposal they made five years ago, which extended a registered investment advisor’s fiduciary duty to retirement accounts.

The president should be directing the SEC to enforce its own rules and permit the DOL to engage in the rule making they’ve already proposed. The new path that the president has established ensures that, after all the bluster, this re-proposal is a problem for the next president and Congress to contend with … or perhaps not.

—By Brian Hamburger, JD, founder and CEO of regulatory compliance consulting firm MarketCounsel.

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