From the September 2007 issue of Wealth Manager Web • Subscribe!

Post-Ruling Spin

It's mid-July as I write this, and it's pretty clear to me that almost no one outside of the Financial Planning Association believed the FPA would prevail in its action against the SEC over the infamous "broker/dealer rule." Seems like every week I see signs of just how profound a surprise this win for the profession has been to some people. There is no shortage of head-scratching commentary in our industry publications.

The brokerage industry's response strikes me as somewhat amusing. Others find their response quite disturbing--in large part because they think that the brokerage industry truly believes what their spin doctors are saying. I don't subscribe in full to that theory because I know too many good quality people in the brokerage industry who are not afraid of fiduciary duty, full disclosure, or the responsibility and liability that comes with a meaningful advisory relationship with a client.

The two most prevalent themes coming from the brokerage industry--and both deeply flawed--are claims that the decision somehow limits consumer choice and that because of this ruling, consumers will pay more.

First, the contention that the consumer would prefer to choose a fee-based account over a commission-based account is far from new. The brokerage industry was touting this even before 1999, when the exemption was put in place. What has always been missing from that particular argument is the simple fact that all of the benefits that purportedly become available in the fee-based brokerage account have always been available in fee-based advisory accounts. The infamous Tully Report emphasized that fee-based compensation eliminates the incentive to churn. In reality, the Tully Report was only sort of correct on this point. The true consequences are a bit ironic.

The brokerage industry pitched these fee-based brokerage accounts to the SEC as a different method of pricing a traditional brokerage account--i.e., fees in lieu of commissions. I have a great deal of sympathy for executives at some of these firms when they lamented that first, regulators said they want them to stop trading so much and later, turned around and fined firms for not trading enough.

In an advisory account there is no arbitrary number of trades that must be executed. A "hold" recommendation is valued equally to that of a "buy" or a "sell." But the fee-based brokerage approach retained the same fundamental flaw that the Tully Report wanted to avoid: Namely that only "buy" or "sell" recommendations have value.

The most fundamental problem with the choice argument is that the choice presented by the brokerage industry did not reflect the realities of the consumer's actual choice. With a few exceptions, most of these accounts were touted as aligning the interest of the broker, (excuse me, "financial advisor") with the interest of the customer. Clients could take a traditional commissioned approach or they could choose this "new" option-- payment of fees-- which would eliminate worrying that trades were being recommended simply to generate transaction fees.

In reality the client probably should still be concerned about transactions that are "suggested" to them. Though these accounts look better on the surface, the fee-based choice still didn't require prior client permission for brokerage firms to utilize principal trades or disclose any conflicts of interest generated by an emphasis on proprietary products or special sales incentives that existed for the brokers. In addition to the lack of meaningful disclosure of conflicts of interest, the accounts also lacked disclosure of the broker's disciplinary history, education and other qualifications. Most importantly, the broker was not obligated to conduct business as if the client's best interests were at the forefront. The fee-based brokerage exemption ignored the fact that the best way to align a broker's interest with a client's is to simply require the broker to act in the client's interest.

There are registered representatives who properly utilize the financial planning process with each and every client. There are in fact, thousands of these reps all over the country. As long as their firms make available to them a competitively priced advisory program, the vast majority of these folks will not be hindered by this ruling at all. For reps who have been selling themselves as advisors while not actually delivering any advice, however, this ruling could prove to be problematic. Reps working with firms that don't offer a competitive advisory platform will have trouble, too. Now is the time to reassess your own process and frankly, review whether your firm will keep up with the trends and support a financial planning and fiduciary approach. I suspect recruiters at forward-thinking firms are drooling at the prospect of so many good guys and gals seeking a supportive environment.

Some firms are going to point the finger at the financial planning community and say, "Mr. And Mrs. Client, those planner people are the ones taking away your choice."

If your firm takes this type of approach, I suggest you think twice before going along. As soon as your client realizes that there is--or worse yet--always has been, an advisory choice in the marketplace, and you either did not offer it or characterized it as undesirable, the trust and good will you have worked so hard to develop will be undermined, if not destroyed.

The second spin we've heard quite a bit of has been that the defeat of this exemption will cost consumers money. This assertion is usually followed by a statement that X number of clients in these fee-based accounts have saved X dollars over what they would have paid in a commissioned account. In order for this mathematical assertion to be true, the brokerage firms would either need to charge a much higher than competitive rate per transaction or to place a high number of trades. I can't help but chuckle at a defense that, in essence, says, "Based on our high fees and propensity for turnover, you are better off paying a flat rate."

Perhaps I shouldn't be so surprised after all. An underlying argument continually made to regulators over the duration of this issue basically boiled down to: "We would love to look like we're doing the right things for clients as long as we aren't actually required to do those things."

Meanwhile, even those within the financial planning community and fiduciary advisors are saying that somehow, now, competition will get tougher because people who were not acting in a fiduciary capacity will start to do so, thus making it even harder to differentiate. But competition was already becoming tougher as more parties entered into the advice business. There is increasing complexity involved with personal finance, and more and more responsibility for one's financial security and financial future rests with the individual. Competition will continue to increase simply because the demand for advice is booming.

This ruling is good for consumers, and it's good for legitimate financial planners--regardless of where they work or how they are paid-- as long as the SEC enforces the law. If the commission does its job well and maintains bright-line standards between advice and sales, the public will be getting the same information from advice providers through form ADV. True, clients may not read the ADV, but at least they have a chance, thanks to this ruling, to get the information needed to make informed choices.

This is meaningful improvement over conditions that existed with the exemption where just about anyone could call themselves just about anything and not have to provide the same basic information about who was working for whom and where the incentives were. Some advisory shops would do well to wake up and see that their worst nightmare had already come true when this exemption existed. Study after study showed unequivocally that clients think their "advisors" give advice and are responsible for that advice. Lacking required disclosure, there was little chance they would ever know otherwise.

Heck, the continuing fight for business presented by the growing demands of the marketplace may even be a fair one. Those who may fear getting run over by the big firms now have the opportunity to take what was merely a required legal document and use it as a great marketing tool. On that point, I would put the understandability of a small independent's ADV up against an ADV of one of the big firms any day the week--and, as they say, twice and Sunday!

For those of you who are not completely independent, let me assure you that I KNOW many of you do right by your clients despite the awkward regulatory environment. You are not the problem here; you are a victim. The problem is that on the surface, the bait-and-switch faux planner looks exactly like you to the public. You hold the same licenses and spout a lot of the same messages. Today, a person who is really only a sales rep can market himself as an advisor. Without meaningful regulatory standards, the public can't tell the difference, and there is no way to deal with the pretenders. This issue will continue in some ways, but helping the public find the good guys and providing a way to hold the bad guys accountable is what this has always been about.

Dan Moisand, CFP, is a principal of Spraker, Fitzgerald, Tamayo & Moisand, LLC, in Melbourne, Fla., Chairman of the Financial Planning Association, and a two-time winner of the Journal of Financial Planning's national "Call for Papers Competition." Several magazines have listed him as one of the country's best advisors.

Editor's Note: Mr. Moisand's opinions are his own and are not to be construed as the Financial Planning Association's position

Reprints Discuss this story
We welcome your thoughts. Please allow time for your contribution to be approved and posted. Thank you.

Most Recent Videos

Video Library ››