Brokers and the Fiduciary Standard

As discussion of re-regulation of financial services continues in Washington, DC, with all sides preparing for upcoming floor debates and votes, SEI Advisor Network and The Committee for the Fiduciary Standard have released the results of a survey of broker/dealer registered representatives' and registered investment advisors' attitudes toward and understanding of the fiduciary standard.

One important leg of proposed House and Senate drafts of the Investor Protection Act, part of the Obama Administration's financial reforms proposed in reaction to the economic and financial catastrophe of the past two years, is whether broker/dealer registered representatives who provide advice to investors should do that under the same fiduciary standard as investment advisors embrace. What's interesting about this survey is the number of registered representatives--both commission-only and commission and fee compensated--who want to embrace this fiduciary standard.

The proposal to have all financial intermediaries who provide advice to investors act with fiduciary loyalty to their clients has bubbled to the top recently. One reason is because, according to the SEC-commissioned Rand Study, the advice-giving functions of financial intermediaries who work with investors have become so similar that most investors do not understand that the person they are getting advice from may be regulated under broker, insurance or investment advisory rules--regulations and principles which are starkly different in terms of duty to client or customer. Further confusing investors, now many intermediaries share the title of "financial advisor" or "consultant", or "counselor," instead of "agent," or "broker, registered representative or salesperson," as they were titled years ago--so roles and loyalties are unclear to the investor.

This fiduciary duty is very different from broker/dealer registered representatives' current requirement of "suitability," which says an investment must be suitable for an investor, but doesn't require the broker to put client's interests first. In fact, reps are required to put their firm's interests ahead of the customer's interests. Fiduciary duty includes putting client's best interests first, acting with prudence, disclosing all material information, avoiding conflicts of interest where possible, and, when conflicts are unavoidable, managing all conflicts in favor of the investor.

Sen. Chris Dodd (D-Connecticut), the chairman of the Senate Committee on Banking, Housing, and Urban Affairs, and Rep. Barney Frank, (D-Massachusetts), chairman of the House Financial Services Committee, have published sweeping draft plans for financial services reform, including fiduciary duty for brokers who provide investment advice. The November 10 draft of the Senate's plan includes a requirement that, "Brokers who give investment advice will be held to the same fiduciary standard as investment advisers--they will be required to act in their clients' best interest," according to the Banking Committee's summary.

The survey, released on December 2, is from SEI Advisor Network, based in Oaks, Pennsylvania, a firm which provides asset management and operations services for institutions and advisors, and The Committee for the Fiduciary Standard, a group of industry leaders who have called on Congress to adopt the authentic fiduciary standard in Wall Street reforms and ensure that investors' best interests are made the number-one priority in new legislation. This editor is a member of that Committee.

"The Fiduciary Standard Survey" of 890 brokers and investment advisors shows that a "majority of brokers support the fiduciary standard," according to Knut A. Rostad, regulatory and compliance officer at Rembert Pendleton Jackson, a Falls Church, Virginia, RIA firm. Rostad is chairman of The Committee for the Fiduciary Standard. There was a "high level of understanding and agreement between brokers and advisors on key elements of the fiduciary standard," Rostad noted.

Some surprising attitudes are found in the survey responses. A majority of brokers--53%--"believe all financial professionals who give investment and financial advice should be required to meet the standard." An even higher 86% of fee-only and fee-based investment advisors agree. In this study, brokers include those who are compensated by commissions only as well as those who receive a combination of commissions and fees. Investment advisors include both fee-only and fee-based.

Perhaps the biggest revelation in the survey's findings is, "the support among brokers for the fiduciary standard in light of the industry's historic opposition to it," Rostad says. In addition to the belief that all who provide advice should be fiduciaries, 61% of brokers and 89% of investment advisors say that they "should not be allowed to ask their clients to waive the standard of care."

There is significant agreement between brokers--75% agree--and investment advisors--82% agree--that, "All professionals who provide financial or investment advice should be required to put the clients' best interest first at all times."

There was high correlation in attitudes of brokers and investment advisors in core areas, according to the survey. For instance, 80% of brokers and 98% of investment advisors reported "understanding what the fiduciary standard requires fairly well or very well.

Counter to what one might expect, more brokers--78% of those participating in the survey--than advisors, 77%, said that, "they must disclose their compensation and all investment expenses in writing."

There was less agreement about whether "adhering to accepted fiduciary procedures can reduce an advisors liability in the event of poor investment performance;" 60% of brokers and 72% of advisors said they believe that is the case.

When asked whether they believe that the fiduciary standard: "should be modified to better fit brokers' selling activities," 49% of brokers and 91% of investment advisors say they do not believe so.

On the important issue of dual registration, or "two hats," there was more of a split between brokers and advisors, according the findings of the study. "Some brokers and most advisors do not believe advisors should be allowed to meet a fiduciary standard in providing advice and then 'revert back to the suitability standard when selecting, recommending and selling investment products.'"

When it comes to compensation however, 85% of brokers and 91% of advisors surveyed "understand that the fiduciary standard permits commission products." The numbers were close regarding proprietary products as well: 91% of brokers and 93% of advisors "understand that proprietary products are permitted under the fiduciary standard."

With vast regulatory changes like these on the horizon, it will be interesting to watch how brokers and investment advisors evolve to meet the changes and opportunities this legislation presents. While investment advisors already must abide by the fiduciary standard, they will also have changes to cope with. Among those, who will regulate them? They are currently regulated by the SEC, but there is an amendment in the draft Investor Protection Act, which was passed by the House Financial Services Committee on November 4, from Sen. Spencer Bacchus (R-Alabama), to have FINRA, the broker/dealer self-regulator, bring registered investment advisors that are part of dually registered broker/dealers under Fire's control. Whether that happens is still up in the air. The only certainty right now is that there will be some very big changes on all sides.

A shorter version of this article appears in Investment Advisor magazine's December issue.

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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