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A New Regulatory Framework?

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In a move that may be the opening salvo in a fight for unified investor protection rules, the SEC is seeking information from potential contractors to conduct a study about how investments and advice are marketed to individual investors. A round of focus groups conducted in early 2005 for the SEC with individual investors showed that such investors are confused by the multitude of titles used by investment professionals, the roles those professionals play in interactions with investors, fees and commissions, and the wording of disclosures.

“I don’t know the difference. I mean I’ve got a guy that gives me advice. I don’t know what he is.” That comment, from a participant in one of the investor focus groups, sums up the confusion that many investors feel and is in large part what is prompting the new SEC study. The focus groups comprised individual investors who had investment accounts (outside of employer retirement plans) with between $2,000 and $499,000 in assets, and were conducted in Baltimore and Memphis by Siegel & Gale, LLC, and Gelb Consulting Group.

According to the new SEC Request for Information, the Commission is looking to gather information on how a number of issues affect individual investors, including: how investment professionals use titles and marketing; fees and costs to investors; compensation from “other sources” to broker/dealers and investment advisors for offering financial products, accounts, programs, and services; disclosures; and investors’ perceptions about what “duties and obligations they are owed” by B/Ds and advisors.

When the SEC’s Broker/Dealer Exemption rule, SEC Rule 202(a)(11)-1, went into effect this year, under which broker/dealers could open fee-based brokerage accounts but are not required to register as investment advisors unless they have discretion, B/Ds won the right to be governed by suitability rules instead of the fiduciary rules that investment advisors are subject to.

One custodian to independent advisors, TD Ameritrade Institutional, based in Jersey City, New Jersey, thinks the investment industry should do better by individual investors. The firm has conducted two studies of its own with individual investors, and their findings agree with the SEC focus group’s reports of investor confusion. TD Ameritrade Institutional President Tom Bradley applauds the SEC’s move to gather more information. “My perception is that [the SEC] viewed this as kind of a short-term solution, and they recognized that they had to do further studies. They did look at our two studies as well,” says Bradley, “and now they’ve announced that they are going to take a hard look at this.

“What you have here [with 202] is something that started off trying to provide better service to investors, and that’s allowing brokers to provide their brokerage services for a fee, which many believe is better than a commission-based brokerage, but what you’ve ended up with is one service–and that’s advice for a fee–under two different sets of rules,” Bradley asserts. “That, we believe, is a bit of an absurdity. We think it confuses investors, we think that it exposes investors to potential harm because, frankly, the Investment Adviser Act of 1940 requires advisors to do what’s in their best interest–it deems them to be a fiduciary. The brokerage rules were created under a different set of circumstances and deemed stockbrokers to be salespeople. Why shouldn’t there be just one set of rules for this one service?”

TD Ameritrade Institutional’s brokerage services are strictly execution–no advice. Advice is given only by affiliated investment advisors, on a fiduciary basis. TD Ameritrade’s “Investor Perception Study” used pollster Penn, Schoen, and Berland to conduct 1,000 interviews with investors across the country. Released in May, it found that 54% of investors believe that both stockbrokers and investment advisors have a fiduciary responsibility to act in investors’ best interests in all aspects of the financial relationship. (See charts.)

Bradley argues that the disclosures that are typically made by B/Ds regarding fee- for-advice accounts read like this: “‘Your account is a brokerage account and not an advice account’ but an investor will be reading marketing material that talks about advice, uses the word advice multiple times, and clearly describes an advice service. Then the fine print says it’s not an advice account, it’s a brokerage account–so that’s going to throw people off, it’s going to seem very strange to any average investor.

“I’m thrilled to see that they are going to go out there with a study. I’m quite certain it’s going to show them that something needs to happen here, that you need one set of rules, not two, for advice for a fee, and that these rules basically need to do what the Investment Advisers Act of 1940 was designed to do, and that’s protect investors. If the average investor is paying someone for their investment advice it’s certainly a wonderful idea to have that advisor act as a fiduciary, which requires them to do what’s in the best interest of investors.”

There could be a day when registered representatives must operate under the fiduciary standard rather than a suitability standard, says Bradley, and that impediments to such a standard, like the principal trading ban for investment advisors, can be resolved. “I think that’s solved through enhancements of the best execution rules.”

Brokerage firms’ investment banking arms–which need distribution–are another item that needs to be addressed, says Bradley. “Stockbrokers are distribution, and that makes them salespeople. How do you act as a salesperson and as a fiduciary?” Among the alternatives, Bradley says, is to have one group of people at brokerage firms give advice for a fee under the Advisers Act as fiduciaries, and a separate group of people act as traditional stockbrokers, “selling directly to the public, and selling to investment advisors for the underlying clients.” That would mean two separate investment professionals dealing with individual investors, with clearly different roles, not one individual wearing the two hats of broker and investment advisor.–Kathleen M. McBride