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August 27, 2010 at 08:00 PM
The public comment period for the SEC’s study of whether brokers should have to put investors’ interests first will end August 30. As the SEC continues a six-month study of extending the fiduciary standard to broker-dealer (BD) reps who provide advice to individual investors, it has pledged a transparent process and requested comments from the public. This is commendable.
Comments are pouring in; through August 22, there have been 1538 comments posted on the SEC’s Web site. To add yours, here is the comment link.
The Level of Knowledge Is Not Equal
Fiduciary duty to clients is a critically important issue because as the investment world has become more complex, individual investors do not–and cannot ever reasonably be expected to–have the same level of knowledge of complex financial issues that their advisor has.
Would a doctor’s recommendation fall into a “buyer beware” category? Of course not! And, no lay person could reasonably be expected to prescribe medicine for or conduct surgery on himself or herself–it would be ridiculous–and dangerous. We rely on the fiduciary duty of a doctor, lawyer or accountant because these are professions that require a high level of specialized knowledge, just as financial services does. We entrust these professionals with our wellbeing and they must to put our interests first.
This uneven level of knowledge is the reason that individual investors must be able to trust that their advisor is a fiduciary, with the individual’s best interest as their legal duty. It is the same as if one was a guardian, entrusted with the wellbeing of a minor child, or an elderly person deemed no longer able to make an informed decision. The individual (with less knowledge) entrusts their assets to the professional, to paraphrase Boston University fiduciary scholar, Tamar Frankel. Also of crucial note: most investors don’t understand the basis on which they deal with “financial advisors.” They do not suspect that they may be entrusting their wealth to someone who, under suitability, is not required to put the customer’s interests first.
To be sure, there are many reps who are fiduciaries when advising on retirement assets or when they have discretion. And there are many who want to practice as fiduciaries. I am by no means picking on brokers. It is the legal structure that is at issue here. Why not back them up professionals giving advice with the legal structure that makes it clear that where there is advice there is fiduciary duty?
In The White House Blog on May 5, called “The Good Guys,” White House Communications Director Dan Pfeiffer put it like this: in a list of financial reforms the White House was watching, he highlighted “a few simple, straightforward
improvements that would further strengthen an already strong bill and really help American families. We’ll call them the “Good Guys”. Let’s hope they prevail over the ‘Lobbyist Loopholes’ as the debate moves forward.” In his list of 10 reforms, the fiduciary standard for investment advice was the number-one issue.
“Investment Advice by Any Other Name. Today, investment advisors have a fiduciary duty to their clients – that is, they are legally obligated to act in their client’s best interest. But brokers offering investment advice have no such obligation. Why does that make sense? Well… it doesn’t. If you’re a retiree managing your savings, or a family saving for college, you should be able to trust that the person giving you investment advice has your best interests at heart -whether that person is called a broker or an investment advisor. It’s that simple,” Pfeiffer said in the blog.
Formerly: A Clear Line Between Sales and Advice
At issue: the ‘suitability’ standard versus the ‘fiduciary’ standard of conduct toward investors. Investment advisors must adhere to the fiduciary standard: in addition to always control and disclose all costs to the investor, the Committee for the Fiduciary Standard (of which I’m a member) has developed Five Core Fiduciary Principles:
o Put the client’s best interests first
o Act with prudence; that is, with the skill, care, diligence and good judgment of a professional
o Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts
o Avoid conflicts of interest
o Fully disclose and fairly manage, in the client’s favor, any unavoidable conflicts
Clarity in Titles and Roles
When brokers simply bought and sold securities for customers and titles were such that everyone could tell they were dealing with a salesperson–advice wasn’t part of the equation. Since advice is now a big part of the sales process for many brokers, most of whom call themselves advisors, the actions of brokers and investment advisors look the same for many investors. This is a big deal. In practice, the advisory function looks like a duck. It walks like a duck. But one is a duck and one is not. When titles contain the words advisor, counselor, or consultant, they convey a duty of loyalty, not a sales function.
These words are very important and no matter what the outcome of the SEC’s study and rulemaking, titles need to be clarified and defined. Anyone who uses a title that conveys prudence, competence, authority and loyalty should be required to act under the highest standard of loyalty–and that is fiduciary duty. This includes the title of wealth manager, private banker–and many others.
Brokers who do not want to advise–but rather to sell–should be permitted to do that, in a fully disclosed way, with a sales title that in no way conveys that an individual is dealing with an advisor.
The Evolution of Banks Since the Repeal of Glass-Steagall
Another issue is the evolution of banks–including the private banking/wealth management arms of most banks–from acting with fiduciary duty toward clients to being brokers under suitability. Clients (now customers) for the most part are shocked to find out that the people who are advising them on their investments at a bank they
may have been dealing with for years–or generations–are no longer fiduciaries. (I am not speaking of trust departments here, of course.) There may be exceptions. But that is a problem. How is an individual investor to discern the difference? Disclosures are not anywhere near enough. The relationship must be clear. Currently it is not.
