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Industry Spotlight > Broker Dealers

Caveat Empty: Most Clients Don’t Understand the Brokerage Business

By Bob Clark

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In response to my last blog (Deadlock: Why the SEC’s Stalled on a Fiduciary Standard for Brokers), a reader called “Watching Out” wrote this comment: “Knut [Rostad] is correct. We should not need lawyers In order to understand what a broker is required to do. However, we do need an education and if we believe that the broker is required to do more than they are, who is at fault?” 

First, let me say right up front that, in general, I’m a firm believer in the legal principle of caveat emptor (let the buyer beware). We all know that the manufacturers of everything from cars to crayons are in the business of “selling” us their products, and that’s it’s up to us to decide which products we want. 

But as with most principles, we also recognize that there are limits to them. For instance, the law recognizes that consumers are entitled to make certain “assumptions” about the products we buy: various levels of quality and safety, as well as veracity in advertising and sales pitches. 

More to our point, professional services — such as legal, medical and accounting — are held to higher standards which restrict these professionals from using their superior knowledge to their own advantage and/or to the detriment of their clients/patients. As a society, we recognize that because these services are often of vital importance to the people who need them, and that the vast knowledge differential puts them at the mercy of these professionals, higher standards are appropriate. 

Thanks to the Investment Advisers Act of 1940, financial advisers have been included among the professionals whose specialized knowledge and vital services require a higher “fiduciary” standard as well. As I referenced in the above captioned blog, the drafters of the ’40 Act specifically excluded the clients of stock brokers from its protections because those clients clearly understood that their brokers were salespeople, not financial advisors. 

And I quoted SEC Commissioner Daniel Gallagher: “It’s the convergence of the roles of brokers and investment advisers that has led to calls for new efforts to harmonize the two regulatory regimes…” 

To directly address “Watching Out’s” question as to whose fault is the misunderstanding of brokers’ duties to their clients, to my mind the principle of caveat emptor went out the window for brokers and their broker-dealers when they starting using the moniker “advisor” rather than “adviser” to evade the ’40 Act standard, and later “trusted advisor,” to make it sound as if they were, indeed, fiduciaries for their clients. 

What’s more, while most of us understand the business that car dealers or department stores are in, I don’t think it’s a stretch to say that not one person in 1,000 understands what business brokerage firms are really in: underwriting and selling stocks and bonds, and their proprietary products, and products of other manufacturers, for which they get paid directly as well as charge sales commissions. 

Not that there’s anything wrong with any of that, as long as they aren’t trying to appear to be doing otherwise. That brings us back to the “adviser/advisor” thing. As I also quoted SEC Commissioner Luis Aguilar saying: “Extending the fiduciary duty that underlies the investment adviser regulatory framework to broker-dealers who provide investment advice is the ultimate investor protection issue — because the harm to investors is real if broker-dealers giving advice are not held to the fiduciary standard and fail to put their client’s interests before their own.”