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Industry Spotlight > Broker Dealers

A Fiduciary Primer: What’s a Rep’s Responsibility to Clients?

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I received the following email from a veteran financial planner who’s been a friend of mine for years. A former broker, he’s been an independent RIA for about two decades. Yet his questions about the current state of a fiduciary standard for brokers made me realize that those of us who have been covering this issue assume a level of understanding that many readers may not have. So as a kind of primer on the current state of broker responsibilities, here’s our conversation. 

“Had to drop you line about this quote from your 11.30.15 column [my column from the December 2015 issue of Investment Advisor, Rethinking Best Practices for Fiduciaries]:
‘Today, brokers who manage assets have a fiduciary duty to their clients when they offer advice about what changes to make in their clients’ investment portfolios. But, thanks to the brokerage exemption, they have no such requirement to advise in their clients’ best interests when selling them the assets to put into those portfolios. Consequently, brokers truthfully can claim that yes, they do have a fiduciary duty to their clients, and then sell investment products that do not meet that standard of protection.’” 

Still Him:
“I’ve missed something very important along the journey from FPA’s lawsuit win: that brokers have any fiduciary duty, much less the one you reference here. So, please assume I was asleep whenever this came into play and cite me chapter and verse that holds brokers to whatever fiduciary duty you are talking about because I really don’t get it.”

“If you remember, around 2001, the SEC tried to expand the “broker exemption” to the Investment Advisers Act of 1940 (which exempts brokers from a client fiduciary standard when their advice is “usual and incidental to the sale of securities”) to include managing assets as well, so brokers wouldn’t have a fiduciary duty then, either. The FPA filed suit and won: which means that when taking fees for managing client assets, brokers today have a ’40 Act fiduciary duty to their clients.  

“And since virtually all brokers these days manage client assets, they all fall under the ’40 Act. However, the way this ruling has been applied by the SEC and the courts, brokers are only acting as RIAs when they are giving “portfolio advice” such as asset allocation, rebalancing, etc. When they are selling the investments that go into a client’s portfolio, they are considered “brokers,” and as such, are exempted from the ’40 Act, and therefore have no duty to act in the clients’ best interests. In my view, this “part-time fiduciary duty” for brokers has created more confusion—and therefore less protection—for investors, who often assume that brokers have a fiduciary duty throughout their relationship.”

“I’m flabbergasted, but think it does answer my question. Unfortunately it also raises others. So let me get this straight. First, a rep makes specific product recommendations (without a fiduciary duty) under the suitability standard. Then, he/she makes recommendations about a strategic model portfolio and periodic rebalancing advice, for which he/she accepts an ongoing fee, has a fiduciary duty, and must be registered under the BD’s RIA in this arrangement.”  

Still Him:
“So am I to understand that under this “part time fiduciary” status, reps are actually held to the fiduciary standard in a fee program but are exempt from the duty in recommending the sale of specific products IN THE SAME PROGRAM?  This logic seems deeply flawed to me, in that such an application completely severs the notions of fairness, and a continuing duty of loyalty, within which the client’s best interest is served.”

“Your summary of the broker sales/advice situation is correct. As far as the application of the “two hat” RIA/broker system, it’s far worse than it sounds. A white paper by the Institute for the Fiduciary Standard details how the SEC has systematically watered down the “fiduciary standard” for brokers even further: reducing best interest, loyalty, and fair dealing to simply “disclosure.” I believe “continuing duty” has been eliminated altogether.”

“So what, then, is the big deal with Dodd-Frank and applying the fiduciary standard to brokers that has been fought for the last five years?  It seems as if that’s already been done.”   

“Not exactly. Dodd Frank Section 913 directed the SEC to establish a fiduciary duty for brokers “that is no less stringent” than the ’40 Act fiduciary duty for RIAs. In other words, Congress and the President were directing the SEC to essentially eliminate the aforementioned “broker exemption,” and to create a fiduciary duty for brokers when they are selling securities. 
“As you might imagine, the securities industry felt that this additional investor protection would cut heavily into the profits from securities sales (which was revealed in the studies showing the loss of billions in revenues, that they cited in their attack on the DOL’s attempt to expand a fiduciary duty to IRAs). Consequently, the industry has convinced the Commission to table a fiduciary standard for brokers for the past six years and counting.” 

I hope this helps our readers to better understand the ongoing fiduciary debate in Washington, D.C.

In my view, it’s important to independent advisors because it’s about better protections for retail investors through more clearly drawn lines between securities “sales” and “advice.” (Not that there’s anything wrong with sales, as long as the clients understand they are being “sold.”)

And in my experience, better client protection is what independent advice is all about. 


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