May 22, 2018
When Seeking Financial Advice, the Old Rule Still Applies: Caveat Emptor
Please read important disclosures HERE
May 22, 2018
Please read important disclosures HERE
Over the past decade, federal regulators have come under mounting pressure to adopt a uniform fiduciary standard that would apply to all broker-dealers and investment advisors providing financial advice. Despite recent attempts at reform by both the Department of Labor (DOL) and the Securities and Exchange Commission (SEC), broker-dealers and investment advisors continue to be held to different standards when it comes to the advice they provide. We’ll explain what this means, why it matters, and what you can expect from B|O|S.
What’s All the Hubbub About?
For years, broker-dealers have been held to a suitability standard, meaning that when their brokers recommend that an investor either buy or sell a particular security, they must have a reasonable basis for believing that the recommendation is suitable for that investor given considerations such as income, net worth, investment objectives, and risk tolerance, among other items. While the recommendation must be suitable for the investor, there is no requirement that it is the best recommendation available. Thus, the suitability standard leaves considerable room for unethical practices and potential conflicts of interest. These conflicts of interest often come in the form of outsized commissions that a broker can earn by recommending certain products ahead of what may be superior alternatives. To gauge the size of the problem: the Obama administration issued an estimate suggesting that conflicts of interest cost retirement asset investors alone over $17 billion annually.
Registered investment advisors (RIAs) on the other hand are held to a fiduciary standard, meaning that all advisors must place the interest of the client above his or her own, as well as take care that all recommendations are prudent and in the best interest of the client. Advisors are compensated by fee arrangements (usually fixed or based on assets under management), rather than by trading commissions. With that being said, advisors are not immune from all potential conflicts of interest. For example, responding to a client who asks whether money should be withdrawn from the portfolio to pay off debt has a potential conflict given that any funds withdrawn from the portfolio would also reduce the asset-based fee paid to the advisor going forward. The fiduciary duty, however, requires the advisor to place the client’s interest before his or her own and even to disclose such potential conflicts and to justify the recommendation based on the client’s facts.
More recently, many broker-dealer firms have become dually registered as investment advisory firms, employing both brokers as well as investment advisors. This has added to investor confusion, leaving many unable to distinguish between brokers and advisors, or even when their agent is acting as a broker versus as an advisor when delivering a recommendation. As a result of the blurring distinction between broker-dealers and investment advisors, various advocacy groups have been fighting for a uniform fiduciary standard since the mid-2000s.
In 2010, Congress sought to address much of the confusion and regulatory gaps in the investment and financial services industry by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (aka “Dodd-Frank”). Part of this act authorized the SEC to study these problems and determine if a more uniform standard for all investment advice should be issued. Unfortunately, even though the SEC’s findings confirmed that significant problems existed, no new rules were issued.
Into this breach stepped the DOL, issuing its final “fiduciary rule” in 2016 that attempted to create a common standard of conduct by applying the higher fiduciary standard to all broker-dealers and investment advisors, but only for retirement plan assets (the only area under its jurisdiction). Given the limited scope of this rule, states also began to look at issuing new standards with the potential of creating multiple layers of rules and additional complexity. Adding to the confused situation, the DOL (under the leadership of the new Trump administration) placed the fiduciary rule under review for possible amendment or rescission. Then, in mid-March of this year, the U.S. Court of Appeals for the Fifth Circuit struck down the DOL’s fiduciary rule, dealing a blow to retirement savers across the United States.
The SEC’s Best Interest Rule Proposal
After remaining on the sidelines for so long, the SEC issued its own proposed “best interest rule” on April 18 in an attempt to enhance the quality and transparency of investors’ relationships with investment advisors and broker-dealers while preserving access to a variety of types of advice relationships and investment products. Specifically, the proposed best interest rule would make the following changes:
The rule is now in a 90-day comment period, but several issues have already arisen from the initial readings and industry discussions of the proposal.
What Does the Proposed SEC Best Interest Rule Mean for You?
While the best interest rule is a small step in the right direction to raise standards of conduct in the investment industry, it really doesn’t change the landscape all that much.
The most glaring takeaway from the proposal is that it doesn’t actually achieve a uniform fiduciary standard for investment advice. The rule would require that broker-dealers be subject to a new “best interest” standard while investment advisors would continue to be subject to their existing fiduciary standard. While this new best interest standard is a step in the right direction, it will likely only add to the confusion surrounding the roles of broker-dealers and investment advisors.
Further, the rule doesn’t require broker-dealers to eliminate conflicts of interest, nor even to prevent the use of some questionable sales practices. It would simply require them to disclose potential conflicts such as bonuses or extra fees earned for selling certain investments, and it would require firms to mitigate or eliminate “material” conflicts. It doesn’t really define what “material” means, though.
Finally, the SEC hasn’t defined the best interest standard adequately or delineated exactly how broker-dealers can show that their advice has met the best interest standard. Nor has the SEC defined the difference between the fiduciary standard versus the best interest standard, although it has clearly implied that they remain distinct.
B|O|S’ Viewpoint and What to Expect From Your Advisory Relationship With Us
From its inception back in 1985, B|O|S has held itself to the high fiduciary standards for all of its clients. This means that as a registered investment advisor we not only work to comply with the standards of the Investment Advisors Act of 1940 and the SEC, but also the standards of the CFA Institute (the professional organization for all Chartered Financial Analyst (CFA®) designation holders) and the Financial Planning Association (the professional organization for all Certified Financial Planner (CFP®) designation holders), which apply to employees with those designations. Additionally, we have designed our own internal standards that all employees must adhere to.
We expect our firm and all employees to behave both ethically and professionally, not just for the client but for our profession. As such, the following are some of our core principles:
In short, any time you receive a recommendation from us, you can expect that it is not only suitable, but also one we feel in our opinion is the best recommendation for you. B|O|S acts as a fiduciary for the recommendations and advice we deliver to you. We are willing to disclose and explain any aspect of the recommendation, including why we are recommending a particular investment or course of action and what its costs are. In fact, you often don’t even have to ask since we usually explain the reasons up front as part of our normal review and ongoing discussions with you.
Investors are best served to approach any financial or investing relationship with initial skepticism. Ask lots of questions and understand not only the reasons for the recommendation and how it should benefit you, but also how the advice provider is being compensated. This strategy should help you determine if you are receiving a sales pitch as you would when shopping for a car (where there is no obligation to sell you only what you need or even to help you obtain the best price) or receiving sage, unbiased advice from a trusted family member or counselor whose only concern is to look out for you. In short, caveat emptor. Let the buyer beware.