Do Your Clients Know Who You Are?

What to do with the securities industry's Depression-era regulations that have investors confused over the difference between a registered investment advisor and a registered rep? After more than a year of collecting and analyzing data, the much-awaited, 219-page RAND report released by the SEC in early January was a disappointment to many. The study makes no policy recommendations, but simply reiterates

What to do with the securities industry's Depression-era regulations that have investors confused over the difference between a registered investment advisor and a registered rep? After more than a year of collecting and analyzing data, the much-awaited, 219-page RAND report released by the SEC in early January was a disappointment to many. The study makes no policy recommendations, but simply reiterates what a U.S. Court of Appeals ruled last March: Consumers don't know the difference between registered reps (who have a suitability standard of care) and RIAs (who have a fiduciary duty). Is the RAND study just another chapter in the turf war between broker/dealers and registered investment advisors, or will it actually help resolve the regulatory dispute?

The Financial Planning Association's (FPA) Duane Thompson says he was “under-whelmed” by the results. Thompson says the report didn't answer the “$64,000 question,” which is: Whose set of rules should registered reps — who now call themselves financial advisors — operate under? “Our concern is that you should play by the same rules if you're doing the same thing,” Thompson says. Most broker/dealers declined to comment, but Smith Barney argues that when advice is offered, the firm — in this case, Smith Barney — is the fiduciary, and its individual reps are not. Meanwhile, in a recent release, SIFMA urged the SEC to consider requiring investment-advisor-only firms to report to a self-regulatory organization (SRO), a far bigger commitment than simply submitting to a possible SEC audit every two to three years (as RIAs currently do).

Trust Me

Essentially, the RAND study pointed out what everyone already knew: The business practices of broker/dealers and investment advisors are increasingly similar, resulting in confusion among the retail investing public — especially when it comes to differences between the legal duties of investment advisors versus registered reps. Moreover, the survey determined that the financial services industry has changed dramatically since the Securities Exchange Act of 1934 (establishing registered reps) and the Investment Advisers Act of 1940 (creating investment advisors) were passed. According to Don Trone, president of the Foundation for Fiduciary Studies, “The reason there is confusion is because we've got a regulatory structure that does not currently address the way we're doing business. The follow-on question should have been, ‘Is the current regulatory structure appropriate for this changed industry?’ Of course the resounding answer would have been, ‘No, it is not appropriate.’”

The SEC's attempt to clarify the boundaries between brokers and investment advisors with Rule 202 (the b/d exemption) was vacated by a U.S. Court of Appeals decision in March 2007. Until then — for eight years — the exemption allowed registered reps to offer fee-based brokerage accounts, and offer financial advice (given certain caveats). The FPA's point, and the court ultimately agreed, was that Rule 202 blurred the distinction between brokers and advisors, which matters since advisors have a fiduciary standard of care; reps, on the other hand, have suitability standards, which are lower.

Merrill Hirsch, the FPA's attorney, says there is a difference between being a “salesman” (a rep) and a professional (an RIA). “There is nothing inherently evil about being a salesman, but it is different,” Hirsch says. “The problem is, if you're going to somebody for advice, they ought to be giving you advice — not just selling you on something. It is understanding what hat the person is wearing that is so difficult.” According to the RAND study, investors are not clear on the differences in the legal duties of brokers versus investment advisors. In fact, the study says focus-group participants struggled to understand the differences between fiduciary duty and suitability, even when these were explained to them; they also expressed doubt that the standards were different in practice. Broker/dealers in the survey acknowledged there was client confusion, but reported that investors rarely read the disclosures they are provided (regardless of how simple the documents are) and, anyway, their business relationships with clients are built on trust rather than investors' understanding of the gory details.

What Now?

According to Thompson, the FPA would like to see a roundtable — similar to the SEC-hosted 12b-1 fee roundtable held in June 2007 — composed of industry and consumer groups to talk about the issue before the SEC considers changing the current regulatory structure. But don't expect any thunder from the SEC any time soon. According to Barbara Roper, the Consumer Federation of America's director of investor protection, the study does make it clear that the industry needs some sort of functional regulation, but it doesn't provide an urgent call to action. “We have an SEC that is very much in flux right now, a Congress with a number of huge financial issues already on its agenda, and we're entering a campaign/election year,” Roper says. “I've had good conversations on this issue with both Chairman Cox and Commissioner Atkins, but it is not clear to me whether this is a priority for either of them.” Moreover, it is unclear what positions any new Democratic commissioners might take, she says.

So far, as of mid-January, no decisions have been made as to whether the SEC staff will conduct a roundtable, according to SEC spokesman John Nester. SEC Chairman Christopher Cox has asked the divisions of Investment Management and Trading & Markets to develop a list of policy options by the end of April based on the RAND study findings, he says.

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