What is financial advice? To some, it’s the methodical process of understanding a retail investor’s objectives and tolerances needed to produce a plan of action that will deliver the most reasonable chance of success for that investor. To others, it’s selling a product that maximizes a commission. Industry experts get the peppered nuances in the spectrum of financial advice—from investment advisor to broker—but many retail investors don’t. And recent regulatory changes haven’t made things easier for retail investors, despite best efforts to explain this fundamental difference.
How we got here is important, but our path forward isn’t as obvious as most would suggest. The current state of regulation and the distinction between brokers and investment advisors that regulators continue to struggle with are the byproducts of the industry’s structure. Most financial regulation we adhere to today results from a group of retail investors unfairly losing a lot of money at some point in time. Investors rightfully look to state and federal securities regulators to do something that would prevent that from happening again. And they usually do.
The challenge is that regulators are subject to a democratic rulemaking process—a great mitigant against regulatory encroachment but one that presents major obstacles when explaining differences in how financial professionals operate and what incentivizes them.
Form Client Relationship Summary (Form CRS) and the larger Regulation Best Interest (Reg BI) are great examples of this struggle. Under Reg BI, the SEC applied a new standard of care on brokers that falls short of a fiduciary obligation but permits brokers to suggest a similarly worded outcome to investors. In some circumstances, you could argue Reg BI makes matters worse because the wording best interest is probably more appealing to an average investor than a fiduciary, even though the latter demands a higher standard of care.
The greater challenge comes from rapid industry change. Take Robinhood, for example, a self-directed platform that does not offer investment advice. Regulators in Massachusetts challenge this view, arguing that we should deem push notifications and other behavioral incentives built into the trading app as investment recommendations. Under current regulation, if it’s not considered a recommendation, Reg BI doesn’t apply, and Robinhood’s Form CRS may as well not exist. But if it’s considered a recommendation, it invites a fundamental shift in how Robinhood’s app operates. The point here illustrates that Robinhood—and the nuances of the advice spectrum it offers—demonstrates how regulators struggle with helping retail investors understand how and where they’re investing.
Recent proposals to revise Form CRS are a good start. Anything that helps explain the difference between a broker, an investment advisor, a self-directed platform and the varying standards of care among them is a great first step. Calls to reform Reg BI to apply a more powerful obligation on the recommender are a wise follow-on.
But just waiting for regulators to catch up with form updates and rule revisions is antiquated thinking. True reform needs to come from the industry itself. And that can only happen when we focus on the heart of the problem—what do firms need to do to deliver the best possible customer outcome?
Trading platforms, a la Robinhood, have amassed customers at unprecedented rates and found success because they’ve made investing far more accessible than ever imagined possible. But, these platforms and apps aren’t necessarily delivering better customer outcomes. As markets are sum to the average, you could probably find several who aren’t so lucky for the several winners we do hear about.
Where trading platforms fall short, brokers and investment advisors pick up the baton to win investor favor. The recent focus on Form CRS and possible revisions could certainly help, but even as someone who’s written many of these disclosures over the years, I often get glassy-eyed as I receive the addendum of documents from my financial advisor. The SEC’s RAND Corporation report supports the view that most investors can’t explain the difference between a broker and financial advisor either.
If the choice is as simple as determining which financial advisor will deliver the best possible customer outcome, why aren’t all financial professionals focused on this? Easy—they don’t need to. There’s enough money to be made. That’s shortsighted thinking. And the tools to make investing more accessible haven’t always helped.
Technology has been the primary obstacle to delivering high-quality financial advice that drives a great client outcome. For years only the wealthy could afford great advice. Trading apps leveled the playing field but don't actually deliver better outcomes. Their popularity only underscores the fact that there’s a drought of quality financial advice in the U.S., and investors are flocking to anything they can so they don’t miss out.
We can certainly wait for regulators to update the rules to help explain the nuances of financial advice. But while we do, retail investors should continue to demand access to the highest-quality financial advice. Only when every investor gets access to a fiduciary can we help increase the chances of any investor achieving their best outcomes.
Mazi Bahadori is an EVP and CCO at Altruist.