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The SEC is Failing to Serve Retail Investors
On July 5, 2018
By Knut A. Rostad
Originally posted on Advisor Perspectives, June 28, 2018
The Securities and Exchange Commission has proposed new rules for advisors and brokers. The rules purport to clear up investor confusion with new disclosures and raise the standard for brokers. Unfortunately, they lack both the clarity and enforcement muscle to be effective.
SEC Chairman Clayton wrote that “to improve investor understanding” there is a “new disclosure mandate” requiring advisors and brokers disclose “the type of professional they are” and their services, fees and conflicts of interest.
Those April 18 proposals, if enacted, would also mean broker and advisor core duties would be essentially the same, according to the chairman. “We’ve called it the best-interest standard, but I want to be clear – for broker-dealers there are core fiduciary principles embodied in that best-interest standard,” as per an article in Investment News. Doing so, the SEC can “eliminate the gap” between “what retail investors would reasonably expect the law to provide and what regulations actually require.”
The proposed rules set ambitious objectives expressed in aspirational statements. They fall far short, however, in providing the clarity and muscle necessary to be real fiduciary and enforceable rules. They are not even close to being what “retail investors would reasonably expect.”
To start, the proposed broker standard, known as “Reg Best Interest” (Reg BI), is too vague and meek. It should adopt, as an alternative, the robust and succinct best-interest definition (99 words) that was codified in the DOL Rule.
Then the SEC should offer explicit guidance regarding written policies and procedures – guidance that’s tethered to specific actions and expectations, as the SEC did so well in the landmark case, In the Matter of Arlene Hughes. Further, regarding conflicts, its voice should be unequivocal. This means, for example, that choosing to avoid conflicts, if humanly possible, always beats disclosing conflicts. Then it must eliminate the worst conflicts that are obviously designed to further brokers’ best interests. Regarding fees, it must require periodic reporting of personalized fees and expenses.
This added clarity and muscle on conflicts and fees, in just these three provisions, will get rave reviews from investors. This is, after-all, what research from CFA Institute illustrates: clarity and transparency around fees and conflicts beat out all other factors that are important to investors. This is what retail investors “reasonably expect” and how the SEC can “eliminate the gap.”
The SEC’s hypothetical disclosure comparing brokers and advisors falls short in remedying investor confusion. The first sentences in the section, “Our Obligations to You” provide an example.
For brokers, it reads, “We must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities. When we provide any service to you, we must treat you fairly and comply with a number of specific obligations. Unless we agree otherwise, we are not required to monitor your portfolio or investments on an ongoing basis.” And then, for advisors, it reads, “We are held to a fiduciary standard that covers our entire investment advisory relationship with you. For example, we are required to monitor your portfolio, investment strategy and investments on an ongoing basis.”
What should a wise, much less a naïve, investor take from these disclosures? That the most important differences between advisor and broker obligations is that brokers are not presumptively required to monitor portfolios? Really?
On disclosure describing “what type of professional they are,” advisors and brokers should start by stating the obvious – i.e., legal, contractual, business and cultural differences divide brokers and advisors. What does this mean?
In securities offerings with a broker, investors should understand they are in a relationship of three: the issuer, the broker and the investor. The broker is paid commissions to distribute products, and like a car salesman at a dealer, is only paid if he makes a sale. No wonder the broker’s advice is limited by law and can only be “solely incidental” to the sales activity for the issuer.
An advisor relationship is different. It’s a relationship of just two: the advisor and client. Courts say this is an “intimate relationship” from a position of trust and confidence. By law, an advisor is a fiduciary who must always be loyal and put a client’s interest first. An advisor has no hidden partners. This is a relationship of two.
This difference is fundamental and important and is not stated and explained in the proposed rules. In the proposed rules, advisors and brokers are presented as virtual identical twins. This is wrong.
This is why my organization, the Institute for the Fiduciary Standard, and five other advisor groups have launched a campaign to urge RIAs to raise awareness of this critical issue with the SEC.
Advising in an intimate relationship of two differs markedly from offering incidental advice in a sales relationship of three. This is what the SEC needs to know to close the gap and create a standard retail investors would reasonably expect.
The Institute for the Fiduciary Standard
Welcome to the Institute for the Fiduciary Standard!The Institute is a nonprofit formed in 2011 to benefit investors and society through its research, education and advocacy of the fiduciary standard's importance to investors, our capital markets and economy. Six key fiduciary duties embody the fundamental elements of an investment fiduciary’s responsibility. Read More
Why an InstituteThe rationale for an Institute for the Fiduciary Standard is straightforward: The fiduciary standard is important, representing ideas central to our form of government and free market economy; it is under significant pressures from market forces that could sharply limit its reach; no other entity is solely focused on preserving and promoting the fiduciary standard. More...
The 6 Core Fiduciary Duties
- ‣ Serve the client’s best interest
- ‣ Act in utmost good faith
- ‣ Act prudently -- with the care, skill and judgment of a professional
- ‣ Avoid conflicts of interest
- ‣ Disclose all material facts
- ‣ Control investment expenses
Best Practices Board
- Christopher Cannon, CFA
- William C. Prewitt, M.S., CFP
- Stephen D. Johnson, CFP©
- Knut A. Rostad, MBA
- General Counsel to the Best Practices Board: Daniel Bernstein
- Clark M. Blackman II, CFA, CFP, CPA/PFS