The original article appeared on Advisor Perspectives on May 5th, 2021.

A 2008 RAND Corporation report commissioned by the Securities and Exchange Commission sought to discover what retail investors know about broker-dealers and investment advisers.

Its basic conclusion: not much. The unasked question: why?

The key RAND finding was that investor confusion about the differences between brokers and advisers was rampant among retail investors.

Thus, the “investor confusion” mantra was born, and its influence soon spread to any SEC discussion of retail investors. RAND’s survey and focus-groups, according to the 2011 SEC report, Study on Investment Advisers and Broker-Dealers, showed investors, “did not understand the differences between investment advisers and broker-dealers, although they were generally satisfied with the services they received from their financial professional.”

The investor confusion mantra has grown. Today it defines what’s the central problem investors face. It is the problem the SEC has struggled to solve – to no avail. The 2018 SEC proposed Form CRS was independently tested. Investors failed to understand their legal obligations, what conflicts of interest meant and what fees and costs they paid.

The AARP co-sponsored the research. The AARP’s Nancy LeaMond pointed out how to improve the disclosure: Stop “the lack of clarity” and clearly state what “best interest” means.

The SEC released its final rule on Form CRS in 2019. For conflicts of interest, the required primary language for broker-dealers and investment advisers was particularly interesting because BDs and IAs are described virtually identically. Here are the two descriptions, with the difference in italics.

For BDs: “When we provide you with a recommendation we have to act in your best interest and not put our interest ahead of yours. At the same time, the way we make money creates some conflicts with your interests. You should understand and ask us about these conflicts because they can affect the investment advice we provide you. Here are some examples to help you understand what this means.”

For IAs: “When we act as your investment adviser, we have to act in your best interest and not put our interest ahead of yours. At the same time, the way we make money creates some conflicts with your interests. You should understand and ask us about these conflicts because they can affect the investment advice we provide you. Here are some examples to help you understand what this means.”

What “differences” will investors – or investment professionals for that matter – understand about conflicts and brokers and advisers from this or similar required disclosure language?

Yet many experts and industry participants blame investors for not “understanding” the SEC disclosure. After all, it’s a view that’s consistent with reams of academic research that show investors make notoriously poor financial decisions.

Is this all there is? Hardly. Many groups and my organization, the Institute for the Fiduciary Standard, have highlighted the legal, business and practical differences that separate broker dealers and investment advisers for years. In 2018, we underscored how brokers in relationships of three and advisers in relationships of two differ.

This month, a CFA Institute letter to the SEC recommended improving Reg BI and disclosures.

It noted that a registered rep must disclose all material facts related to the scope and terms of the relationship with the BD, and conflicts associated with the recommendations.

The CFA Institute asked, with respect to securities offerings, whether the disclosure obligations require broker-dealers and associated persons disclose the details of the relationship between the issuer and the broker-dealer and registered representative? It argued that a disclosure should include:

• The BD acts as an agent for the issuer in addition to the retail customer (whose) primary role in the offering is to offer and sell the issuer’s securities.
• The BD compensation is determined by and paid by the issuer and not the customer.
• The registered rep is compensated only if their sales efforts for the issuer are successful and sales activity is dictated by the issuer via a selling agreement.
• As a consequence, the registered rep owes a duty of care and loyalty to the issuer whose interests differs significantly from the interests of retail customer.
• The registered rep is not paid for the recommendations or advice but for securities sales.

The CFA Institute asked a simple question: Should investors know that, regarding securities offerings, brokers are not advisors to customers? Brokers are sales reps for issuers, loyal to issuers, and paid by issuers only when they sell products to customers.

The 2008 RAND Report launched the blame investors for “investor confusion” era. Subsequent research suggests this is a misnomer. The CFA Institute has a better idea for a new disclosure that is understandable, practical, clear and to the point. It tells investors the simple truth.