Brokers don't have to act in a client's best interest when dispensing advice, but a new study from the Securities and Exchange Commission recommends changing that.
The SEC staff report released late Friday says brokers should be required to have a so-called fiduciary duty to put clients first when giving personalized investment advice. Right now, only investment advisers must meet this higher legal standard.
"Retail investors are relying on their financial professional to assist them with some of the most important decisions of their lives," according to the SEC report. "Investors have a reasonable expectation that the advice that they are receiving is in their best interest."
This would be an important advancement for investor protection — though whether it will come to fruition any time soon is not a sure thing. The five SEC commissioners must vote to adopt new rules, and two of them have already raised objections to the report. And even if new rules are approved, it's always possible for Congress to intervene and gut them.
"There is a lot that can still go wrong," says Barbara Roper, director of investor protection with the Consumer Federation of America, who has lobbied for a fiduciary standard for brokers for a quarter century. "But we just got an important step closer to that goal."
Brokers and investment advisers have labored under different standards for decades. Brokers must make sure an investment is "suitable" for clients.
"Basically, the broker has to do research about the investor, about their financial situation and risk tolerance to determine if a particular investment is generally appropriate," Roper says. But the broker doesn't have to take the next step and determine whether the investment is in a client's best interest.
So your broker might determine you need a bond fund but can recommend the one that pays the highest commission.
Last year's financial reform law required that the SEC study whether brokers should come under the higher fiduciary standard. The hot-button topic generated more than 3,500 comments to the SEC, including some from insurance agents who could also come under a fiduciary standard if they sell variable annuities.
The SEC report noted that investors often don't know the difference between brokers and investment advisers because they use similar titles, such as "financial consultant" and "financial adviser." And many investors erroneously believe that both acted in the best interest of clients. Investors shouldn't have to "parse through legal distinctions" to find out if they're getting the standard of advice that they expected, the report stated.
But not everyone is convinced.
As the SEC staffers released their report, the two Republican-appointed commissioners issued a dissent, saying more research is needed.
Commissioners Kathleen L. Casey and Troy A. Paredes say the report fails to justify the need to fundamentally change the rules and doesn't prove investors are being harmed under the current system. They added the study ignored the potential costs of new regulations that ultimately could lead to investors paying more for services or having fewer products to choose from.
It doesn't appear everyone in the industry is dead set against a higher standard — and that's a hopeful sign for investors.
The Securities Industry and Financial Markets Association released a statement saying it supports a uniform fiduciary standard for brokers and investment advisers. The trade group added that it will continue to work with the SEC to make sure that the role of brokers is not hindered.
"I'm very happy that the SEC recognized how important the fiduciary duty is to all investors," says Melanie Senter Lubin, Maryland's securities commissioner. She says it's much easier for her office to resolve investor complaints when there is a fiduciary standard involved than just a suitability obligation.
The SEC staff recommendations should please investor advocates as well as "ease the minds of members of the securities industry who feared a more extreme approach," Roper says.
For example, some in the industry worried they would no longer be able to sell investments affiliated with their firm because it might be a conflict of interest under a fiduciary standard, Roper says. The report notes that selling proprietary products doesn't necessarily violate a fiduciary standard, although the investments might require certain disclosures and investor consent beforehand.
The issue now rests with the five commissioners of the SEC. Let's hope they vote to protect investors.
Before you invest
•Check the record of a broker or adviser with your state regulator. Marylanders can call the state's Securities Division at 410-576-7048.
•Look for a broker or adviser who has clients similar to you. If you're seeking advice on saving for college, for instance, you don't want an adviser whose specialty is estate planning. Ask about the adviser's education and work experience.
•Make sure you understand how your financial professional is compensated. Advice is never free. You'll pay for it one way or another.