The Dodd-Frank Wall Street Reform and Consumer Protection Act (known as the “Dodd-Frank”) was passed in July 2010, and by most accounts, it brought the most significant changes to the regulation of financial institutions in the United States since the reforms following the Great Depression. As part of Dodd-Frank, the Securities and Exchange Commission (SEC) was required to conduct a study on the effectiveness of the differing standards of care required of brokerage firms and registered investment advisors (RIAs) providing investment advice to retail customers.
Before turning to the study’s recommendations, let’s review some basic definitions and rules, because there are significant differences in how brokerage firms and RIAs are regulated under current law. RIAs are regulated by the Investment Advisers Act of 1940. The terms of this law impose a fiduciary duty on all RIAs (but not brokerage firms), stating: “As a fiduciary, an adviser [has]…an affirmative duty of utmost good faith to act solely in the client’s best interests. [RIAs] are required to make full and balanced disclosure of all material facts, especially with respect to actual or potential conflicts of interest that may be materially adverse to a client’s interests. [An RIA must] place the interest of clients ahead of the interests of the firm or its personnel.”1
By comparison, brokerage and insurance firms are held to a lower “suitability standard,” which Forbes defines as a “legal standard that requires that whoever is handling your investments puts you in products that are suitable for your objectives, means and even age.”2 Writer David Serchuk goes on to say that the suitability standard “doesn’t require brokers to find the best products, only ones that are ostensibly suitable for you. If an underwhelming, house-brand security lines up with the vague outlines of what is considered suitable, they can still push it, even if it costs more to own or underperforms peer securities.”3
The Study’s Recommendations
On January 21, 2011, the SEC released its much-anticipated study. After reviewing the different regulatory frameworks applicable to brokerage firms and RIAs discussed above, the study recommended that the SEC establish a uniform fiduciary standard for brokerage firms and RIAs no less stringent than the law currently applied to RIAs. The study explicitly rejected other alternatives that would have allowed brokerage firms to continue using the suitability standard.
Importantly, the study recognized the distinctions between brokerage firms and RIA business models, and recommended that any future SEC rulemaking should “particularly focus on assisting brokerage firms with complying with the minimum requirements of the uniform fiduciary standard” applied to RIAs.4 In addition, the study recognized that a fiduciary duty does not mandate “the absolute elimination of any particular conflicts,” nor does it mandate avoidance of conflicts; rather, the study recommended that the SEC should facilitate disclosure of conflicts to retail customers.5 In essence, the study stated that a new uniform standard — along with the existing guidance and precedent established under the Investment Advisers Act of 1940 regarding fiduciary duty — would continue to apply to RIAs and should be extended to brokerage firms.
The Current State
Almost 10 years after the Dodd-Frank reforms were put into place, the law is back in the news again. At the time of publication, the U.S. House of Representatives passed a bill that, if written into law, would undo significant aspects of the Dodd-Frank. In the same week, key provisions of the U.S. Department of Labor (DOL)’s fiduciary rule for investment advice took effect; the rule requires financial services professionals providing retirement advice to act solely in their clients’ best interests — a standard already upheld by RIAs.
Numerous organizations — including the Investment Advisor Association (IAA), the Financial Planning Association (FPA), the National Association of Personal Financial Advisors (NAPFA) and The CFP Board, among others — have been fighting fiercely to establish the highest legal standard of care for every professional that provides financial advice.
Conversely, many insurance companies, brokerage firms and banks have spent millions fighting this type of standard, arguing that their clients have the right to “freedom of choice.” But in fact, that choice often isn’t in their clients’ best interests to begin with — especially when the cost of hiring an RIA, who operates at the highest standard of care, is often less than the cost of hiring “advisors” who aren’t required to live up to the fiduciary standard. What’s truly at stake for the opposition is not their clients’ right to choose, but the revenue they earn from product sales, which may or may not be the best for their clients.
Unfortunately, most investors who are purchasing investment advice and securities through traditional brokerage firms have no idea that there is a lower standard of care applied to their advisors, compared to RIAs. In its study, the SEC cited numerous surveys and study groups, which concluded that the general public had difficulty determining whether a financial professional was an RIA or a broker; instead, most believed that RIAs and brokers offered the same services and were subject to the same duties, which is not the case.
In the meantime, what can you do to ensure your advisor is working in your best interest?
– Start the conversation — ask your advisor if he or she is a fiduciary.
– Find out how your advisor is being compensated — and don’t let them get away with answers like, “Don’t worry, it’s included in the product.”
– Be wary of certain products that have a history of high fees, such as annuities, structured notes, hedge funds and the like.
–Practice healthy skepticism. If any advice or product sounds too good to be true, you need to make sure you fully understand what you’re being offered, and how your advisor is being paid.
At Hewins Financial | Wipfli Hewins, we proudly serve as fiduciaries to our clients; we strongly believe this is the proper standard for providing financial advice. In our opinion, you shouldn’t have to question whether your advisor is considering your best interest when making recommendations for your financial future.