In the wake of finalizing the Regulation Best Interest regulatory package, the SEC issued
a series of informational videos for investors that purport to explain the differences between brokerage and advisory services. As is true of the regulatory package itself, the videos bypass any mention of the fact that a broker is not accountable to the customer as a fiduciary whereas an investment adviser is a fiduciary.
When the 5th Circuit Court of Appeals vacated the DOL's fiduciary rule, it based its decision on the premise that brokers and advisers serve fundamentally different purposes.
The court declared that "Stockbrokers and insurance agents are compensated only for completed sales ('directly or indirectly'), not on the basis of their pitch to the client. Investment advisers, on the other hand, are paid fees because they 'render advice.'"
The court then added: "Only in DOL's semantically created world do salespeople and insurance brokers have 'authority' or 'responsibility' to 'render investment advice.'"
The court found that the DOL exceeded its jurisdiction by extending fiduciary status to salespeople, but it also noted that if salespeople provide personalized advice, or misrepresent their role by implying that they do, an appropriate regulator should address that problem (i.e., either require them to adhere to the fiduciary standard for advisers or to clearly disclose their sales role and refrain from giving advice).
But is the SEC that regulator? And is
Regulation Best Interest the mechanism that clarifies the distinction between brokers and advisers and regulates each in a manner that adequately protects investors?
Two recent academic studies show that fiduciary accountability leads to lower investment costs and better advice but that mixing fiduciary and nonfiduciary standards can be counterproductive. These studies cast further doubt on the wisdom of the SEC's current regulatory approach.
In the video "Brokers and Investment Advisers — Know the Difference, " SEC Chairman Jay Clayton says there are two main differences between brokers and advisers: the types of services they provide and how they are paid. He makes no mention of the
standard of conduct required and even remarks that both can provide advice. Additionally, dual registrants (licensed brokers who are also investment adviser representatives of the broker-dealer's corporate RIA) are permitted under Reg BI to continue to refer to themselves as advisers, even when acting in a brokerage capacity.
"Fiduciary Duty and the Market for Financial Advice" was published in May by the National Bureau of Economic Research. Building upon earlier academic studies, this research focuses on the differences in the behavior of state-registered brokers in states where brokers are accountable as fiduciaries versus those where brokers are not fiduciaries under state law.
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To control for "noise" in the data, the research analyzes data provided by a top-five company by market share in the market for annuities. It assesses each annuity transaction from 2008 to 2015. It not only examines the transactions within each state, it explores the behavior of the broker or adviser when they sell annuities across state lines. The research finds that extending fiduciary duty to broker-dealers "causes clients to purchase products with lower fees" and for broker-dealers to "steer customers towards products with a larger and more diverse set of investment options that … lead to improved mean returns."
"The Worst of Both Worlds? Dual-Registered Investment Advisers" by Nicole Boyson of Northeastern University, also released in May, compares investment practices of
dual registrants to those of independent RIAs.
It concludes that "[w]hile these [dual registered] advisers mostly meet the letter of the law (frequent disciplinary actions aside), their conflicts, high fees, and poor investment performance imply that they are not serving their clients' best interests." Essentially, the author finds that lower obligations to evaluate and manage conflicts, costs and due diligence under the suitability standard undermine the attention of dual registrants to their fiduciary duties when they switch hats from brokerage to advisory relationships.
These studies add to the substantial body of research demonstrating that the fiduciary standard should be embraced by the SEC as central to its investor protection responsibilities.
While Reg BI does elevate the suitability standard for brokers, by inexplicably navigating around fiduciary accountability, it exacerbates the blurred lines between sales and professional advice; that is contrary to the interests of investors and the profession of financial advice.
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Blaine F. Aikin is executive chairman of Fi360 Inc. and Cefex.
