WASHINGTON - SEPTEMBER 18: The U.S. Securities and Exchange Commission seal hangs on the facade of its building September 18, 2008 in Washington, DC. Republican presidential candidate Sen. John McCain (R-AZ) has called for the ouster of SEC Chairman Christopher Cox in the wake of the collapse of several giant banks on Wall Street and the resulting financial crisis. (Photo by Chip Somodevilla/Getty Images)
Best efforts: the US securities regulator has approved a new standard for broker-dealers © Getty

In the investment advisory community, the F word — fiduciary — is uttered often and loudly. US registered investment advisers proudly declare that their fiduciary status means investors can trust them because they are held to the highest standard of conduct for giving investment advice.

As fiduciaries, advisers — such as the companies recognised in this year’s FT 300 list — are required to act in the best interest of their clients at all times.

In contrast, the Securities and Exchange Commission’s “Regulation Best Interest” standard of conduct for brokers — approved by the SEC earlier this month — requires brokers to act in the best interest of their retail clients only when recommending a securities transaction or investment strategy involving securities.

Unlike the fiduciary standard, this “best interest” rule does not require brokers to have an ongoing duty of care and loyalty to their retail clients.

Hence advisers are keen to stress their more stringent regulatory status. But being a fiduciary is not an assurance that an adviser will not go on to commit fraud. After all, as a dually registered broker and adviser, Bernard Madoff — who scammed thousands of investors in the largest Ponzi scheme in history — was a fiduciary.

Hester Peirce, a commissioner at the SEC, the industry regulator, has expressed her own misgivings that the fiduciary standard for advisers and the “best interest” rule for brokers could both contribute to the deception of investors. These standards are “wonderful for marketing purposes but potentially misleading for investors”, she said last year.

“Just as ‘fiduciary’ has been used to lull investors into not asking questions about their financial professional, so ‘best interest’ runs the risk of becoming a term that encourages investors simply to rely on the fact that their best interest is being taken care of.”

Ira Hammerman, general counsel of Sifma, a lobby group for brokers, is tired of hearing arguments that advisers can be trusted more than brokers. He says that while brokers are subject to frequent examinations from Finra and the SEC, the adviser community “gets to go on its merry way without a whole lot of the regulatory friction — there’s no one really kicking the tyres”. Finra is the Financial Industry Regulatory Authority, the self-regulatory organisation of the broker-dealer industry which is under the SEC’s supervision.

“If you’re really worried about investor protection, I would take greater comfort from a broker who has Finra crawling around, the SEC looking over their shoulder, and who has to have a whole supervisory system with branch managers, compliance, everyone looking at records . . . challenging the transactions,” he says.

Robert Case, chief executive of Ingalls & Snyder — a dually registered broker-dealer and adviser — says the examination cycles his company’s broker-dealer business goes through under Finra are indeed “much more frequent” than SEC scrutiny of its advisory business.

However, Mr Case believes the difference in the frequency of examinations is “risk-driven” rather than a free pass for advisers. “There are some more risks in the broker-dealer world that need to be actively regulated and so Finra is here more often than the SEC,” he says.

Karen Barr, president and chief executive of the Investment Adviser Association, a lobby group for advisers, says: “No one is saying the fiduciary standard is a guarantee of good behaviour.” However, she maintains this standard is the highest level of investor protection and customer care because it is “overarching and ongoing”.

Because the fiduciary standard has been around since the Investment Advisers Act of 1940, it is a level of conduct that has been ingrained in the adviser community for nearly 80 years, Ms Barr adds.

The introduction of the “best interest” rule for brokers is actually an opportunity for advisers to engage with prospective clients, thinks John Anderson, head of practice management solutions for independent advisers at platform provider SEI.

They should highlight the distinction between the conduct requirements for broker-dealers and advisers in newsletters, blogs, social media posts and other communications with investors, he argues.

There is nothing inherently wrong with having different conduct standards for different business models in the advisory industry, argues Mr Case. The fiduciary standard is appropriate for an adviser, he thinks, because advisers have an ongoing relationship with clients, while the best interest standard is well suited for a broker whose relationship with a client tends to be “transactional in nature”.

The difference in the standard, and consequently, the difference in how brokers and advisers are regulated, is “correctly built around the functions” of financial professionals, in the view of Mr Case.

He notes that advisers are prohibited from some activities that broker-dealers are allowed to carry out — such as taking custody of their clients’ assets and margin lending. When the advice brokers give their clients goes beyond the transaction, brokers must register as advisers and fulfil the resultant obligations.

Nevertheless, several states such as New Jersey, Massachusetts and Nevada are stepping up to fill the regulatory gap they believe the SEC has left by not requiring brokers to be fiduciaries.

In April, New Jersey proposed a requirement that all registered financial services professionals act in accordance with fiduciary duty to their customers when: providing investment advice or recommending an investment strategy; opening up or transferring assets to any type of account; and purchasing, selling or exchanging any security.

In January, Nevada proposed a fiduciary rule for brokers or sales representatives who provide investment advice to clients, manage assets or perform discretionary trading. It pulls in those who hold titles including adviser, financial planner, financial consultant, retirement consultant, retirement planner and wealth manager.

Meanwhile, the Department of Labor is planning to take another shot at crafting another fiduciary rule after the previous one was struck down last year by the US Court of Appeals for the Fifth Circuit. This time, the DoL is collaborating with the SEC on the new fiduciary rule, according to labor secretary Alexander Acosta.

But these rules can only do so much. The onus to discern whether an adviser is to be trusted will rest with the investor, says Brian Vendig, president of MJP Wealth Advisors.

“Considering that we’re talking about people, and people are not perfect, there’s always the potential for someone to make a mistake or be a bad actor,” Mr Vendig says.

“In this type of business, where people are trying to establish a mutually beneficial relationship, clients should conduct due diligence on their advisers, as much as advisers are trying to conduct due diligence on their clients.”

MJP’s Mr Vendig suggests a few questions investors could ask. Is the adviser really giving conflict-free advice or trying to push a product for personal gain? How does the adviser get compensated? Does the adviser’s company influence the investment advice given to clients?

Ultimately, standards and regulations — no matter how robust — can only do so much to protect investors. There is still the problem of unregistered financial professionals who are under the radar of regulators until they get caught scamming investors.

“The truth is that most of the harm happens outside the realm of regulation,” says Gerri Walsh, senior vice-president for investor education at Finra.

One of the basic steps investors can take is to check the websites of the SEC and Finra to see if advisers and brokers are registered, Ms Walsh says. If they are, investors can check their disciplinary records.

“That’s the best piece of advice we can give investors. It’s the first place they can go to find out whether the individual they’re dealing with is licensed and whether they have a history of complaints,” Ms Walsh adds.

Copyright The Financial Times Limited 2023. All rights reserved.
Reuse this content (opens in new window) CommentsJump to comments section

Follow the topics in this article