Last year, a new 771-page rule – Regulation Best Interest: The Broker-Dealer Standard of Conduct – took effect. Why the need for this regulation? It’s a long story.
After the 1929 U.S. stock market collapse and the subsequent Great Depression of the 1930s, Congress decided to take action to prevent such events from happening again. They passed the Securities & Exchange Act of 1934, which created the Securities and Exchange Commission and promulgated new regulations for broker/dealers (BDs) who, at the time, were focused primarily on buying and selling securities.
Among other things, the 1934 act required that BDs be able to demonstrate that any recommendations they make are “suitable” for each client.
Six years later Congress took aim at registered investment advisors (RIAs), who are in the business of providing broader investment advice to clients. The Investment Advisors Act of 1940 required that RIAs maintain a fiduciary relationship with their clients. That meant they had to put their clients’ interests ahead of their own, a much more stringent requirement than suitability. BDs were specifically exempted from the 1940 act as long as any investment advice they provided to clients was merely incidental to their primary business.
The difference between a fiduciary standard and a suitability standard might sound trivial, but it’s not. Here’s an example: Under the suitability standard, a commission-based BD could recommend you buy the higher priced of two mutual funds (thereby making more money on the transaction) as long as both funds are considered suitable for you. RIAs would be required to offer only the lower-priced fund. Over time, the difference could become substantial.
In 2016, the U.S. Labor Department found that “conflicts of interest (with the suitability rule) lead, on average, to about 1 percentage point lower annual returns on retirement savings and $17 billion of losses every year.”
Conflict of interest?
Starting in the 1990s, BDs began promoting themselves as investment advisors rather than as securities salespeople. The result was a bigger and bigger share of many brokerage firms’ profits coming from investment advice, which should have made them subject to the 1940 act’s fiduciary rule. But regulators paid scant attention.
After the 2008 stock market collapse, lawmakers once again felt the need to take action, and this time the RIA versus BD standards came under the microscope. The simple solution would have been for the SEC to start enforcing the provisions of the existing Investment Advisors Act, requiring BDs that provided investment advice to adhere to the fiduciary standard.
But brokerage and insurance firms pushed back hard, seeing that solution as a threat to a major source of income for them. They lobbied to come up with a new rule that would allow them to avoid having to follow the fiduciary standard but at the same time call themselves investment advisors.
Finally, 11 years and 771 pages later, we have the Regulation Best Interest rule. BDs and RIAs will continue to be governed by two standards, and BDs will continue to be allowed to provide advice as well as sell products. The new regulation relies mostly on additional disclosures to make the difference between them clear to the public.
Not surprisingly, the brokerage industry is happy with the result, while most consumer groups opposed it. When it was first proposed, Pamela Banks of Consumers Union wrote, “There is mounting evidence that the proposed (disclosure) Form CRS would increase investor confusion and the potential for investors to make costly mistakes. … The proposal … does not adequately address the conflicts of interest that may compromise broker-dealers’ investment advice.”
If you prefer to get investment advice from a BD rather than an RIA, at least consider choosing an advisor who is a Certified Financial Planner practitioner. They are required to commit to providing financial advice under a fiduciary standard regardless of firm type. That should improve your chances of getting authentically unbiased advice rather than being sold financial products.
Los Altos resident Artie Green is a Certified Financial Planner and founder of Cognizant Wealth Advisors. For more information, visit cognizantwealth.com.