August 30, 2010
Fiduciary Standard Comments to SEC re Brokers, Dealers, Investment Advisors
As the SEC looks at creating a common standard for brokers, dealers, and investment advisors, I would recommend a fiduciary standard for anyone who offers investment advice to the public.
Under current law, registered investment advisors are held to a fiduciary standard as required by the Investment Advisers Act of 1940. Registered reps, brokers, and dealers are held to a suitability standard as defined by the Financial Industry Regulatory Authority (FINRA), formerly National Association of Security Dealers (NASD). As a former registered rep who was regulated by FINRA and is currently regulated by the 1940 Investment Advisers Act, I am very familiar with both sets of regulations.
An investment advisor who is regulated by the 1940 Act is required by law to have a fiduciary standard with his clients. If he does not uphold a fiduciary standard, his clients can take him to court and a judge will decide if the advisor acted in a fiduciary manner with his clients. A registered rep and/or broker dealer is exempt by law from the 1940 Act. Those that give advice to the public should have the same standard OR the differences should be clearly delineated.
Let me give you some real life examples of the differences between the fiduciary standard and the suitability standard.
Example1. A person is employed making $30,000/year, has $10,000 in credit card debt with an interest rate of 14%, is not contributing to a 401(k) even though the employer is providing an employer match for the first 6% of employee contributions, and the person has no emergency fund.
An uncle dies and leaves the person $20,000. What is the best use of that money? Under the fiduciary standard, the best advice to the person would be to pay off the credit card debt which eliminates a liability charging 14% interest, adjust cash flow to contribute some money to his 401(k) plan to gain the employer match which is essentially free money to the employee, and put the balance into an emergency fund. The person would be out of debt, would be saving money through his 401(k) plan for retirement, and would have an emergency fund for an emergency.
Under the suitability standard, a registered rep could have the person invest the $20,000 in a mutual fund, annuity, or other appropriate investment vehicle suitable to his risk tolerance and time horizon and earn a commission on the sale of the products sold.
Although both sets of advice are legal under current law, I highly suggest that the first advice with a fiduciary standard is more appropriate and helpful to a person than the second advice with a suitability standard.
Example 2. A person has retired and wants to move money from his 401(k) to a retirement account. A registered investment advisor might suggest putting the money in an appropriate portfolio mix of mutual funds. A registered rep suggests that the person put the money inside an annuity using the same mutual fund sub accounts as the registered investment advisor. Both actions are considered legal. However, the first action is honest and ethical the second was done for the significant commissions earned by the registered rep. In this example, the retired person was aware of the death benefit, but did not want or need it.
People should be allowed to earn commissions on the sale of financial products. However, the regulations that are designed to protect the public should require that any person who sells products is clearly labeled a sales person, not an advisor. Sales people can be honest and selling can be an honorable profession. However, selling is different than advising.
The public believes that all financial advisors are the same. The public cannot differentiate among fee only advisors who charge for advice given, fee based advisors who charge for advice and earn commission on products, and commissioned advisors who solely earn commissions on products.
True financial advisors are paid for advice given, not product sold. Advisors provide the investor with all facts relevant to making a thoughtful decision including pros and cons on various options. Registered reps are different than financial advisors who earn commission on products sold. Registered reps provide the investor with facts relevant to making a sale, not facts relevant to making a thoughtful analytical decision. Today, investors cannot tell the difference.
Recommendation
I would recommend that you apply the 1940 Investment Advisers Act fiduciary standards to all advisors who offer financial advice to the public.
I would recommend that you allow people who want to sell financial products to do that but to be CLEARLY labeled as sales people, not financial advisors, and be prohibited from calling themselves in any fashion financial advisors, financial consultants or any other term. People who are not licensed to practice law cannot hold themselves out to be attorneys and can be prosecuted for practicing law without a license. The same standards should be true for financial advisors. True advisors are paid for advice given, not products sold.
Please keep these comments in mind as you consider your recommendations. Feel free to contact me if you would like to discuss this in more depth.