An SEC vote aimed at helping retail investors could end up adding to their confusion.
Tomorrow, the Securities and Exchange Commission (SEC) will vote on a package of rulemaking proposals aimed at protecting retail investors by, among other things, requiring brokers to act in the best interest of their customers. While the SEC’s intentions are good, I fear that the focus on labels (broker versus adviser) and on legal distinctions (“best interest” versus “fiduciary duty”) will only add to the confusion faced by many retail investors.
The world of wealth management can be a confusing, daunting place for the average investor. At the same time, there has never been more information available to the investing public. This apparent paradox is a problem that regulators and consumer advocacy groups have tried to address for years by, among other things, mandating more disclosures and imposing “plain English” requirements. Unfortunately, even the best intentions often have unintended consequences. Recent regulatory efforts seem to have added to the confusion by moving the concepts of “suitability” and “fiduciary duty” to the forefront, and those with a financial interest in the confusion (i.e. broker-dealers, investment advisers, and other financial professionals) have taken advantage.
Let’s take a step back and examine where all the confusion comes from. The financial services industry is populated by several types of financial professionals, including financial planners, insurance agents, accountants, estate planning attorneys, brokers, and investment advisers. Each of these professionals has different duties and legal obligations, including the fiduciary duty owed by investment advisers to their clients (which means they are held to the highest standard of conduct and must act in the best interest of their clients) and the duty of fair dealing owed by a broker to a customer (which, in part, means that they will only make recommendations to buy securities that are suitable for the customer).
These various players used to stick to their own turf and serve distinct needs of the investing public. For example, brokers typically buy and sell securities for their customers and, in return, the customers pay the broker commissions on the transactions. As long as a transaction is suitable for a customer (i.e. appropriate for the customer’s investment objectives), a broker can recommend a security that paid the broker a higher commission even if there were suitable alternatives that were cheaper for the customer (and therefore generated smaller commissions). On the other hand, investment advisers provide regular and continuous investment advice, usually to high net worth clients, for a fixed, asset-based fee. While there can be other fees involved, all fees have to be clearly disclosed to a client before the advisory relationship begins.
These days, any given financial professional or entity might offer two or more products or services (insurance, financial planning, estate planning, stock trading, and investment management), this includes companies that are registered as both investment advisers and broker-dealers. These so-called “hybrids” act as investment advisers in some situations and as brokers in others. Needless to say, the duties, legal obligations, and compensation structure of such companies can be murky at best.
The SEC introduced its current proposals way back in April of 2018 in an attempt to clear up the confusion. These proposals are intended to “enhance the quality and transparency of investors’ relationships with investment advisers and broker-dealers while preserving access to a variety of types of advice relationships and investment products.” Easier said than done.
The most ambitious of these proposals, known as Regulation Best Interest, has garnered the most attention. It would require broker-dealers to “act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer [and] … make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer in making recommendations.” Another proposal is “an interpretation to reaffirm and, in some cases, clarify the [SEC’s] views of the fiduciary duty that investment advisers owe to their clients,” which, as the SEC says, includes the obligation to “act in the best interest of its client.” The SEC believes that “[by] highlighting principles relevant to the fiduciary duty, investment advisers and their clients would have greater clarity about advisers’ legal obligations.”
As an aside, it seems reasonable to assume that any investment professional will act in the best interest of their clients or customers. However just because they are supposed to act a certain way doesn’t mean that they will. The SEC’s website is full of enforcement actions against investment advisers that failed to uphold their fiduciary duties.
These two proposals have yet to be implemented by the SEC, but they have already sparked a fierce debate among brokers and advisers, some of whom believe that all financial professionals should be held to the fiduciary standard and others who think there was nothing wrong with the status quo. The proposals also appear to have spurred a new wave of marketing, with some firms touting the fact that they are fiduciaries and that they don’t accept commissions and others talking more about their low brokerage fees.
The additional disclosure and marketing prompted by the SEC’s proposals is great, but I fear that in all the noise of the suitability/broker vs. fiduciary/adviser argument that the real jewel of the SEC’s proposals is being missed. People who are looking to hire a financial professional shouldn’t do so based on a label, the label is only one part of the equation. Investors needs to take a deeper look under the hood to find out exactly what they are getting.
The SEC’s third proposal aims to allow investors to do just that by requiring brokers and advisers to provide their clients with a new short-form disclosure document, referred to as Form CRS (short for client relationship summary), that would “provide retail investors with simple, easy-to-understand information about the nature of their relationship with their investment professional” and supplement other, more detailed disclosures. For advisers, those detailed disclosures would be those found in Form ADV, which advisers are already required to provide to their clients. For brokers, the detailed disclosures would be those required under Regulation Best Interest (which, again, has not been enacted).
I believe that Form CRS would make a real difference in the industry by laying out the key distinctions between an independent investment adviser (i.e. an investment adviser that is not also a dually registered has no broker-dealer affiliation) and a broker-dealer. Moreover, for clients of an investment adviser, the ADV is typically the primary source of the adviser’s disclosures. But the ADV can run dozens of pages long and is often drafted by a law firm hired by the adviser. They often contain so much legalese and such detailed disclosure language that it can be very difficult for most people to read and understand, if they even bother to read it at all. As a result, it is easy to miss a lot of the important disclosures relating to fees, conflicts of interests, and regulatory events. Form CRS can be a better vehicle for disclosing these key issues in a simple, straight-forward way. Form CRS is supposed to be no more than four pages long and would disclose the services offered, fees and costs, conflicts of interest, and any regulatory disclosures such as disciplinary events and complaints.
At Spotlight Asset Group, we felt so strongly that Form CRS is the direction the industry needs to go that we came up with our own document ahead of the SEC finalizing any of these rules. Our “Prospect Proposal” is a two-page document that highlights all of the information we feel is important for prospects to know before they sign up with us as a client. This includes the services we will provide, the fees they will be charged as both a percentage and as a dollar amount, any additional costs like trading commissions or expense ratios, any material conflicts of interest we may have, and how their individual investment adviser representative is compensated. If at some point we have a regulatory or disciplinary item that should be disclosed, we would disclose it in our Prospect Proposal. We are working to implement the use of the Prospect Proposal across the firm because we believe that it is important to be completely transparent with our clients at the outset of the relationship. Not only is this fair, it serves to set the tone for an open dialogue and cooperative partnership with our clients. As noted in a recent Intelligent Investor editorial by Jason Zweig of the Wall Street Journal, this dialogue is the real key to a good relationship between a financial advisor and their client.
I think such upfront disclosures are vitally important and should become the standard for all financial professionals. While the current disclosure documents lay out an adviser’s duties or a broker’s obligations, in my 15 years in the investment business I can count on one hand the number of clients who have asked questions about disclosures in an ADV or other document. It doesn’t happen often because a lot of people don’t read them. Wouldn’t it be better if a financial professional had to proactively go through all relevant information with a prospective client or customer before they signed on the dotted line? That is the argument we should be focusing on, not a confusing discussion about who is a fiduciary and what that means.
 See SEC Proposes to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Investment Professionals at https://www.sec.gov/news/press-release/2018-68 (April 18, 2018) (emphasis added).
 See Regulation Best Interest, Release No, 34-83062, available at https://www.sec.gov/rules/proposed/2018/34-83062.pdf (April 18, 2018) (emphasis added).
 Jason Zweig, A New Rule Won’ Make Your Broker an Angel, available at https://www.wsj.com/articles/a-new-rule-wont-make-your-broker-an-angel-11559313036?mod=hp_lead_pos11 (May 31, 2019).