Image Credit: Christophe Vorlet
By Jason Zweig | 4:07 pm ET Mar. 20, 2015
Your broker still doesn’t have to be on your side, but he’s getting pushed in that direction.
Speaking at a financial-industry conference this past week, Mary Jo White, chairman of the Securities and Exchange Commission, voiced her view that stockbrokers, insurance agents and other financial salespeople should have to put their clients’ interests ahead of their own.
Last month, President Barack Obama endorsed pending rules, drafted by the U.S. Department of Labor, that would require brokers recommending investments for retirement accounts to do what is best for their clients.
But this transition is likely to be slow and imperfect. And the move to compel brokers to act exclusively on your behalf should remind you that no new regulation will ever replace the oldest rule in the book: Trust but verify.
At the heart of the problem are two opposing ways of dealing with investors.
By law, investment advisers—the people who run mutual funds, for example, along with some but not all financial planners—have a “fiduciary duty” to act in the best interests of clients and seek to avoid conflicts of interest.
Stockbrokers, insurance agents and other financial salespeople need only ensure that investments are “suitable” for a client’s needs and ability to withstand risk.
“Retail investors need good advice,” said Ms. White in remarks at a seminar sponsored by the Securities Industry and Financial Markets Association. The SEC, she said, should implement a “standard to act in the best interests of investors without regard to the financial or other interests of the [brokerage firm] or the investment adviser.”
The Dodd-Frank financial-regulatory law of 2010 required the SEC to study the issue but didn’t mandate a particular conclusion.
Choosing between two investments similar in all respects except cost, a fiduciary should recommend that you purchase the cheaper one, rather than the one that would pay him the higher fee. A broker, on the other hand, may recommend the one that generates higher fees for himself and his firm.
“In theory, it’s very hard to oppose the idea that someone who’s giving you investment advice should have only your best interests at heart,” says Hillary Sale, a securities-law professor at Washington University in St. Louis.
But in practice it isn’t that simple.
When a brokerage firm helps a company issue stocks or bonds, the issuing company—not the investing public—is the firm’s client. Although paying through the nose for stocks or bonds is unlikely to be in your best interest, your broker might not belabor that point if his firm is helping to issue them.
That’s just one example of the complexities regulators will face in attempting to impose a uniform fiduciary standard on two drastically different ways of serving investors.
As Ms. White said this week, “getting the balance right [between the different interests] is essential,” because “if what we succeed in doing is, in effect, depriving investors of reliable, reasonably priced advice, obviously we will have failed.”
Since the brokerage industry has long been a sales-driven culture, while the investment-advisory business is based on trust, “the difficulty of some of the issues you will have to reconcile is mind-numbing,” says Robert Plaze, a former senior regulator at the SEC and now a partner at the law firm Stroock & Stroock & Lavan. “It’s like in that Glen Campbell song ‘Rhinestone Cowboy,’” he adds. “There’ll be a load of compromisin’ on the road to this horizon.”
As regulators grapple with how to turn salespeople into fiduciaries, it’s worth remembering that even those who already have the duty to put your interests first don’t always do so.
Allan Roth, a financial planner at Wealth Logic in Colorado Springs, Colo., points out that many fiduciary advisers keep their clients’ cash in money-market mutual funds earning as little as 0.01% interest. That cash, he says, could be put to better use in bank certificates of deposit, where it would earn around 1% and be federally insured against loss.
But, says Mr. Roth, that can reduce the assets under management upon which the advisers’ fees are based—so investors often aren’t told they are missing an easy way to earn more income with less risk.
A few questions can help you determine how likely an adviser is to act in your best interest.
Mark Van Mourick, president of Optivest, a financial-advisory firm in Dana Point, Calif., urges asking an adviser whether he is paid the same amount no matter which particular investment he recommends. The answer should be a simple yes.
Boston University securities-law professor Tamar Frankel suggests asking, “Am I the only one who pays you?” If anyone else pays the adviser for recommending an investment, how can that conflict be resolved?
Ask the adviser to name a few situations where his interests might conflict with yours, and how he would handle them. “If he says, ‘There are no conflicts, because I’m a fee-only planner,’ you should walk away,” says Mr. Roth. “Everyone has conflicts. And the people who don’t even question their own motives are more likely to have the potential for mistreating their clients.”
Source: The Wall Street Journal