For decades, financial institutions have purposefully blurred the distinction between stockbrokers and investment advisors to the point that most investors believe those designations mean the same thing.
More than two thirds of the investors in the United States have the mistaken belief that stockbrokers hold themselves to the same fiduciary standards – including a commitment to always put the interests of the client first – as registered investment advisors. These mistaken beliefs have troubling consequences for investors, and the Dodd–Frank Wall Street Reform and Consumer Protection Act should lead the SEC to promptly solve this significant problem. As discussed below, the SEC needs to clearly establish that fiduciary standards apply to all investment professionals.
Investment advisors proudly acknowledge a fiduciary duty to their customers; including a duty to always put the customer’s best interests first. In contrast, once a dispute arises or when pressed on the issue, stockbrokers and brokerage firms often contend that they are not held to this high standard despite describing themselves as trusted advisors, financial advisors, investment consultants, and other names that make them sound like they are investment advisors.
Brokerage firms have further confused the issue in recent decades by attempting to act as an investment advisor, without giving up all the conflicts of interest arising from their simultaneous sales and brokerage activities. As a result, brokerage firms receive what amounts to advisory fees while their employees simultaneously act as stockbrokers pitching high fee/commission “house” products such as principal protected notes, reverse convertibles, private equity funds, hedge funds, and other investment products that are created and packaged by the brokerage firms.
These “house” products are often riddled with conflicts of interest that should be avoided by a competent and ethical independent registered investment advisor. For example, many “structured” notes such as principal protected notes and reverse convertibles that brokers and brokerage firms recommend are actually unsecured loans from the investor to the brokerage firm under loan terms that a professional lender like a traditional bank would reject. Investment Advisors, operating under their duty to always put their customers’ best interests ahead of their own best interest, would be troubled by this practice of borrowing money from their own client base.
As another example of the impact of this issue on retail investors, even products as mundane as bonds can be sold differently depending on the duties undertaken by the investment professional. Specifically, an investment professional with a fiduciary duty is required to diligently seek out the best price available on a particular bond to purchase for a client. On the other hand, a brokerage firm refusing to acknowledge a fiduciary duty can simply call its own firm’s bond desk and buy the bond at the price being offered rather than shopping for the best price. Most fixed income investors would be troubled if they realized they were commonly overpaying for bonds sold by their brokerage firms.
Unfortunately, brokerage firms such as UBS, Ameriprise, LPL, Raymond James, Morgan Stanley, Merrill Lynch, and others often claim that their financial consultants are only required to stay within the client account’s “suitability requirements” – a lesser standard that only requires the broker to determine that the product being pitched is “suitable” for the client. This is akin to having your attorney or physician recommend an option that is suitable for you, without regard as to whether it is the best way to proceed among multiple suitable options. In this scenario — as argued by brokerage firms — the stockbroker is free to choose the suitable option that is most lucrative and/or easiest for the stockbroker.
The results of a nationwide survey on fiduciary standards conducted by Infogroup/ORC this past August, show that a nearly unanimous 97 percent of the people agreed that “when you receive investment advice from a financial professional, the person providing the advice should put your interests ahead of theirs and should have to tell you upfront about any fees or commissions they earn and any conflicts of interest that potentially could influence that advice.” The survey shows that two out of three investors surveyed assumed that stockbrokers are held to a fiduciary duty standard. In fact, three out of five investors believe that “insurance agents” also have a fiduciary duty to their clients – but most insurance agents will often deny a fiduciary standard if pressed.
FINRA, the private self-regulatory organization funded entirely by the securities industry, acknowledges that a fiduciary standard should be instituted for brokerage firms and their licensed financial consultants, i.e. stockbrokers. In FINRA's 2009 Year End Report, FINRA’s Chairman and CEO Mr. Richard Ketchum commented: “We support a fiduciary standard for broker-dealers who provide personalized advice and believe the SEC is the correct agency to ensure that the standard is both effective and properly reflects the diverse business models and complex organizations that characterize the broker-dealer industry.”
On July 21, 2010 President Barrack Obama signed into law the Dodd–Frank Wall Street Reform and Consumer Protection Act. This comprehensive legislation gives the SEC the necessary tools to overhaul many regulations in the financial sector, among them fiduciary duty standards. Although the Act requires the SEC to conduct a six-month study to determine if stockbrokers should be held to the same fiduciary standard as investment advisors, SEC Chairman Mary Schapiro has already publicly commented on this issue:
“I have advocated such a uniform fiduciary standard and I am pleased the legislation provides us with the rulemaking authority necessary to implement it,” Schapiro said in a July 2010 speech at the Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce.
Based on the foregoing, the SEC must now step up and promptly force brokerage firms to accept that they have the same legal duty as true investment advisors. If the SEC decides to impose a fiduciary duty on stockbrokers as it should, it would force all investment professionals to put the investor’s interests ahead of their own. It would also force the securities industry to address significant and troubling conflicts of interest that lead members of the brokerage industry to deceptively put their own financial interests ahead of the financial interests of their own clients.
Given the fact that FINRA, the SEC, lawmakers, and investor rights advocates all agree that brokerage firms should have a fiduciary duty to their client base, it is hard to imagine how this standard would not be implemented by the SEC in early 2011. Investors should look forward to this very significant improvement to the system and hold the SEC accountable if it fails to fix this problem.
Christopher Vernon is a Naples-based attorney with the law firm Vernon Healy. He advocates for the rights of investors throughout the United States and abroad—both in and out of the courtroom and arbitration hearing room. Mr. Vernon currently holds an AV rating by Martindale-Hubbell, has been repeatedly recognized by his peers in The Best Lawyers in America and has also been consistently recognized in the Florida editions of the Super Lawyers publication. Mr. Vernon has spoken at both national securities and national trial attorney conventions and has also conducted continuing education in the U.S. and abroad for CPAs, CFAs, CFPs, investment professionals, board certified business litigation lawyers, board certified trust and estate lawyers, and securities regulators. Mr. Vernon has also testified as an expert on issues relating to FINRA arbitration.
This article was co-written by Victor Bayata. Mr. Bayata is also with the law firm of Vernon Healy.
