SEC weighs raising the standard for brokers

Investors still have time to tell the SEC what they think

August 29, 2010|By Eileen Ambrose, The Baltimore Sun

You might assume that all investment professionals must act in the best interest of clients.


Decades-old securities laws have set different standards for financial professionals. Investment advisers who are paid for their advice on securities must put you first. Brokers, who earn commissions on stocks, bonds and other products sold, just need to make sure an investment is suitable — a much lower legal threshold.

The Securities and Exchange Commission is finally taking a hard look at whether this double standard should continue. And it's about time, given that so many investors don't even know that these different rules exist.

The new Wall Street reform law gave the SEC six months to study whether current regulations leave a gap in consumer protection and whether brokers need to be held to a higher standard. The agency is accepting public input through Monday, and hundreds have weighed in on its website.

Many brokers are warning that a change would lead to more regulation and lawsuits, and higher costs passed onto consumers. And they wouldn't be the only ones affected. If the SEC imposes what's called a "fiduciary standard," it would also apply to insurance agents selling variable annuities.

Consumer advocates and state regulators have long argued that brokers should have a fiduciary duty to put customers' interests first.

"The brokerage industry has spent a lot of time and money over the last several decades selling the idea that they are trusted advisers. And it's time they be held to that standard," says Barbara Roper, director of investor protection for the Consumer Federation of America.

Decades ago, the line between brokers and investment advisers was clear-cut. Boundaries started blurring in the early 1990s, as investment firms began offering both brokerage and advisory services to provide clients with one-stop shopping. Brokers also started calling themselves financial advisers and financial consultants, adding to investor confusion.

No wonder that a 2008 study commissioned by the SEC found that the average investor didn't know the difference between brokers and investment advisers, or their legal responsibilities to clients. Even the study's researchers sometimes had difficulty distinguishing brokerages from advisory firms.

"It's absurd to pretend that investors are going to understand that an investment adviser is acting in their best interest, but a financial adviser doesn't," Roper says.

Whether your investment guru owes a fiduciary duty or not can have a big impact on your finances.

Brokers are required to know enough about clients to suggest appropriate investments. But once brokers determine you should have, say, a large-cap mutual fund, they can recommend the one with the highest commission, and they don't have to tell you that, Roper points out.

But an investment adviser must recommend the large-cap mutual fund that's best for you, taking into account the fund's cost, among other factors, she says. For this service, advisers usually are paid an hourly fee or a percentage of assets under management.

Brokers say they already put clients' interests first and don't need additional regulation.

Holding brokers to a fiduciary standard could create more problems, brokers claim. Some question whether they would still be able to offer their clients investments in which their firm is involved in without creating a conflict of interest. For example, would brokers be able to sell mutual funds run by the brokerage or municipal bonds and initial public offerings that the firm underwrites?

Dick O'Brien, executive vice president of Folger Nolan Fleming Douglas in Hunt Valley, warns that brokers might start charging annual fees, like advisers do, if commissions fall off because of a fiduciary standard. In some cases, annual fees can be much more expensive for investors than paying a one-time commission, says O'Brien, whose firm offers brokerage and advisory services.

Daniel McHugh, president of the brokerage Lombard Securities in Baltimore, said a fiduciary standard could put a burden on brokers to research every stock in a new client's portfolio and recommend which ones to sell.

"A lot of clients don't want that," he says. "They really want to be able to pick and choose their own stocks and accept or reject recommendations from their stockbroker."

Plenty of people wrote to the SEC in support of a higher standard for brokers, including Jim Ludwick of Odenton.

Ludwick, a former broker and now a fee-only planner, says a minority of brokers push clients into fee-laden products to earn higher commissions, and a fiduciary standard could prevent this practice that hurts investors. "The higher the embedded fees in an investment, the lower the potential returns," he says.

Consumer Federation's Roper says brokers are manufacturing problems.

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