Fuzzy regulation for US advisers

Advisers and brokers are governed by different rules, but customers are often unaware of this distinction. Tighter controls look imminent despite the SEC’s reluctance to implement reforms.


Buyer beware

Doctors, who swear Hippocratic oaths, would hopefully not recommend a particular surgery primarily to line their own pockets. Clients who consult lawyers assume their attorney will act in their best interests. But most Americans who engage stockbrokers – registered representatives of broker dealers like Merrill Lynch or Morgan Stanley – naively expect to receive similar care, and they are mistaken.

They fail to distinguish between investment advisers, who are regulated under a 1940 law and broker dealers, who are governed by a 1934 statute. The former owe customers a higher, “fiduciary” obligation to avoid conflicts of interest, disclose any fees, and above all, put the client’s interest ahead of their own. Brokers, who basically facilitate securities transactions, are held to a weaker “suitability” standard: not to recommend inappropriate investments, lie, deceive or commit fraud. Caveat emptor, not fiduciary loyalty.

The trick is recognising which one sits across the table. About 15 years ago, the dividing lines become fuzzier.

Brokers began to portray themselves as trusted financial advisers who offered a panoply of investment products, many manufactured in-house and packaged to look like those of their adviser counterparts. As a result, few investors now grasp the opposing legal distinctions and titles have lost meaning. “Under today’s standards, an investor can talk to two people, get a business card with the same title, and not know they are receiving different standards,” explains Luis Aguilar, one of the five Securities and Exchange Commission (SEC) commissioners. However, if both card givers were subject to the same broad based fiduciary requirements, Aguilar adds, “One could call oneself ‘The Grand Pooh-Bah’ and it wouldn’t matter.”

Disclosing compensation is only one aspect of the current different discrepancy, and does not ensure that the investors get a better product. Commissioner Aguilar supports raising the standard for broker dealers who provide personal financial advice (versus only executing trades) to an affirmative fiduciary obligation. “If a broker dealer tells a client that investment A pays Y, and knows another investment B pays Y plus 2, and we can somehow prove the broker knew the investor would be better served by the second one, then the broker should go beyond disclosure of what he is being paid,” Aguilar explains.

Brokers still have an incentive to push their in-house products while advisers must discuss a full range of available options. If standards were elevated, “those brokers who give advice would even have to include competitors’ products. That’s the beauty of full disclosure!” says Aguilar.


A Shattered Life

In 1997, 47-year-old Vikki Vargas spent three months in a coma and became permanently disabled, after suffering brain injury from a ruptured aneurism. Vargas, who had worked as a telephone operator at Pacific Bell Telephone for 30 years, entrusted her life savings to Sharon Kearney, a financial representative from SunAmerica, who, under state law, owed Mrs. Vargas fiduciary care.

Kearney fell far short of that benchmark, according to Sheryl Garrett, the Arkansas-based head of Garrett Planning Network, who provided testimony in the ongoing Vargas lawsuit. Kearney encouraged Vargas to take a lump sum rather than monthly pension, without discussing the pitfalls. She recommended a variable annuity, lucrative for Sun America and of “absolutely no benefit to Vargas,” Garrett says, noting, “withdrawals from Vargas’ retirement accounts had no chance of lasting through the client’s lifetime.”

Disturbed by such lamentable cases, and concerned about overall public confusion, Garrett and 10 others joined forces last June to set up the Committee for the Fiduciary Standard. Spearheaded by Knut Rostad, regulatory and compliance officer at Rembert Pendleton Jackson, the group is urging Congress to adopt new legislation to extend fiduciary duties.


Happily Ever After Ads

“One phenomenon of the blurring between advisers and brokers was how brokers advertised themselves as trusted advisers,” Rostad points out. He points to a Morgan Stanley television commercial that depicted a wedding reception and a speech by a man who appeared to be the bride’s father – but turns out to be a financial adviser. The successful “At Your Side” campaign also included emotional scenes of supposed family members at graduations and retirement beach homes, who are revealed to be friendly Morgan Stanley reps.

Other Wall Street firms, with substantial retail clientele, followed suit. UBS aired its “You and Us” ads, which always showed two people in an intense business context. In a one-on-one relationship, “our advisers take the time to understand you thoroughly”, they promised. The Citi message focused on fulfilling goals and ambitions. One of their ads proclaimed, “Dreams are good. Realities are better.”

Charles Schwab’s taglines offer to listen to you and your needs: “Let me take care of that for you,” one suggested. Bank of America chips in, “You can trust our experience.”

Major brokerage firms employ both brokers and advisers, many of whom are licensed to perform both functions interchangeably. The relevant standard of care depends on how an account is set up. No wonder the American public is baffled.

Rostad and his committee members are hopeful that lawmakers are finally ready to impose fiduciary requirements on all financial advice providers. Until now, he says, “The SEC has been too relaxed about interpreting the law and keeping the standard as tough as it should be. In the aftermath of the crisis, the ground is finally moving under our feet, which no one expected five years ago.”

The SEC and its new chief, Mary Shapiro, seem to have picked up the slack. “The dialogue is not new, but has been crystallised by Obama’s proposed regulatory reforms,” Aguilar says. Even Wall Street firms, while wary of attracting legal liabilities from stricter rules, see reforms coming and have embraced some aspects.

The Commissioner takes a straightforward view. “The principle-based rule – if that’s not an oxymoron – is to take into account clients’ best interests, and fully disclose conflicts so people can make informed decisions,” he simply states. “It’s so fundamental, it’s hard to get around.”

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