Wall Street Journal columnist Jason Zweig spells out a fundamental difference between Registered Investment Advisers and stockbrokers (legally known as “registered reps,” since they represent the broker-dealer) in his column this week, “The Fight Over Who Will Guard Your Nest Egg.” He notes:
A power struggle in Washington will shape how investors get the advice they need.
On one side are stockbrokers and other securities salespeople who work for Wall Street firms, banks and insurance companies. On the other are financial planners or investment advisers who often work for themselves or smaller firms.
Brokers are largely regulated by the Financial Industry Regulatory Authority, which is funded by the brokerage business itself and inspects firms every one or two years. Under Finra’s rules, brokers must recommend only investments that are “suitable” for clients.
Advisers are regulated by the states or the Securities and Exchange Commission, which examines firms every six to 10 years on average. Advisers act out of “fiduciary duty,” or the obligation to put their clients’ interests first.
Most investors don’t understand this key distinction. A report by Rand Corp. last year found that 63% of investors think brokers are legally required to act in the best interest of the client; 70% believe that brokers must disclose any conflicts of interest. Advisers always have those duties, but brokers often don’t. The confusion is understandable, because a lot of stock brokers these days call themselves financial planners.
So what, you say, isn’t this all just semantics? No. Here’s one small example of how the lower standard of care for stockbrokers hurts the investing public:
A key factor still is missing from Finra’s suitability requirements: cost. Let’s say you tell your broker that you want to simplify your stock portfolio into an index fund. He then tells you that his firm manages an S&P-500 Index fund that is “suitable’ for you. He is under no obligation to tell you that the annual expenses that his firm charges on the fund are 10 times higher than an essentially identical fund from Vanguard. An adviser acting under fiduciary duty would have to disclose the conflict of interest and tell you that cheaper alternatives are available.
If brokers had to take cost and conflicts of interest into account in order to honor a fiduciary duty to their clients, their firms might hesitate before producing the kind of garbage that has blighted the portfolios of investors over the years.
That last sentence of Mr. Zweig’s is one of the clearest statements I’ve read for why starting today all financial advisors of whatever stripe ought to be required to put the client’s interests before their own.
But it’s far from clear that this will ever come to pass. Last I looked there were over 600,000 stockbrokers in the U.S., each of them part of the vast, powerful product-distribution channel of the financial-services industry. By contrast there are only about 40,000 independent Registered Investment Advisors scattered among all the states.
The stakes are too high for the financial-services industry to let a true fiduciary duty be required of stockbrokers under all circumstances. Yet the stakes are too high for the investing public not to receive this protection. Someone will have to give. And hasn’t the investing public given enough already to the financial-services industry?
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