You might have missed the news that the SEC released new regulations called “Regulation Best Interest” designed to improve the investment advice provided by those dispensing financial wisdom. The rule change specifically requires brokers to put the interests of their customers before their own, disclose to customers how they are paid, if they have any disciplinary history and disclose any conflicts of interest that create incentives for them to distribute certain products.
Most of you reading this probably already thought your investment guru was mandated to have their clients needs placed before their own. Well, you were only partially right.
The Regulation Best Interest law is the type of consumer protection that fee-only fiduciaries have been living up to and cheering the rest of the industry to adopt. However, unlike a fee-based advisor, a broker is an individual licensed by Financial Industry Regulatory Association (FINRA), and they tend to earn commissions by selling clients financial products. The types of products that often pay commissions include mutual funds with a certain share class or a variable annuity. This doesn’t mean that everyone who is a broker and sells a product doesn’t provide other planning services, but if the way your advisor is compensated falls into the commission category, the rules look different starting June 30th 2020.
I have been in the industry for about 25 years, and ever since I started, Brokers responded to the suitability standard when making investment recommendations to clients. In my opinion, holding a broker to a suitability standard feels like it is designed to protect their brokerage company from a bad investment recommendation, more than protecting the needs of a customer. This standard means that products sold must be reasonable for an investor. However, the suitability standard does not necessarily mean the recommendation is always the best option for a particular customer. The difference with a fee-based advisor who makes a recommendation to their client is that the advice must be absolutely in the client’s best interest with the advisor taking a fiduciary risk as soon as the investment is made. My view is that the greater the risk to the advisor making the recommendation, the more level the playing field and greater alignment between client and investment advisor.
Currently, the fear is that brokers can be influenced by conflicts of interest. Think of proprietary mutual funds, or investment firms that offer bonuses/trips and awards to brokers who meet sales quotas. It isn’t impossible to imagine how an advisor may make a certain recommendation to a client in order to meet the minimum requirements to make it into an elite sales club or group that can open the door to prizes and extras that can create a conflict. As soon as a broker pushes an in-house fund, or an incentivized investment product it can taint the recommendation away from an investor’s most likely best fit investment solution. While we believe that most brokers honestly try and do a good job for their clients, it’s impossible to be certain that a product isn’t sold to earn a trip to Hawaii without giving the highest consideration to a clients particular investment situation.
Again, if you have been working with a Registered Investment Advisor who reports directly to the SEC, as we do, RIAs have traditionally been held to a different, more stringent standard of care. The fiduciary standard requires an unyielding commitment to clients while offering them conflict-free advice based on definable research. This rule applies to all of the advice and recommendations an RIA makes to their clients, not just for investments but across all areas of wealth management.
Now, this rule change doesn’t necessarily mean that the standards for RIAs and brokers are the same moving forward. This new rule aims to help protect consumers and increase the responsibility that brokers face when making recommendations to clients. One of these big changes is the new client relationship summary (CRS) document. The CRS document describes the firms’ services, fee structures, disciplinary history, and any conflicts of interest. This document and requirement is an improvement but it doesn’t necessarily fix the entire conflict naturally present in the brokerage world. This means that a broker may still win a competition or award and earn a prize for selling a certain investment type to their clients, but perhaps with the proper disclosure now, they could safely accept the award.
Previous to this rule, regulations proposed by the Department of Labor were tossed away by the Trump administration before going into effect in 2018. The DOL rule would have banned commission-based sales when recommending products for retirement accounts, but again, that rule never saw the light of day.
It is worth noting that commissions are not always bad. Commissions can potentially introduce a conflict by creating an incentive to sell things to get paid more up front, but there are some cases where a commission may end up being a more cost-effective option than paying a fee-based advisor a high recurring fee. For example, sometimes a client will have a portfolio of investments that almost never changes. In some cases, it may make sense to pay a one time cost to establish the portfolio of professionally chosen investments rather than an annual fee that can eat away at investment returns.
Nevertheless, we will always applaud the regulators for taking steps to eliminate the bad actors in the investment advisory field. It’s always heartbreaking to meet with a new client who brings a portfolio of obviously one-sided investment selections made by a broker who was looking out for solely their own best interest. If everyone can improve the quality of their advice by increasing the rules and responsibility of an investment advisor to do the right thing for their clients – this only serves to reduce the conflicts and hopefully increase the quality of the investment guidance. And that is never a bad thing.
If you have any more questions about this initiative, your specific tax situation, or whether a donor-advised fund is right for you, give us a call and we’d be happy to help you.
Michael Carlin, AIF®