Most investors are not aware that brokers are not necessarily required to act in their customers’ best interest, even if they are advising on their retirement money. While that would seem to be a basic consumer protection, in Washington and on Wall Street it has proved to be wildly contentious.
The Investment Advisers Act was passed in 1940, and regulates all persons and firms who, for a fee, advise people, pension funds, and institutions on investment matters. The Act imposes on the advisors “an affirmative duty to their clients of utmost good faith, full and fair disclosure of all material facts, and an obligation to employ reasonable care to avoid misleading their clients”. In short, the clients’ interests must come first.
Generally excluded from coverage under the Act are those professionals whose investment advice to clients is “incidental” to the professional relationship. Brokers whose advice is considered incidental are regulated by FINRA, and are for the most part held to a different, weaker standard of “suitability,” which requires them only to reasonably believe that any investment recommendation they give is suitable for an investor’s objectives, means and age.
It has been nearly five years since the Department of Labor proposed new regulations for the financial services industry, that would require a larger group of advisors to act as fiduciaries and put their clients’ interest ahead of their own. The financial services has spent millions of dollars lobbying Congress to delay or water down the proposed rule.
Advocates of a fiduciary standard for brokers argue that investors don’t understand the current rules. That leaves the door open to abuses by brokers intent on selling products that pay them a commission, whether those investments are the best option for the investor or not. For example, you can satisfy the suitability standard by recommending the worst of what is suitable. If a variable annuity is suitable, you can recommend a variable annuity offered by a weak insurer with exorbitantly high fees and poor investment choices. Clearly, suitability does not equal what is best for the client.
You can read an article on this topic in the June 12, 2014 edition of the New York Times here.
The Wall Street Journal also covered this topic in detail on April 13, 2014, here.