Based on: S.E.C. Tells Brokers to Work for You, but Don’t Skip the Fine Print. NY Times
The Securities and Exchange Commission said new rules would help ensure investors get advice they can count on. Advocates are skeptical. Photo by Jonathan Ernst/ReutersJune 29, 2019
When you go to the doctor, there’s an expectation that she will act in your best interest. You don’t expect to be prescribed costly pills because the office is getting a commission from the drug company when a healthier diet will do the trick.
The next time you get a financial checkup or make an investment, there will be new rules in the US about what you can expect from your investment professional. But the rules shouldn’t necessarily give investors the comfort of a doctor-patient relationship.
Not everyone is convinced that the new rules will really protect retail investors. These changes may have weakened the standards governing one class of financial professionals while giving an unwarranted veneer of trustworthiness to another.
Let’s hope Europe will soon follow the lead while fixing the shortcomings of S.E.C. changes.
What you should know.
What’s new?
The changes made by the Securities and Exchange Commission the past June 5, 2019 — one rule change alone takes up 771 pages — but the agency said they would help ensure investors get advice they can count on.
The most notables involve the rules for financial brokers and investment advisers.
Brokers (usually investment banks in the US and commercial banks in Europe) — technically known as registered representatives — are licensed to sell mutual funds, stocks, bonds and other financial products to retail investors. Investment advisers are paid to provide financial guidance.
In the US, under the old rules, brokers were generally required to recommend investments that were “suitable” based on a customer’s characteristics, like their age, goals and tolerance for risk. Investment advisers have been held to a higher standard: fiduciary duty, which means always putting their customers first, in part by eliminating conflicts of interest or at least trying to mitigate them.
The Positive: The new rules say that brokers cannot put their own interests ahead of their customers’ — an arguably higher standard than suitability, which experts say still falls short of saying customers come first.
The Negative: They also offer a new interpretation of the fiduciary duty standard, Investment advisers and Brokers (now) merely have to disclose conflicts of interest, not avoid them.
That disclosure provision is important for the clients of both as it can be potentially buried deep in the paperwork in order to profit at clients’ expense.
In Europe, brokers (banks) only have to inform about their direct revenue from the products the are offering the client, which is buried under a load of paperwork regarding the investment profile questionnaires, investment characteristics, and contracts, etc. They have no fiduciary duty to their clients because they don’t act — or so they say– as investment advisors.
A European example: A bank may hold stock of a captive mutual funds wholesaler, indirectly receives a share of the money that may be received from another mutual fund provider through a practice known as placement incentives and it may also receive money from the mutual fund provider through a practice known as revenue sharing. A bank could — would — favor those funds over a lower-cost alternative when making a recommendation to a client. This type of activity is legal in Europe only disclosing the direct revenue sharing while hiding any indirect revenues.
In Europe, when you work with a bank/broker under current regulations, you cannot expect it will recommend the investments that are in your best interest..
The other loophole
In both, the US and Europe, sometimes brokers look like and act like advisers — as when they help people plan for retirement, buying a home, or save for college.
The new American regulations have widened a loophole for brokers when they offer advice on meeting those goals. If the advice was “solely incidental” to their service as a broker and they didn’t receive special compensation for the advice, they don’t have to act as fiduciaries — something that will now be easier to do. It also means they don’t have a duty to monitor your account, so you might not get a heads-up if things go off track.
In Europe, even though it’s prohibited, it’s commonly done during the verbal selling of the product, but afterwards and buried deep within the paperwork the client signs that it hasn’t received such verbal recommendations.
There are exceptions: Brokers with authority to move your money around without your permission are considered advisers, under the law, and the same goes for brokers who collect a regular fee to manage your money.
This puts the onus on customers to understand who they’re working with and how those financial professionals are compensated.
Advisers remain the best bet in Europe and the US
The safest course is picking an independent, fee-only adviser who makes an explicit promise to act as a fiduciary.
Fee-only pros are not compensated when they sell you something. Instead, they will receive a flat fee, an hourly charge, or payment calculated as a percentage of the assets they manage for you. It’s clean and transparent.
Another option: certified financial planners (uncommon in Europe), a professional designation with rigorous curriculum and experience requirements. They pledge to act as fiduciaries when providing financial advice and can lose their designation if their self-governing board discovers they have not.
You can find these types of professionals through the following associations: The Garrett Planning Network, the National Association of Personal Financial Advisors and XY Planning Network. Roboadvisers — which provide automated advice, sometimes with human help — are another alternative.
If the brokerage firm that your adviser works for will not permit them to use their certified financial planner credentials, that is a huge red flag.
The pledge
Then there’s the ultimate test: Ask your advisers to sign a contract that expressly contains a fiduciary pledge clause, which states that you expect them to put your interests first all of the time, with all of your money, in all of your accounts.
Don’t forget to check that contract explicitly contains the following: as an annex a mandatory policy underwritten by with a renowned insurer covering professional malfeasance for an adequate floating amount (X% of asset managed), any change to the insurance contract must be notified to you with at least 5 business days in advance to their enforcement and that you should receive a certificate from the insurer every time any part of the 5 days before prime due stating it has been paid, another 5 business before any anniversary stating that the policy it’s in good standing and will be renewed, and the last one once stating it has been renewed.
Any disputes you have — with brokers and advisers alike — are most likely to be settled in court in Europe and arbitration in the US. But having an expressly signed pledge in your contract can only bolster your case and an having insurer at least asure there is — some — money to pay for the damages.
