For nine years now, the financial industry and the federal government have been embroiled in a debate over a rule change to the ethical standards for investment brokers that are enshrined in law as consumer protections.
Currently, the rules state that only those who sell investment advice have a fiduciary duty to their clients. Brokers and others engaged in sales have a duty to be sure the products they offer are suitable for the purposes they sell them for and for their clients’ needs.
This keeps them honest as salespeople, but it doesn’t prevent them from taking investment positions that compete against their clients if they feel it is in their interests to do so. The federal government cited misconduct leading to the financial crisis of 2007 and 2008 and blamed it on the lower suitability standard, arguing a fiduciary duty would have prevented it in most cases.
The industry has taken another opinion, often putting out bombastic opinion pieces on the topic that claim throughout the editorial pages of financial publications that the proposed rule change would disrupt the industry and marginalize small investors.
While a bit overstated, the claim has some merit, because the prospect of being sued for breaching their fiduciary duty to clients could lead firms to prioritize larger accounts and fewer of them in an effort to limit their exposure to the risk and to make sure their staff is better acquainted with each client’s holdings.
Why the Proposed Rule Change Might Not Matter
There are three really compelling reasons why this rule change probably wouldn’t have the impact that its opponents predict. This isn’t to say it’s a good thing, but it is to say that it might not be as big a deal as either side is making it. The first reason is simplest, investors won’t change their behavior if they don’t know their situation has changed.
Advisers wonder if investors will understand the difference because many small investors are already confused about how financial regulations apply to them and which
Well, if your broker only exists to sell you products and you’re paying for advice from an RIA and following it, then the RIA following her fiduciary duty to you should protect you from misleading advice, and what your broker does on the side won’t impact the quality of your decision-making. It might cost the broker some money, though.
The third reason is the most compelling. Basically, there’s good reason to think that investors don’t go to their brokers for advice even when they don’t pay an RIA. There aren’t a lot of hard numbers on it, but consumer sentiment, by and large, indicates an awareness on the part of small investors that brokers are salespeople and they need to do their own research.
That’s why there’s a proliferation of sites offering advice to beginners and articles warning of the perils of copying your strategy from a guru with a large platform.
Why Court Battles Might Be Worse Than Any Change (Or Lack of It)
Currently, the use of the courts to derail new rule proposals has led to the push to enact some versions of the rule in individual states. This leads to several issues.
- Consumer confusion about which laws apply to them based on their home state and the location of their broker
- Industry confusion about the interaction between state and federal rules
- Uneven competition as some states become easier for investment firms and small investors than others
Whether the rule change goes into effect or not, the battle is taking a toll. Let’s hope the industry settles down soon.