Brokers who offer advice to investors may be held to the same fiduciary standards as investment advisers if legislation proposed by the Obama Administration is passed by Congress.

Brokerage advocates support the move in theory, but don't want it to be too restrictive, while a coalition of agencies representing financial advisers says the proposed changes don't go far enough.

Several recent studies have shown that most Americans don't understand the subtle but important differences between brokers and advisers. While they may look and act the same, their motivations are different. Advisers charge a fee for giving advice but have a fiduciary duty to look out for the best interests of investors. Brokers don't charge a direct fee but get a commission on the products they sell, and must make "suitable" recommendations to their clients.

Advisers and broker/dealers use interchangeable, generic titles such as adviser, financial adviser and financial consultant, and the services they provide often appear virtually identical from a retail investor's perspective, even though they are regulated under different statutory and regulatory frameworks.

Brokers and dealers are governed by the Securities and Exchange Act of 1934 and are overseen by the Financial Industry Regulatory Authority, while investment advisers fall under the Investment Advisers Act of 1940 and are regulated by the Securities and Exchange Commission.

The Obama Administration aims to close this gap by requiring both brokers and advisers to look out for the best interests of their clients. Furthermore, the proposal recommends that the SEC be able to prohibit compensation that encourages intermediaries to steer investors into products that are profitable for them, but that are not in their clients' best interest, according to a new report by the Treasury Department, titled "Financial Regulatory Reform: A New Foundation."

"The Administration's legislation would give the [SEC] authority to require a fiduciary duty for any broker, dealer or investment adviser who gives investment advice about securities, aligning the standards based on activity, instead of based on legal distinctions that are no longer meaningful," the Treasury report said

Fiduciary Duty

The concept of fiduciary duty requires firms to act in the best interests of their clients and to place their client's interests ahead of their own, said David Tittsworth, executive director and executive vice president of the Investment Adviser Association.

"Investment advisers are subject to fiduciary duty, and the same fiduciary duty should be extended to brokers," he said. "We have supported the concept of extending fiduciary duty to brokers or anybody who provides investment advice. We think it's a great idea, but we want to make sure that legislation actually does what they say it's going to do."

A coalition of investment groups comprised of the Certified Financial Planner Board of Standards, the Consumer Federation of America, the Financial Planning Association, the National Association of Personal Financial Planners, the Investment Adviser Association, the North American Securities Administrators Association and the nonprofit advocacy group Fund Democracy, supports the administration's whitepaper, with just a few minor suggestions.

"While we applaud the intent evident in this provision and believe it represents a good starting point, we believe revisions will be needed to unambiguously provide for the extension of the overarching fiduciary duty that investment advisers owe their clients under the Advisers Act to brokers and others who provide investment advice, that this fiduciary duty is explicitly recognized in law, and that the legislation does not in any way undermine the fiduciary duty that already exists under the Advisers Act," the coalition of industry groups wrote in a letter sent Tuesday to Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee.

"Over the years, we have looked on in dismay as brokers have been allowed to offer extensive advisory services without having to comply with the Investment Advisers Act of 1940," the coalition said. "We share the view that the highest legal standard-a fiduciary duty-should apply to all who give financial advice to clients."

Barbara Roper, director of investor protection for the Consumer Federation of America, said a simple change in the wording would mandate the SEC to take action and could lead to real reform, instead of past efforts that went nowhere.

"The legislation authorizes but doesn't require the SEC to act," Roper said. "It gives the SEC unlimited leeway to decide whether or not to provide this fiduciary light, and relies on the SEC to fix the problems that the SEC created."

Merrill Lynch Rule

The SEC previously attempted to blend the regulations for brokers and advisers in 2005, with a rule called "Certain Broker-Dealers Deemed Not to Be Investment Advisers," also known as the "Merrill Lynch Rule."

Large firms like Merrill Lynch do a significant amount of business in both the investment advisory and brokerage fields, while smaller firms tend to provide a more limited and focused range of either investment advisory or brokerage services.

The rule would have allowed brokers to call themselves financial advisers and charge fees for information without being subject to the same regulations as independent advisers, but the legislation was successfully challenged and overturned by the U.S. Court of Appeals for the District of Columbia in 2007.

According to the SEC, 90% of the more than 11,000 registered investment adviser firms have fewer than 50 employees, and 68% (more than 7,500 firms) have 10 or fewer employees. While there are some dually registered advisers who have both a Series 7 license to work as a registered representative and a Series 65 license to work as an investment adviser, less than 6% of registered investment advisers are dually registered. Most of these dually registered advisers work for large firms.

Investors' trust in their financial advisers has been badly shaken in the wake of the global financial crisis and several highly publicized Ponzi investment schemes. Investors are demanding changes, and old standards that require only a commercial duty of fair dealing in arm's-length transactions are not commensurate with the trust and confidence that investors place in their financial services professional, Tittsworth said.

"We believe any 'harmonization' of laws and regulations governing brokers and investment advisers should extend the investor protection benefits of investment adviser fiduciary standards to anyone who offers investment advice," he said.


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