Lots of news and views lately on the apparent judicial demise of the SEC's so-called "Merrill Lynch Rule," which exempted brokers from the fiduciary duties and disclosure requirements of the Investment Advisers Act of 1940.
Last night at Marketwatch, Thomas Kostigen offered his perspective on this story in his Sophisticated Investor column. Here are a few key passages:
The U.S. Court of Appeals for the District of Columbia ruled March 30 that the Securities and Exchange Commission doesn't have the authority to allow some brokers to sidestep regulation as investment advisers....
Investment advisers adhere to a different set of standards than the transaction-oriented broker, or registered representatives, as they are known in the financial services industry. Investment advisers are mandated to provide advice that is in the best interest of a client. They can't recommend an investment product strictly for the purposes of a sale....
Registered representative brokers, however, could until now sell investment products that were in their best interest (say a higher-paying commission product) instead of in their client's best interest.
This is probably why more wealthy people have chosen investment advisers to manage their money. Can you trust that a broker employed by a large Wall Street brokerage firm is selling you the right type of investment product for your portfolio or is merely trying to make a buck?...
The brokerage industry says this is doing the client a disservice because brokers can offer advice on whether some products may be more appropriate or better than others and they should be allowed to speak up. However, the brokerage industry doesn't want the liability that goes along with the role of dispensing that advice....
If the brokerage industry bucks the new ruling, which is a good bet, then people should look for investment advisers who are fiduciaries.
The brokerage houses are in a tough spot here. Fee-based "advisory" accounts have become enormous revenue centers for companies like Merrill, Morgan Stanley, Smith Barney, major banks, and insurance companies. Shifting back to a transactional, commission-based business model seems very unlikely. Fuller disclosure--true disclosure--of brokers' potential conflicts of interest would be problematic for the big brokers as well. But assuming fiduciary responsibility for the actions of huge sales forces--some of whom, to put it bluntly, are not especially sophisticated or well-trained*--would expose these firms to tremendous litigation risk. We'll be fascinated to see how the corporate players handle these difficult trade-offs...and the PR risk of saying "No thanks, we don't want to be forced to act in our clients' interests."
Regardless of how all this plays out, independent firms like Interlake will retain an important distinction. Rather than fight it, as the big brokers have, we welcome our fiduciary duty, because it's the right way to do business and because it assures our clients that our interests are fully aligned with their own.
We'll have more on all this in future posts, including some interesting research findings on public understanding of the broker/advisor distinction. (UPDATE: We describe those findings briefly in this post.)
For another take on this story, see William Barrett in Forbes.
*We want to be clear here: Many brokers are sophisticated, effective investment professionals. From experience, however, we can tell you that their employers are much more interested in training them to sell than they are in training them to manage money responsibly.
Sources
Thomas Kostigen, "Trust is a must: Where rich people go for advice, and why," Marketwatch, April 10, 2007
William P. Barrett, "Is Your Broker an F-Word (Fiduciary)?" Forbes, April 9, 2007