According to a 2004 study by the brokerage firm TD Waterhouse (now TD Ameritrade), more than 80 percent of all investors believe that everyone who provides them with financial advice is subject to the same industry regulations. But that’s not true at all. The big Wall Street brokerage firms have long had their salespeople exempted from the SEC rules that apply to most investment advisors.
As we discussed in last month’s newsletter, wealth managers or anyone else who is registered with the SEC to provide financial planning advice is required to act as a fiduciary—i.e., they have a duty to act in the best interests of their clients at all times. However, a little-known regulation called the Merrill Lynch rule exempts brokers who offer financial advice from registering as investment advisors, as long as the financial advice they provide is deemed “solely incidental” to their business.
The rules for financial advisors have been around since 1940 but have been revisited and reiterated by the SEC several times, including as recently as a year and a half ago, when the Merrill Lynch rule was codified. It is purportedly intended to provide an incentive for brokers to move from their traditional commission-based payment structure—charging their clients for each trade—to a fee-based structure. The SEC wanted to make sure that brokers could use a fee-based structure without triggering the fiduciary responsibilities that have gone along with that in the past.
The problem, though, is that the rule blurs the distinction between who is truly a financial advisor and who is not, and thus the line between who is a fiduciary and who is not. It allows brokers to migrate from their traditional arena of recommending stocks toward a more comprehensive role without assuming the responsibilities that ought to go along with that role.
There’s a reason that the big brokerage firms are loathe to take on a fiduciary role. In addition to trading stocks for their retail customers, brokerage firms like Merrill Lynch also engage in such activities as underwriting and investment banking for their big corporate clients. It’s possible that those types of business can put pressure on the big firms’ brokers to push the stock of those corporate clients. While most brokers are certainly very scrupulous, these conflicts of interest are inherent in any large corporate brokerage firms.
So where does the SEC draw the line? It lies in who is or is not claiming to provide “financial planning services.” Non-fiduciaries may not offer financial planning services, although they are permitted to call themselves “financial advisors” or “financial consultants.” They cannot, however, call themselves “financial planners.” Brokers, then, are allowed to offer incidental financial advice alongside their stock tips without taking full responsibility for that advice.
The SEC does require that brokerage firms offering fee-based advice must make the following disclosure:
Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salespersons’ compensation may vary by product and over time.
That would seem to provide adequate warning, but there is no obligation to deliver that notice orally. So you will have to read the fine print and make sure you ask questions to help you determine who is acting in your interest and who isn’t.
You’re In Charge
The bottom line is, don’t be afraid to ask any financial service provider exactly what services you’re paying for. And don’t be afraid to ask if the person is acting as a fiduciary. Of course, just because someone hasn’t taken on that fiduciary role, that doesn’t mean the person is offering you bad advice.