New SEC Form CRS: Is Your Financial Adviser An ‘Adviser’?
Originally posted on Forbes.com
Under new SEC rules, your financial adviser may no longer be an "adviser."
When people talk about their financial advisers in the future, they may need to use a different title. The U.S. Securities and Exchange Commission (SEC) issued new regulations on June 5, 2019, to “Enhance and Clarify the Obligations Financial Professionals Owe to our Main Street Investors.” Under the new rules, your financial adviser may no longer be an "adviser."
If you’re wondering what’s going on, here is some perspective as someone who has been following these developments and commenting on the underlying rule proposals.
Titles
Today, you have brokers and investment advisers, but brokers can and do call themselves financial “advisers.” That will no longer be allowed under the new SEC rules that were adopted on June 5, 2019. Effective June 30, 2020, a broker who uses the title “advisor” or “adviser” will be “in violation of the capacity disclosure requirement” under the new rules.
Here is the rationale, as stated by the SEC in its “Regulation Best Interest: The Broker-Dealer Standard of Conduct” release (P. 155-156)
“Given that the titles ‘adviser’ and ‘advisor’ are closely related to the statutory term ‘investment adviser,’ their use by broker-dealers can have the effect of erroneously conveying to investors that they are regulated as investment advisers, and have the business model, including the services and fee structures, of an investment adviser.”
Calling brokers something other than financial advisers is easy enough. However, there is a complication. Many brokers work for large broker-dealers that are dually registered (as broker-dealers and advisers), for example, Merrill Lynch and UBS. Can they be called advisers? The SEC says maybe: if the broker is “not also a supervised person of an investment adviser” he or she cannot use “the term 'adviser' or 'advisor' as part of a name or title.” (P. 149 of the release). However, he or she can use the firm’s name if the firm uses “adviser” or “advisor.”
It would have been a lot easier to mandate the dually registered firm’s call their representatives “dually hatted,” a term the SEC used in the release. But alas, that was not the case.
What’s in a Name: Brokers are Different from Advisers
This all has to do with investor confusion. Regulators have studied whether investors know who’s who on Wall Street. They don’t.
For example, a RAND Study concluded that investors did not understand the differences between broker-dealers and investment advisers and that common job titles contributed to investor confusion. Focus group participants did not understand the term fiduciary, or how the fiduciary standard differed from suitability. Confusion about titles, services, legal obligations, and compensation persisted even after a fact sheet on broker-dealers and investment advisers was provided to participants. For more information on studies, you’ll want to read the SEC’s April 18, 2018 CRS proposal.
Do the Differences Matter to Investors? They Should.
There are differences in services and obligations and that should matter to every investor.
As the SEC said in its June 5 interpretive release on duties of investment advisers: “Investment advisers and broker-dealers have different types of relationships with investors, offer different services, and have different compensation models. This variety is important because it presents investors with choices regarding the types of relationships they can have, the services they can receive, and how they can pay for those services.”
The differences have to do with retail customers’ (that’s you) transactions versus ongoing advice.
“Broker-dealers typically provide transaction-specific recommendations and receive compensation on a transaction-by-transaction basis (such as commissions) (“transaction-based” compensation or model). A broker-dealer’s recommendations may include recommending transactions where the broker-dealer is buying securities from or selling securities to retail customers on a principal basis or recommending proprietary products.” Quoting from the Best Interest Release p. 7)
What about investment advisers?
“Investment advisers, on the other hand, typically provide ongoing, regular advice and services in the context of broad investment portfolio management, and are compensated based on the value of assets under management (“AUM”), a fixed fee or other arrangement (“fee-based” compensation or model).” Quoting from the Best Interest Release p. 7)
What’s important about these developments, which were a very long time coming, is this: The SEC established a new standard of care for brokers. The new standard (called Best Interest) is more than the current “suitability” standard, but it is less than a “fiduciary” standard that applies to registered investment advisers.
As the SEC stated in its June 5 release, “Regulation Best Interest will enhance the broker-dealer standard of conduct beyond existing suitability obligations and make it clear that a broker-dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations.”
This new best interest standard will come into play when a broker is making an investment recommendation to a retail customer:
“A broker, dealer, or a natural person who is an associated person of a broker or dealer, when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer, shall act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or natural person who is an associated person of a broker or dealer making the recommendation ahead of the interest of the retail customer.” Quoting Regulation Best Interest (section (a)(1)).
There will be four new obligations for brokers to comply with: disclosure, care, conflict of interest, and compliance. What’s most important? From my point of view, conflict of interest.
New for Brokers: Conflict of Interest Obligation
Brokers will need to comply with the new conflict of interest obligation, which is designed to:
“Mitigate conflicts that create an incentive for the firm’s financial professionals to place their interest or the interests of the firm ahead of the retail customer’s interest;
Prevent material limitations on offerings, such as a limited product menu or offering only proprietary products [products sponsored by the firm], from causing the firm or its financial professional to place his or her interest or the interests of the firm ahead of the retail customer’s interest; and
Eliminate sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.” Quoting from SEC Release 2019-89 of June 5, 2019.
Best Interest - Open to interpretation
This new best interest standard will evolve over time as it begins to be applied in the real world. The SEC had “a perfect opportunity to firm up what ‘best interest’ means, but the SEC declined to do so,” noted Jamie Hopkins, Director of Retirement Research at Carson Wealth. We will see how this plays out in the future.
What’s in a Name?
In today’s world, the term “financial adviser” is simply a marketing term, which may disappear at some point after brokers are prohibited from using it.
From my perspective, the distinction is pretty clear: you want a broker for discrete investment recommendations on a transaction-by-transaction basis, as opposed to ongoing investment management.
You want an investment adviser for ongoing investment management.
By the Numbers
More than 102 million retail customers are served by 428,404 brokers (also called “registered representatives”) who work for 2,766 stand-alone broker-dealers. There are more than 13,300 investment advisory firms registered with the SEC, 8,235 of which serve over 32 million retail clients. There are 359 dually-registered firms (both broker-dealers and investment advisers).
For Context
If your financial professional is a broker, you may want to read the SEC’s 771-page release. The length of the release will tell you that this is a complicated topic that took a lot of study and careful consideration by regulators; however, if you want context, the introduction and background are only a few pages long and worth everyone’s time. You may also want to read comment letters from the public and the industry; there are thousands to choose from, including mine, which you will find here.
To read Julie Jason's books, go to: https://juliejason.com/books/julies-books.
