Is fiduciary duty the fix?

Debate is heating up about whether stock brokers and insurance salesman should have a fiduciary duty to their clients—that is, whether they should be required to always act in a client’s best interest or whether they must simply recommend investments that are “suitable” (the current, lower threshold).

The financial regulatory reform bill that the House already passed made this change, but things have gotten bogged down in the Senate, thanks in large part to lobbying on the part of banks and insurers. That’s probably because unlike the House bill, which requires the SEC to set a new standard for brokers, the Senate version would simply bring brokers under the same umbrella as investment advisers—ostensibly a higher bar.

A recent Bloomberg article captured both the debate and the reason certain policy makers think a change is needed:

Investors have difficulty distinguishing between investment advisers and brokers, and most see their brokers as advisers, according to a 2008 Rand Corp. study commissioned by the SEC. Without the fiduciary requirement, brokers don’t have the same accountability for their advice as investment advisers and have more leeway to sell financial products created by their own firms instead of seeking the best investment for the customer.

What often makes matters worse is that the same person giving investment advice might also be selling, say, variable annuities. In the first capacity, he is an advisor with a fiduciary duty; in the second he’s a salesman without one.

My question in all of this isn’t whether or not fiduciary duty is appropriate, but whether it goes far enough. Since 1979, mortgage brokers in the state of California have had a fiduciary duty to the people they’re providing with home loans. That didn’t do much to stop the real estate free-for-all.

The imposition of fiduciary duty is meant to give individuals legal recourse should a professional not act in his client’s best interest. That’s fine, but it’s punitive, not proactive. It seems what we also need to go along with this is a better way of tying the economic fate of a financial advice-giver to that of his client.

In high finance we now have the notion that banks should have to retain a certain ownership stake in any assets sent out to be securitized. Link the ultimate performance of the asset back to the institution creating it and you’ll probably get better quality stuff, the thinking goes.

I wonder if there could be an equivalent for people suggesting which stock and insurance products to buy.

James

I have been both a registered representative (broker) and an investment adviser representative, and I agree that clients are basically totally clueless as to the difference. However, I take the view that putting fiduciary duty on all brokers is not the correct solution. Here’s some background.

Many people who aren’t in my field of practice aren’t aware of the so-called “Merrill rule”. The way the laws are written means that brokers who give advice on investments ought to be registered as investment adviser representatives, except when advice given is “solely incidental” to normal business, e.g. the client asks the broker for a one-off shot of advice and the broker does not advertise offerings of investment advice. However, in the 90s and going into the 2000s, large broker-dealers, led by Merrill Lynch, began to stretch the definition of “solely incidental”, until the Chris Cox-led SEC basically gave an official OK to that idea, which was called the Merrill Rule. Brokers could get away with advertising customized client service with the strong implication that the broker would provide the services that ought to be offered by investment advisers.

My point is that the structures were in place to require fiduciary standards from brokers by forcing dual registration as an investment adviser, but the SEC let the industry cripple such protection.

An alternative reform is to eliminate the “solely incidental” exception entirely. Brokers serve a valid and useful purpose inasumuch as they effect transactions on behalf of informed (or overly self-confident) individuals. This function is important, but it ought to be very, very distinct from the role of providing advice.
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I appreciate the concern which is been rose. The things need to be sorted out because it is about the individual but it can be with everyone.

Yabs – Not to defend JMK, but my oversimplistic opinion was ever that he essentially argued a regime should pay heavily in a downswing AFTER having redeemed a favorable hoard of surpluses from the beneficent times.
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Barbara Kiviat

@James: Thanks for the insight.
jimc1004

Rules are only as good as the enforcement. We have had a long period of “free market” anarchy where the government regulators did not believe in either government or regulation.

Why should financial advisers be held to a far lesser standard of ethics [and - usually - education and licensing] than a legal or medical adviser? Nobody would routinely expect double dealing and conflicts of interest as a matter of course with other professionals they have a personal relationship with and on whom they rely on [and PAY] for critical help.

The financial industry needs to decide whether they are going to become professionals and act professionally, or continue to act like the world’s oldest profession.

I have a friend who is a senior citizen and naive investor. One of these sharks has been sending her notes and little gifts along with proposals that she turn over her inherited Vanguard portfolio full of Blue Chip stocks and low cost funds to his company. Besides the huge tax bill [from selling everything], and fund expenses many times higher than Vanguard, they also charge a management fee of 1% of assets under management per QUARTER! [I'd really love to see where they proposed to place her CASH at those fee rates - other than in their own pockets, I mean.]

Willie Sutton was kinder to banks!
dochosvet

I guess I will never understand capitalism. For 60 years I thought business/capitalism was supposed to do the best job for it clients it could do with the understanding they would be so grateful they would always come back and be faithful for ever. At the same time they should do the best for less. So now I learn that fiduciary or what is best for my client is not what business is all about. But of course the health argument told me that already last year. The true capitalist are the French and other Europeans who provide medical and health to the people for about half what it costs in this country. So from that we can conclude that capitalism is not for the people but of course the ones that already got IT. Why am I always surprised and disappointed? Slow, slow learner.
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There are some interesting opinions here. Ppersonally I don’t see how the responsibilities of a fudiciary can be put on a stock broker or insurance salesman.