First Person: Will Brokers and Registered Investment Advisers Be Treated the Same?

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First Person: More Fun, Less Expense
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First Person: More Fun, Less Expense

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I have a modest financial planning and registered investment advisory firm in Connecticut and for the last decade have been serving my clients under what is known as a "fiduciary standard of care." It works well for them and suits my personality.

The recently enacted Dodd Frank Act authorized the Securities and Exchange Commission to regulate both brokers and registered investment advisers under the same legal standard. What is the difference? That is an excellent question and one reason that the Dodd Frank bill addresses the issue is because many people in America, at least according to a RAND report, don't know the difference between the two jobs and there are some important legal distinctions.

A broker is usually someone who buys and sells securities on usually on behalf of someone else. If a client needs 100 shares of Apple stock, they contact a broker and place the trade. The broker will act as an intermediary and secure the stock for you either from a third party or perhaps from inventory. A broker may discuss with you your goals and may offer you some suggestions. The broker is required to "know the client" and make suitable recommendations. That means broadly speaking that the broker needs to know some basic information and offer recommendations that are not supposed to blow up in your face. They should not do you any harm. The broker does not need to disclose to you that they may receive a different payout from investment A versus B. The broker is not required to place your interests ahead of the firm in all circumstance.

A registered investment adviser is someone who does not actually buy or sell securities but may make the suggestion to you and charge a fee. They may manage your money for a fee. They are required to place their firm's interest in a subordinated position to yours. That means that they cannot base their recommendation to you on the amount of compensation that they will receive. This is part of the fiduciary relationship.

In 1940 when the world was much different Congress did pass the legislation that created the distinction. Back then the investment scene was totally different with individual securities being the norm and pooled investments such as mutual funds still in their infancy. It made sense to impose additional layers of protection on people who were managing wealth through the selection of individual securities usually on a discretionary basis, not needing approval to conduct transactions.

Today, there are more mutual funds and ETFs than individual stocks and most RIAs have become asset allocators as opposed to selectors of individual securities. Many RIAs while offering advice, couch it as a suggestion and do not manage money on a discretionary basis but rather leave the decision to the client. Roles have indeed blurred.

Often the fiduciary standard is referred to as in the client's best interest which seems to imply that indeed the client is being safeguarded. The best interest is just a distinction between the client and the firm, something that is totally lost on many people.

I become more convinced of that fact as I read articles and comments in the papers. The New York Times recently ran an article advocating the fiduciary standard and comments that were made from readers ludicrous. The first referred to the crash of 87 and had the broker been operating as a fiduciary that the client would not have lost money; the other along the same veins - that to judge if an adviser is a fiduciary verify that he recommended all cash in 08.

The reality is that a fiduciary is not prescient and that if the plan called for an allocation of 50% stocks and 50% bonds then they were under a legal obligation to follow that plan. The fiduciary responsibility is to follow the strategy that you signed up for and that fact is lost on the majority.

The term "In the client's best interest" does mean what is best for the client in the bigger picture.

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