Brokers have been fighting hard to avoid regulation as advisers subject to fiduciary duties. After all, they argue, every other type of salesperson gives advice without bearing fiduciary duties. However, the difference is: “It depends on what is being sold and to whom.”
The legal status of brokers is somewhat complex. On the one hand, they are salespersons. And salespersons give advice, or at least speak to potential buyers in praise of the product or service (in this case, securities) they offer for sale. Not every investor is an expert in evaluating securities. Therefore, securities salespersons’ sales talk is likely to be classified as advice.
The Investment Advisers Act of 1940 imposes duties on advisers that are similar to those of fiduciaries. Yet Congress recognized that while securities brokers are offering advice, that is not all they are doing (nor even mostly what they are doing). After all, they offer to sell or buy securities for their clients. Therefore, the Act contains a list of exemptions for activities that involve services, which might and usually do, include advice, such as publications. With respect to brokers the section provides that the definition of “investment adviser” does not include “any broker or dealer . . . whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.”
In addition, brokers are subject to rules imposed by their self-regulating organization Financial Industry Regulatory Authority (FINRA). FINRA Rule 2111 has long imposed on brokers a duty to offer only “suitable” securities. Therefore, a broker is recognized as a salesperson that has usually more expertise in evaluating securities as compared to his or her clients. In fact, a study by the staff of the Securities and Exchange Commission has found that retail investors “rely on broker-dealers and investment advisers for investment advice and expect that advice to be given in the investors’ best interest,” and may not understand that broker-dealers and investment advisers have different regulatory regimes and standards of care. In recent years the “baby boomers” began to retire. A large number of Americans received their pension funds upon retirement. Many of these retirees never managed a large number of securities, or any securities. Concern for these retirees raised the pressure to impose on brokers fiduciary duties for advice or sales talk in connection with investors’ pension funds. The Labor Department, which enforces investor protections for ERISA-regulated pension funds, initiated the controversial Rule. In addition, after the latest 2009 securities markets crash, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act which, among other provisions, required the Securities and Exchange Commission to research and authorized it to pass a rule imposing fiduciary duties on brokers who advise family members and families. Thus, the regulators and Congress have focused on the type of investors who might need to rely on brokers’ advice in their investment decisions.
The rules imposing fiduciary duties on brokers did not fare well. The Department of Labor rule took years of negotiations. After its passage in 2016 the effective date of the rule was frozen under the new administration, and the Assistant Secretary of Labor who negotiated and worked on this rule was fired. The Securities and Exchange Commission did not ever start its research regarding the fiduciary duties of brokers’ advice to families. The new administration has proposed to combine the two rules: the DOL rule that was passed but is not yet fully in effect, and the Securities and Exchange Commission rule that has not been prepared yet. There are questions on whether the combination of these two rules makes sense. On the one hand, the combination of the two rules would benefit brokers. They would have one rather than two rules to deal with. On the other hand, it is unclear how these two rules, aiming at different protected groups, and regulated by two different administrative agencies, might be effectively designed and enforced.
Currently, brokers are fighting hard to avoid bearing fiduciary duties to their clients. They reject the proposed imposition of fiduciary duties and threaten to cease giving advice to investors who need it. Therefore, the duties to act in the best interests of their clients and to avoid conflicting interests may cost the advisees—especially retirees—much more than the status quo. What will the retired advisees do without the brokers’ advice? The answer is: Retirees will seek the advice of professional advisers. Since 1940 America has imposed on investment advisers the duty to register and act as fiduciaries.
What will happen if fiduciary duties apply to brokers? Some brokers might accept fiduciary duties to people who need helping advice and must trust their advisers. Other brokers would avoid advising retirees. Disclosure about what is being advised is not helpful. The advisees are not likely to fully understand toxic advice, and may pay brokers in a roundabout way more than they should have.
To brokers who refuse to bear fiduciary duties one should say: “If you cannot give advice in the best interest of the clients and without conflict of interest don’t advise!” However, remember that under the current regulation of broker dealers you must give “suitable” advice. This is the rule that applies to you now. How will the retirees know the difference and invest more of their savings without you than with you? It seems that some of your competitors are willing to take a deep breath and accept fiduciary duties with their sales talk. They will let the retirees know the difference. In this area, competition may lead to the imposition of fiduciary duties by brokers that give advice as sales talk.
Who Is a Fiduciary?
The definition of fiduciary is not simple but can be explained simply. When I buy a pair of shoes I put them on, view their form, and test their comfort. No matter how much the shoes are praised by the sale person, I can exercise my own judgment and if I make a mistake—I can blame no one but myself. In contrast, there are many people, both young and old, who do not know enough about securities and the securities markets to make informed decisions. Complex securities can be hardly understood by seasoned investors.
Therefore, unlike shoes, most or at least many buyers cannot evaluate an offer of securities without advice by experts or unless they themselves possess sufficient expertise. In addition, if shoes do not fit, most buyers can still retain their wealth. If the securities chosen are either expensive as compared to other similar securities or if the proposed securities are risky, investors and retirees might lose their main source of livelihood. This possibility drove the imposition of fiduciary duties on the brokers who offered investment advice. Whether the administration decides to impose the rules or retain the status quo may affect America’s retirees and investors as well as America’s younger generation. After all, this generation will bear the burden of the retirees.