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by Mercer Bullard, Associate Professor, University of Mississippi School of Law, Public Policy Institute, September 2011
Many broker-dealers are not subject to a fiduciary duty when they provide personalized investment advice to their clients. Broker-dealers regularly provide investment advice, but not all of these broker-dealers are subject to the federal fiduciary duty that applies under the Investment Advisers Act of 1940. This anomaly has led to calls to regulate broker-dealers under the Advisers Act, or at least to impose a fiduciary duty on broker-dealers when they provide investment advice. Historically, the brokerage industry has opposed imposing a fiduciary duty on broker-dealers that are not subject to the act.
Instead, broker-dealers and their representatives are only required to make suitable investment recommendations. While the duty to make suitable recommendations prohibits many abusive practices, it does not require, as a fiduciary duty would, broker-dealers or their representatives to give advice that is in the best interest of their clients. A fiduciary duty would also require broker-dealers and their representatives to disclose their conflicts of interest, including how they are compensated. The higher fiduciary standard of care could make a substantial difference in the retirement security of individual investors over the course of a lifetime of investing because investors would receive better advice under the fiduciary standard.
The Dodd-Frank Wall Street Reform and Consumer Protection Act specifically authorizes the Securities and Exchange Commission (SEC) to adopt a rule imposing a fiduciary duty on broker-dealers and their representatives when they provide personalized investment advice to certain investors. How such a rule is structured will determine whether investors receive an adequate level of protection. Factors that will affect the level of investor protection afforded by the rule include (1) the scope of investment advice covered by the rule; (2) how it regulates conflicts of interest, especially in connection with compensation arrangements; (3) what additional disclosure is required for broker-dealers; and (4) how the fiduciary duty will apply to principal transactions between broker-dealers and their clients.
The SEC should adopt a broad, principles-based rule that requires broker-dealers to act in the best interest of their clients when giving investment advice. The SEC should also clarify the broad rule, either through its own separate rulemaking or through the Financial Industry Regulatory Authority, the largest self-regulatory organization for broker-dealers.
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