Views on improving the integrity of global capital markets
04 June 2015

SIFMA Best Interests Standard for Broker-Dealers: Right Words, Wrong Substance

The way forward railway

If we were just to go by the brokerage industry’s words, convergence of the existing brokerage suitability standard and the investment advisers’ fiduciary standard of care for providing personalized investment advice in the US might seem closer to a reality.

On 3 June, SIFMA (the Securities Industry and Financial Markets Association), the trade association for the US securities industry, announced a proposed “Best Interests of the Customer Standard for Broker Dealers” to replace the current suitability standard imposed by FINRA (Financial Industry Regulatory Authority).

This follows on the 2012 publication by FINRA (the self-regulatory body overseeing brokers) of guidance on its Rule 2111 addressing suitability, in which it is noted that a broker’s recommendations are required to “be consistent with his client’s best interests.” “Best interests” has been the generic way to refer to fiduciary duties (without the legal connotation of the term in jurisdictions like the US), and so to a casual observer it might seem like the long-held ideal of a uniform standard of care for advisers to retail clients might be approaching fruition.

But not so fast. SIFMA helpfully provides a mark-up of what a revised FINRA Rule 2111 might look like, and the draft of a new version proposes that “the sale of only proprietary or other limited range of products by the member shall not be considered a violation of this [best interests] standard.” This is tough to reconcile with SIFMA’s advocacy of “strong, substantive, ‘best interests’ protections for retail customers,” and seems much more concerned with protecting distribution models that justify the investment in investment product manufacturing. It also clings to the increasingly antiquated thinking that product sales is a reasonable substitute for quality advice. Understanding client objectives, risk tolerances, preferences, and constraints and crafting an investment program to address client needs requires access to best of breed strategies and products. Brokers make the point that best doesn’t always mean least expensive, and they’re onto something — which should be good news for those brokers who understand that a durable business model can be envisioned that offers fair returns for advice and execution.

Lest we be too cynical, there’s some good stuff in the existing FINRA Rule 2111 guidance, including discussion of the importance of knowing the customer’s objectives and constraints:

“The customer’s investment profile, for example, is critical to the assessment, as are a host of product- or strategy-related factors in addition to cost, such as the product’s or strategy’s investment objectives, characteristics (including any special or unusual features), liquidity, risks and potential benefits, volatility, and likely performance in a variety of market and economic conditions. These are all important considerations in analyzing the suitability of a particular recommendation, which is why the suitability rule and the concept that a broker’s recommendation must be consistent with the customer’s best interests are inextricably intertwined.”

So although SIFMA’s latest entreaty may not be the substantive step forward to assuring retail investors of the primacy of their interests, we might take some encouragement from the evolution of the brokerage suitability standard as an indication of recognition that things can and should change. All of this occurs with the backdrop of the new US Department of Labor (DOL) proposals to impose a fiduciary standard of care on those who advise pension plans, plan participants, and IRA accountholders. The broadest agreement across the industry seems to be that the proposals have the potential to create a dramatic change in how (or if) advice is rendered to individuals with respect to their retirement assets, and that the potential for confusion among investors is high if the SEC and DOL can’t agree on a harmonized approach. There’s more disagreement over whether the DOL acting alone improves the status quo, with one side predicting an exodus of service providers worried about compliance costs and unbounded liability, thus leaving investors with no advice. Others predict eventual adaptation to a new regulatory regime with opportunity for profitable service to retail investors. Our inclination is that the DOL rules are steps in the right direction, but need improvements. We continue to analyze the voluminous DOL proposals and listen to our members to inform our response.

The next few months will be fascinating as politics, practitioners, and industry lawyers consign the DOL rules to their ultimate fate. Meanwhile we keep harkening back to the point of view we’ve been expressing for a few years that investors would be better served if they had easy insight as to the business model and duty of care of the person offering them advice. Whether it concerned retirement assets or other funds, investment advisers regulated by the SEC pursuant to the Investment Advisers Act of 1940 should be allowed exclusively to call themselves “advisers,” and brokers who operate under FINRA rules should call themselves “brokers.” Drawing the distinction in a way that doesn’t impart value as to one business model or the other would help investors understand more than any rote disclosure ever would, and might transcend some of the complexity of the current debate. Be it this relatively simple step or the more involved fiduciary rulemaking allowed by section 913 of the Dodd-Frank Act, all eyes are on the SEC.


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Image credit: iStockphoto.com/hxdyl

About the Author(s)
Bob Dannhauser, CFA

Bob Dannhauser, CFA, is head of global private wealth management at CFA Institute.

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