“Trust Me!” Sales talk, advice, and financial planning

August 25, 2009

Professor Tamar Frankel– Tamar Frankel, an authority on securities law, is a professor at Boston University School of Law and author of “Trust and Honesty: America’s Business Culture at a Crossroad.” The opinions expressed are her own. –

Historically securities brokers have been viewed as salespeople with special legal responsibilities:  Treat customers fairly, follow special rules regarding the customers’ money and securities, and recommend to customers only suitable investments.  Brokers offered liquidity by creating markets in certain securities, actions also subject to special rules designed to ensure customers were treated fairly.

Through the years, broker dealers also began to offer investment advice and financial planning.  They not only collected commissions, as do pure-play brokers, but sometimes charged a percentage of the clients’ assets, as do advisers.  Thus, small and large brokerage firms and banks, which have entered the fray, offer four types of services: Brokerage, dealership, advice, and financial planning.

While these four functions are differently regulated, the customers — and many of the broker-dealers-advisers-financial planners themselves -– don’t know the difference. Legally, broker dealers are not subject to fiduciary duties; advisers and planners are.  The difference between broker dealer regulation and fiduciary law is fundamental.  Broker dealers can act for their own benefit, but must do so fairly.  Advisers and financial planners must provide service solely for the benefit of their clients.

What does this difference mean in practice?  A broker may offer a client securities that, while suitable for the client, may be more costly because the broker dealer received higher commissions or compensation for “pushing” the particular securities.  Other securities would be better for the client, but the client never hears about them.  If advisers recommend with incentive pay, they can be liable for breach of fiduciary duty, unless they make it clear to the client that they received financial or other incentives to make the offers.  Brokers are assumed to engage in “sales talk,” aimed at inducing a sale or another transaction.  Advisers are assumed to give advice solely for the client’s benefit.

The two main duties of fiduciaries are to act for the sole benefit of the client (and to not act in conflict with the client’s interest) and to do their job well — the duty of care.

In light of the recent deteriorating reputation of broker dealers, it is not surprising that they would like to be called fiduciaries.  They would not mind the required duty of care.  After all, no adviser is a guarantor of the securities that he recommends, and the duty of care is very similar to the current duty of suitability that the broker dealers have borne for years.

The fiduciary duty of loyalty, however, is another matter. That duty would require broker dealers to disclose conflicts of interest to clients, something they would rather not have to do. For example, they would be forced to disclose that they did not complete a high school education, that they are charging clients above the maximum acceptable in the market place (more than 3% of the assets), that they are paid far more for selling one type of security and not another, that they are paid to put certain securities at the top of their list of 8,000 funds, or that they recommend certain notes as “cash” without mentioning that the notes carry some risk.

When brokers say that clients should know the risks, they are speaking as salespeople.  But if they are advisers, their burden is heavier — they must have a better understanding of what they recommend and must explain it as if they were the client, or from the client’s point of view.

Even under current law, some courts will impose fiduciary duties on brokers, especially when clients have a harder time fending for themselves, such as the elderly.

Yet, the question is more fundamental: Should broker dealers who offer investment advisory services be required to give advice as fiduciaries? Should they be prohibited from having conflicts of interest when they give advice, and, if they do have a conflict, to tell their clients clearly what those conflicts are?

In the end it’s a matter of trust.  If a client decides to buy the offered securities (with or without understanding what they are buying) at least the customer will know how much they can trust the offers of such broker dealers/adviser/financial planners.

7 comments

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Excellent discussion of the different roles of brokers and fiduciary advisers. The key point: generally, brokers may act in their own best interest, while fiduciary advisers must act in their clients’ best interests. These are opposing roles which most investors do not understand.

Knut A. Rostad
The Committee for the Fiduciary Standard

Posted by Knut Rostad | Report as abusive

There is room in the industry for different levels of service and care. In fact, a reasonable number of choices for the consumer is fair and desirable, as I discussed in an op-ed in Investment News (http://bit.ly/12Clrd). But the key is for the consumer to understand what type of professional you are, and whether or not you have a fiduciary duty. If you hang a shingle as advisor (or “counselor”, “investment manager”, or other terms implying that you work on the client’s behalf) you are a fiduciary. If you are a salesperson, you are not a fiduciary but you can create fiduciary liability for yourself depending on what you call yourself and what you tell the customer. In any event, clear disclosure should be required to be given as to your status as a fiduciary (or not) and how you are paid. See my op-ed for examples.
And if you are acting in a fiduciary capacity, the Duty of Loyalty should be followed and you should obtain consent for any conflicts, not simply bury them in Form ADV. A true fiduciary adviser never sells product.

Posted by Jan Sackley | Report as abusive

To put it simply:
An Advisor should be an advisor and not a salesman.
A salesman should be a salesman and not be allowed to appear as an Advisor.
The distinctions between fiduciary and non-fiduciary positions should be made perfectly clear and reflected in “titles” given to financial representatives. The titles being used by many salesmen are, in my opinion, fraudulent and should be treated as such by the regulators.

As someone who has practised law, conducted business as an RIA and held securities licences, I must respectfully disagree. Whether one is a fiduciary is a question of function not form. If a broker gives investment advice beyond whether a particular security is suitable, his advice is no longer incidental to his brokerage activity, and the quacking will make this duck a fiduciary. That there is confusion among the public, investment professionals and lawyers suggests the need for a single minimum standard that the courts can expand to counter the schemes of those who would seek to evade it.

The article by Tamar Frankel could not be more accurate. The problem is that the brokerage industry does not want the issue presented so clearly. There is certainly a role for products sold by brokers where they are compensated based on the product and the transaction — but this is for a product and not an ongoing service such as investment advice. If brokers had to compete with fiduciary advisors with full disclose (of the type outlined in Ms. Frankels article) they would not be in business very long.

I have more to say but no time now….

Posted by Peter Savarese | Report as abusive

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While I greatly admire and agree with many points of Professor Frankel’s clear discussion I must agree with Roger Levy’s point – mostly on the basis of the reality of how the investment industry operates. The lines between RIAs/BDs/suitability/advisory/planning get crossed so routinely in reality that moving towards a single standard is the only path that makes sense to me.

If we all agree that the prime function of the fiduciary is to put the client’s interests at the forefront of decisions, then the idea of reinforcing lines becomes clearly about protecting institution’s interests. Is forcing the consumer to understand the subtleties between brokers, advisors, & etcetera really the best we can do?

Posted by Will Brown | Report as abusive

Great Post. I am Sick of this Post

Actually, I agree some of the views of the author and some not.

Thanks
Raushan

[...] at a Crossroad.” ponders whether or not securities brokers should be prohibited from having conflicts of interest when they give advice, and, if they do have a conflict, to tell their clients clearly what those [...]