When it comes to advisors maximizing their own compensation at investors’ expense, the salad days might be over.
That goes for both broker-dealers and registered investment advisors as the Securities and Exchange Commission and the Financial Industry Regulatory Authority ramp up enforcement to halt practices perceived to pose a conflict of interest, such as the charging of 12b-1 fees on mutual funds and differential compensation.
The two agencies were requiring firms to disclose this conflicted compensation before, but now will likely move to stop it outright through enforcement actions, say two industry veterans.
The new enforcement actions are taking place after the implementation of the SEC’s new “Regulation Best Interest,” which has set as its goal a higher standard of care for advisors in their work for clients.
Christine Lazaro, a professor and director of the Securities Arbitration Clinic at St. John’s University School of Law, said that the new enforcement actions will help clarify how far the SEC intends that advisors go to comply with the new rule.
“I think there will be a focus early on in a few areas where brokers may maximize their compensation at the expense of their customers,” said Lazaro at a press call last month sponsored by the Institute for the Fiduciary Standard. (Lazaro is also the past president of the Public Investors Arbitration Bar Association.)
Enforcement will result in fines and restitution orders for firms and individual sales professionals who fail to eliminate compensation and advice practices that enrich them at the cost of investors, said Lazaro.
One of the likely enforcement flash points will be products that pay higher or “differential” compensation, especially in connection with complex products, she said.
Firms have long justified paying brokers more for sales of complex products because they require the brokers to spend more time understanding and explaining them. But the practice “raises serious conflicts and places the broker’s interest in direct competition with the investor’s interest,” Lazaro said.
She said she has seen “so many cases” where a broker has justified the recommendation of a complex product because it generates income for the investor, but with no justification or appreciation of the risk of the investment or its illiquidity. “In many cases, it’s often obvious that the reason for the recommendation is that it generates a substantial amount of income to the broker,” she said.