Hamburger and other attorneys said they have no doubt that the SEC will be sued if it pushed forward with Reg BI as is.
Advisors’ anger may not be entirely misplaced. In current law, fiduciary advisors are required to put their clients “best interests” before their own, while brokers can offer products that are merely suitable. Now, the SEC’s proposal uses the same “best interest” term for brokers without extending the fiduciary standard of care to the brokerage profession, critics say.
By law, brokers are only allowed to offer “incidental” advice without “special” compensation such as fees.
But it appears that someone forgot to tell the SEC that. The Reg BI proposal repeatedly characterizes the broker-dealer model as a “model for advice” and calls it a “pay as you go’” model for advice. In the proposal the SEC also suggests that preserving the broker-dealer model is about “preserving investor choice across products and advice models” and advocating for “continuing existence of the broker-dealer model as an option for retail customers seeking investment advice.”
SEC Chairman Clayton continues to defend the proposals, with investors, the industry and lawmakers. “Retail investors expect high-quality advice where their investment professional is not placing their interest ahead of the investor’s interest.” Clayton said recently. “I want to make sure they are getting the protections they expect.”
Investors themselves have told SEC Chairman Clayton in recent months during seven roundtables that they are unable to use the SEC’s Reg BI or its “relationship summary” to discern the legal standard of care they should expect or what they’ll be charged. The form is ostensibly supposed to lay bear brokers’ costly conflicts of interest. Those conflicts—such as more expensive commissions, sale charges and a limited selection of under-performing products that pay the BD more for platform space, cost investors some $18 billion annually, according to the GAO. One investor, a 70-year old retiree in Baltimore, asked SEC Chairman Clayton point blank why he doesn’t just make brokers fiduciaries “since that’s what investors think.”
But investors have no idea the depth and breadth of conflict they’re paying for, said one former high-level broker who left behind a lucrative commission-based sales practices at Merrill Lynch in 2011 to create a fee-only fiduciary firm.
Paul Pagnato, the founder and partner of PagnatoKarp, a fee-only firm, recounted the numerous ways that investors are ripped off by what he said are hidden and costly brokerage industry conflicts of interest, which the SEC proposal does not prohibit.
Pagnato spent three years interviewing experts, regulators and SEC officials about what a fiduciary practice should look like, in order to strip out virtually all conflicts from his new firm’s practices, which has grown from $900,000 to nearly $4 billion in advisable assets in seven years.
Pagnato said he took a 35% pay cut when he left broker-dealer, a financial hit that comes from stripping out conflicts brokerage clients pay unwittingly. “Where did that 35% come from? It’s from the deferred sales charges, commissions, IPOs, secondary offerings, 401(k) plans, deferred compensation plans, mutual fund trails that broker-dealers charge,” Pagnato said.