The Securities and Exchange Commission has released new rules proposals regarding advice for retail investors. They proposed a new document they dubbed a customer relationship summary (CRS) that is supposed to help the public distinguish between broker/dealers and investment advisors. It has been over two months since the release and I am still flabbergasted at how badly the SEC missed the mark.

To provide more consumer protections, the SEC proposes “Regulation Best Interest” as an enhancement to the suitability standard. Sadly, Reg BI, as some are calling it, would be better described as Reg BS.

The release acknowledges that there is a difference between suitability and fiduciary with suitability being a lower standard than the fiduciary duties that apply to advisors. This difference is offered as a reason for this new regulation.

The release states, “Our goal in designing proposed Regulation Best Interest is to enhance investor protection, while preserving, to the extent possible, access and choice for investors who prefer the “pay as you go” model for advice from broker-dealers, as well as preserve retail customer choice of the level and types of advice provided and the products available.”

That sounds nice but the proposal veers off course quickly. It is fundamentally flawed and actually makes the consumer’s choice more difficult.  

Rebranding Suitability

First, Reg BI is simply not a substantive change from suitability. Here is FINRA’s explanation of suitability from the FINRA website:

Suitability Obligations

Rule 2111 lists the three main suitability obligations for firms and associated persons.

• Reasonable-basis suitability requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.  Reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards of the recommended security or strategy.

• Customer-specific suitability requires that a broker, based on a particular customer’s investment profile, has a reasonable basis to believe that the recommendation is suitable for that customer. The broker must attempt to obtain and analyze a broad array of customer-specific factors to support this determination.

• Quantitative suitability requires a broker with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions, even if suitable when viewed in isolation, is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile.

Compare that to Reg BI:

• understand the potential risks and rewards associated with the recommendation, and have a reasonable basis to believe that the recommendation would be in the best interest of at least some retail customers,

• have a reasonable basis to believe that the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks and rewards associated with the recommendation; and

• have a reasonable basis to believe that a series of recommended transactions, even if in the retail customer’s best interest when viewed in isolation, is not excessive and is in the retail customer’s best interest when taken together in light of the retail customer’s investment profile.

I see no difference in the substance of the requirements. The only difference is the rebranding of “suitability” to “best interest.” This is an enormous step in the wrong direction.

What Is A Fiduciary?

If there is a plain English, layman’s definition of the role of a fiduciary, it is to act in another’s best interest. To call a non-fiduciary role a “best interest” role is horribly misleading.

Advisors are fiduciaries. Registered reps are not. The Commission acknowledges this and deserves some credit for proposing to ban the use of the title “financial advisor” by persons not registered as an advisor or IAR. That change is long overdue. I hope they add “financial planner” to that and it is enforced soon.

To bring further clarity for the public the Commission proposes a new Customer/Client Relationship Summary. I like the idea behind the CRS document, but the SEC’s sample document has more BS in it than a cattle ranch. It doesn’t just fail to clarify things, it muddies the waters further and goes out of its way to present brokerage services as equivalent to advisory services.

What Is An Investment Advisor?

To understand why this is terrible from a consumer protection standpoint, we should look at the actual law of the land, passed by Congress and held up by the courts as recently as 2007 when the FPA successfully sued the SEC over the Commission’s last major attempt to weaken consumer protections at the behest of the brokerage industry.

Section 202(a)(11) of the ‘40 Act defines an investment advisor as “any person or firm that: for compensation; is engaged in the business of; providing advice to others or issuing reports or analyses regarding securities.”

“Advice…regarding securities” What is that exactly?

According to the Staff of the Investment Adviser Regulation Office, Division of Investment Management of the U.S. Securities and Exchange Commission in “Regulation of Investment Advisers by the U.S. Securities and Exchange Commission” March 2013, the SEC staff has stated:

i. advice about market trends is advice about securities;

ii. advice about the selection and retention of other advisers is advice about securities;

iii. advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities;

iv. providing a selective list of securities is advice about securities even if no advice is provided as to any one security; and

v. asset allocation advice is advice about securities”

Those are indeed the things the public thinks it is getting when it works with an “advisor.” Those are also the things a large part of the financial services industry advertises as their business and offers to provide the public for compensation. Further, throughout the nearly 1000 pages of the proposal, the Commission refers to getting investment advice from broker/dealers.

Problem is B/Ds aren’t truly supposed to be giving advice.

The Investment Advisor Act of 1940 states that “A broker or dealer that is registered with the SEC under the Securities and Exchange Act of 1934 (“Exchange Act”) is excluded from the Act if the advice given is:

i. solely incidental to the conduct of its business as broker or dealer,

ii. and (ii) it does not receive any “special compensation” for providing investment advice.”

The B/D is exempt because their role is to facilitate transactions, NOT to give advice. Once they get into determining what the transactions should be for a given client, the advice is integral, NOT incidental. Holding out as an “advisor” should make the advice integral, NOT incidental.

The fundamental consumer protection problem is too many firms, or their reps are using the language about the fiduciary standard but delivering a brokerage relationship in which the advisor standards do not apply.

Presentations Are Misleading

I’m not necessarily opposed to someone changing roles and I do favor preserving choice but the choices must be accurately presented. When the client doesn’t know the standard has dropped when the role changes, what is often referred to as “hat switching,” becomes a classic bait and switch maneuver and the SEC should put a stop to it.

The CRS could be a way to address improper standards switching but instead of making things clear, the Commission just makes things worse for the public. The sample documents use the word “fiduciary” to describe the advisory standard but don’t describe what the word means.

Yet, alarmingly, they use language descriptive of fiduciary to describe their newly rebranded suitability standard—the one that is supposed to apply because advice is incidental.

There is also this odd bit of language that suggests it will be cheaper to buy things through a brokerage account as if the difference between an advisory account and a brokerage account were simply the form of payment. That’s more BS.

As stated in the law, B/Ds affect transactions and get paid when a “buy” or “sell” recommendation is executed. A brokerage relationship provides no value to the B/D firm for a “hold” or “avoid” recommendation.

Advisors figure out if transactions are needed at all and get paid when clients pay a fee for that service. In fact, when an advisor implements a recommended transaction, the advisor employs a B/D to execute. That B/D has no fiduciary obligation to the advisor or the advisor’s client nor should it. The advisor is the one looking out for the client through it fiduciary duties including its best execution responsibilities.

What Should The SEC Do?

Given this, below is how I imagine good CRS documents could look. These could be more plain English but I opted to use language from the law and the SEC’s own words for the bulk of this. Instructions are in brackets <>

Dan’s CRS For Advisory Relationships:

We are an investment advisor and provide advisory accounts and services rather than brokerage accounts and services. “Advisory accounts and services” means we, for compensation, are engaged in the business of providing advice to others or issuing reports or analyses regarding securities. “Brokerage accounts and services” are transactional—for facilitating the buying and selling of securities and investment products. If you do not want or need advice about securities, a brokerage account may be more appropriate.

“Advice about securities” means:

i. advice about market trends is advice about securities;

ii. advice about the selection and retention of other advisers is advice about securities;

iii. advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities;

iv. providing a selective list of securities is advice about securities even if no advice is provided as to any one security; and

v. asset allocation advice is advice about securities

As advisors, we are subject to a fiduciary standard that includes

Duty Of Care. Fiduciaries have a Duty of Care to their clients (in addition to a Duty of Loyalty) that they actually take steps to ensure that the advice they’re providing for their clients actually is the right and proper advice, which would include:

• Duty To Provide Best Interests Advice. When providing personalized investment advice, the investment advisor would have a duty to make a reasonable inquiry into the client’s financial situation, level of financial sophistication, investment experience, and investment objectives, beyond making a recommendation (with the breadth of diligence based on the breadth and scope of the advice engagement).

• Duty To Seek Best Execution. To the extent that the investment advisor manages the client’s portfolio and has a duty to select broker-dealers for execution and actually facilitate execution of client trades (e.g., with discretionary accounts), the RIA has a duty to seek best execution for those client transactions.

• Duty To Act And To Provide Advice And Monitoring Over The Course Of The Relationship. Once an advisor provides advice, they have a duty to follow through and subsequently monitor the implementation of that advice (e.g., to monitor a portfolio over which they have discretionary management), although to the extent that the scope of the relationship is limited (e.g., to a one-time financial plan), the scope of monitoring would be limited to the duration of the actual (limited) relationship.

• Duty Of Loyalty. The duty of loyalty is the obligation of a fiduciary to put their clients’ interests first, and not favor its own interests, including providing full and fair disclosure of all material facts relating to the advisory relationship, and taking steps to avoid or at least make fair disclosure of any conflicts of interest.

Our Form ADV brochure can be read here (link to regulatory and/or advisor site). It includes important details about our practices, fees, other costs, conflicts of interests, how those conflicts are addressed, our disciplinary history, experience, credentials, how we choose investments, risks, and who you should contact about any issues that arise, among other things.

Dan’s CRS For Brokerage Relationships:

We are a broker-dealer and provide brokerage accounts and services rather than advisory accounts and services. This means our primary role is facilitating the buying and selling of securities and investment products. We must have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer.

Advisory accounts and services are subject to fiduciary duties. These duties include duty of loyalty (to you), duty of care, duty to provide best interest advice, duty to seek best execution, duty to Act and to provide advice and often, monitoring over the course of the relationship.   

We are exempt from these fiduciary duties because any advice given is solely incidental to the conduct of our business as broker or dealer. If you wish to receive advice regarding any of the below, an advisory account is more appropriate.

i. advice about market trends is advice about securities;

ii. advice about the selection and retention of other advisers is advice about securities;

iii. advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities;

iv. providing a selective list of securities is advice about securities even if no advice is provided as to any one security; and

v. asset allocation advice is advice about securities

Dan’s CRS For Personnel Capable Of Switching Hats:

We can act as both an investment advisor and a broker-dealer. If our role changes, you will receive a written notification before that change occurs that states to what role we are changing and outlines the standards that apply.

At this time, our relationship with you is as <choose “an investment advisor” or “a broker-dealer” or “both as an investment advisor and as a broker-dealer” and include all of the language above that applies given this initial relationship.>

<When a change of role is contemplated, the notice should state that a change of role and standards is occurring. If the switch is to an advisory account, the notice should include the language above for advisory relationships. The notice for a switch to a brokerage account should include the language above for brokerage relationships.>

The “S” in CRS stands for Summary so each of my versions are short. This was not hard since many of the “key questions to ask” that the SEC put in its CRS are already required to be answered in an ADV brochure making that section of the advisor CRS unnecessary.

Even though my version completely skips a discussion of brokerage conflicts of interest, I think it would be a much better form of consumer protection than the SEC’s version. My version gets right to the point about the nature of the relationship which is the one item prospective customers and clients need to understand most.

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines.  He practices in Melbourne, Fla. You can reach him at www.moisandfitzgerald.com.