Fiduciary Standard vs. Broker’s Standard: What Every Investor Needs to Know

Tougher Dodd-Frank Fiduciary Standard for Brokers Stalled – Bloomberg.

All of the investors reading Bloomberg are trying to figure out when Uncle Ben is going to fire up the printing press, and they will probably overlook this article.

On its face, it looks very boring. I fell asleep when I got to the word “Dodd.” Nevertheless, this article is a must-read for any retail investor.

When an investor receives financial advice, the entity giving the advice will be under one of two very different standards depending on what type of business the entity practices. To make matters more confusing, the entity could practice both types of business and steer you to one or the other channel. What if a lawyer could change his legal advice to you depending on what kind of client you were? How about a doctor changing your treatment based on what kind of patient you were? This situation is normal in the financial services industry.

There are two types of firms, but they overlap. Most of the TBTF banks offer both services, and in my experience the clients do not understand which one they are  using. Let me break it down for you.

The first type is known as brokerage services. You have a stockbroker who makes recommendations to you. The stockbroker only gets paid if you make a transaction. For example, Mr. Fox gives you a call and recommends that you buy Apple. You decide to take the plunge, and he gets paid a commission based on your purchase.

The relationship between you and Mr. Fox is based on what is known as the suitability standard. All of his recommendations must suit you according to your financial circumstances and transactional history. This is a very loose standard. As long as you don’t sell people risky stocks when they have liquidity needs that require short-term treasuries, the broker should be okay.

The second type is known as advisory services. You have a financial adviser who makes recommendations to you. The financial adviser gets paid whether or not you take his advice because you are paying for the advice. The adviser will either charge you an hourly rate or a percentage of the portfolio under his management.

This relationship is a fiduciary one and carries the strictest level of professional care. The adviser cannot merely recommend investments that suit you; he must only make recommendations in your best interests. It is much easier to prove that a fiduciary standard has not been followed. Additionally, the adviser is getting paid no matter what you choose to do and has no incentive to steer you to riskier products for a larger commission. Hence, there is very little room for shenanigans here.

What makes the situation more confusing is that most large firms market their advisory services to brokerage clients. Usually, it is the same person selling both. These retail clients do not see the distinction between these programs.

In order to protect investors, the SEC decided to promulgate the stricter standard. If the rule is ever adopted, the stockbroker will quickly become extinct. A broker subject to the stricter standard will not want to conduct the riskier brokerage business if he is subject to the stricter rules that come with a steadier payout.

The article claims that both Wall Street and consumer watchdog groups want this rule based on Sifma’s involvement in lobbying. This view is incredibly naive. While Sifma is lobbying for the rule to help its TBTF bank paymasters appear concerned about the plight of the common investor, these same banks are busy handing money hand over fist to Republican legislators to ensure the rule never hits the books.

The new standard would kill the business models of several brokerage firms not to mention that these firms make a killing selling financial products that would never survive a fiduciary standard. For more details, read about “structured products” and why you should never, ever buy them.

You should never use a stockbroker. Use an adviser who must adhere to the fiduciary standard. Better yet, learn about investing yourself and make your own decisions.


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