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Holding Brokers Responsible For Their Investment Advice

Holding Brokers Responsible for their Investment Advice

Not all advice is created equal.

Financial planners and investment advisers, by law, hold a "fiduciary" duty to their clients. This means that they're required to give advice that's in their clients' best interest, even if this might result in a smaller paycheck for them.

Brokers, on the other hand, aren't bound by a "fiduciary" responsibility. They're free to push clients toward a financial product that offers a plush commission, even if they know that the client could utilize an equally effective and lower-priced alternative.

The U.S. Securities and Exchange Commission is considering creating a rule that would hold brokers to the same fiduciary responsibility that investment advisers and financial planners share.

In late January, however, the SEC refrained from passing the new rule, saying it needs more time to study the matter.

Why Should Advisers and Brokers Share Standards?

The SEC conducted surveys that showed that the average investor doesn't realize that brokers and investment advisers are bound by different fiduciary standards, according to a report in the Wall Street Journal.

This means that "retail investors" - the industry term for mom-and-pop investors - may be following the advice of someone whom they mistakenly think is operating in their own interest.

As a result, investors may be losing thousands of their hard-earned dollars in unnecessary fees.

Most investors "start with the presumption that the professional who is working with them and to whom they entrust their capital is looking out for their best interests," former SEC Chairman Harvey Pitt said at a forum hosted by Bloomberg Link.

But that presumption is false.

"A consumer can find brokers who essentially function as planners but who are held to a lesser standard," noted Chuck Jaffe, senior columnist for MarketWatch, in an article reprinted in the (Tacoma, Wash.) News-Tribune.

So What's the Hold-Up?

The SEC, in theory, seems to agree that brokers should adopt a fiduciary duty. The agency sent Congress a report on January 21 recommending that brokers and investment advisers who give personalized advice be held to a "uniform fiduciary standard," Bloomberg News reported.

But the agency may be gun-shy about creating a rule without conducting an extensive cost analysis.

Last year, the U.S. District Court of Appeals for Washington, D.C. struck down an unrelated SEC regulation on the grounds that the agency hadn't conducted a thorough cost analysis before passing the rule.

Although the District Court's decision applied to an unrelated case, several news outlets - including the Wall Street Journal - report that this may be the reason the SEC is dragging its feet on this rule.

What's the Status of the Rule?

The District Court decision "changed the climate for all future SEC rule making," investment adviser David Tittsworth told the Wall Street Journal. "The SEC doesn't want to be proposing rules that will just be struck down."

SEC Chairman Mary Shapiro confirmed that the SEC is delaying its decision while it conducts additional cost analysis, Bloomberg News stated.

Shapiro didn't indicate any timeline for a decision.

Consider This If You Work With A Broker

How can investors protect themselves if they need to work with a broker before the SEC makes a decision?

Jaffe offers several suggestions:

  • Inquire. Ask any potential adviser if they hold a fiduciary duty to you. If the answer is 'no,' re-consider whether or not you want to work with them.
  • Keep It Simple. "Stay away from 'sophisticated' investment products - the kind no one buys without a sales pitch," Jaffe says. He recommends a "plain vanilla portfolio."
  • Go Elsewhere: If you do want to buy a sophisticated product, go to an adviser who carries a fiduciary duty to you.
  • Think Ahead: Don't buy an investment, annuity or other product or service without first asking yourself, "What's my legal recourse if this goes awry?" Jaffe says. Remember, brokers are merely required to give "suitable" advice, not optimal advice.
  • Remember the Number One Rule of Investing: "If you don't understand it, don't buy it."

Tell Us: Do you think brokers and advisers should share a uniform fiduciary standard?

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.