Nothing ruins a Sunday afternoon football game for Roy Diliberto more than one of those ads about stockbrokers who are unusually committed to their clients. The ones where a wirehouse broker is shown to be like a member of an extended family. “I get a good chuckle from that,” says Diliberto, who founded his Philadelphia-based financial planning firm, RTD Financial Advisors, in 1983. “That's not the kind of experience most people get when they walk into a broker's office.”
For Jack Blankenship, another independent planner who first hung out his shingle in Delmar, Calif., 31 years ago, it's the ad with the couple on the beach contemplating their future that gets him. “Their broker is there with them and he suggests they might jigger their portfolio so they can buy their dream house a few years earlier [than they otherwise could],” he sneers. “Brokers don't do that kind of planning — they can't.”
Actually, Series 7 holders can offer financial planning advice — provided that they are registered investment advisors (RIAs), too. The problem, financial planners grouse, is these ads don't tell the full story. While Diliberto and Blankenship's criticism of the wirehouse ads may be overstated, their comments do accurately portray the contempt RIAs and “true” financial planners have for brokers who talk like planners but walk like sales agents for their firms. And it isn't just the ads on television that drive them crazy. It's the business cards that say “financial advisor” or “investment consultant” rather than “stockbroker” or “registered representative.” It's the entire marketing of brokers as purveyors of comprehensive financial advice rather than sellers of securities.
“You can't give lip service to fiduciary duty, and then not act in the client's best interest,” says Diliberto, a past president of the Financial Planning Association (FPA), which has a membership of 29,000 financial advisors, CPAs and other financial planners.
David Meets Goliath
The fragmented world of individual financial planning shops, however, has been fighting back. Last year, the FPA filed a lawsuit against the SEC over the so-called “Merrill Lynch rule,” which exempts broker/dealers offering fee-based brokerage accounts from registration as investment advisors. The Denver-based organization (annual budget of $14 million) may be overmatched against the deep-pocketed Securities Industry Association (SIA), which is made up of the largest names on Wall Street and is known as one of the most formidable political forces in Washington.
While the FPA successfully raised the exemption rule's profile, it did not win its battle. Last April the SEC, under former Chairman William Donaldson, made the exemption permanent, but it did make some significant changes to the rule. Come Jan. 31, 2006, when the rule goes into effect, all discretionary accounts run by Series 7 brokers (whether fee- or commissioned-based) must be transferred over to the advisory side of the firm. That's not a problem because b/d units that are registered under the Advisers Act of 1940 manage about 75 percent of all fee-based accounts. The SEC has also required brokers offering fee-based accounts to more clearly disclose in their advertisements, contracts and marketing materials that the account is not technically an advisory one but a brokerage account, meaning that it carries no fiduciary obligation on the part of the broker.
Not exactly the slam-dunk that the FPA was hoping for — it refiled its lawsuit shortly after the SEC decision. But the changes, and the SEC's own admission that investors currently aren't well-informed about the differences between brokers and registered advisors, have given investor advocates hope that the new SEC chairman, Christopher Cox, will take the issue more seriously. “For years, no one has talked about this. Now at least there's the potential for progress,” says Barbara Roper, director of investment protection at the Consumer Federation of America.
The FPA's contention is that fee-based brokerage accounts offer financial planning-like advice but that the brokers are not subject to the same fiduciary responsibilities and regulatory oversight that registered advisors are. “We want a level playing field,” says Duane Thompson, group advocacy director for the FPA.
The commission issued the exemption from SEC registration and regulation six years ago. At the time, SEC Chairman Arthur Levitt was responding to the findings of the Tully Committee Report on Broker/Dealer Compensation Practices. The report found that investors in traditional commission-based brokerage accounts were suffering from portfolio churn and abusive sales practices. The exemption from registration as an advisor was intended to encourage a shift in the industry to fee-based accounts that would better align broker interests with those of their clients.
On that score the exemption was a resounding success. Fee-based brokerage accounts have become enormously popular with investors. Last year, customer assets in such accounts totaled $269 billion, according to Cerulli Associates. And per SIA data, they accounted for 32.7 percent of total revenues generated by b/d reps. That's up from less than 10 percent in 1996. “These relationships are very popular with investors, and it's an efficient way for our members to serve their clients,” says SIA spokesman Travis Larson.
It may be efficient, but it isn't fair to investors, or to financial planners who are required to register under the Investment Advisers Act, argues the FPA. When the b/d exemption was granted in 1999, it was issued as a “no action” letter. Diliberto, the financial planner who served as FPA president in 2000, and now sits on the body's government-relations committee, recalls discussing the possibility of a lawsuit back then, but the FPA board decided to give the SEC time to draft a permanent rule. Months, however, became years, and while the SEC was busy rooting out conflicts of interest elsewhere on Wall Street, the Merrill rule remained on the shelf.
The issue has only become more important as the popularity of fee-based accounts has grown. Last April, goaded by the FPA lawsuit, the commission finally acted, voting unanimously to make the b/d exemption from registration permanent, as long as the advice brokers provide is “solely incidental” to their brokerage services.
Advice and Brokering
What is the difference between a brokerage and advisory account? Investor surveys and SEC focus group findings suggest that consumers couldn't tell you. And Roper says the SEC's decision does little to dispel the confusion. “If the SEC lets brokerage services be advertised as advisory services, then they have given the securities industry a loophole to drive a Mack truck through,” she says. The truck being the continued blurring of brokerage and advisory services to consumers.
The essential difference between brokers and registered advisors, say financial planners, is fiduciary duty. Financial planners have a legal obligation to act in their client's best interests. If they don't, clients can take them to court. Brokers, on the other hand, have no such duty. In fact, boilerplate disclosures for all fee-based brokerage accounts include a warning label that brokers may not always act in the best interests of their clients.
Instead of fiduciary duty, brokers are required to meet suitability standards drafted by the NASD for the investment recommendations they make. Financial planners, however, say that the idea of “suitability” is a lot more open to interpretation than that of a client's best interest. And if clients believe their broker has directed them into unsuitable investments, the vast majority must take their grievances to the NASD for binding arbitration — a process that, critics say, rarely results in more than a fine for brokers. What's more, financial planners have to provide details on all compensation they receive from mutual funds and other outside parties in their regular ADV filings, while the NASD-regulated brokers are not required to disclose potential conflicts of interest, like principal trading in securities underwritten by the broker's firm or the existence of compensation agreements with mutual fund companies (which has since been changed).
The notion that b/ds have a lighter burden of regulation than registered advisors, however, is something the securities industry vigorously disputes. “B/ds face the most comprehensive regulation in the financial services industry,” says Michael Udoff, associate general counsel for the SIA. In its comment letter to the SEC on the b/d exemption, the SIA argued that forcing brokers to register under the Advisers Act would impose an unnecessary and onerous duplication of regulation, and would likely result in fewer brokers offering fee-based accounts. Besides, Udoff says, the issue is not just one of adequate oversight, but also of the character of individual account managers. “A lot depends on the integrity and knowledge of the people offering the services. And no one has a monopoly on whether they call themselves financial planners or registered representatives.”
While the FPA might rightfully claim a moral victory for forcing the SEC out of its “no action” posture, it would be hard to call the commission's reaffirmation of the exemption — albeit with some amendments — a major win for financial planners. “This could either be a major victory for investors or it could be nothing at all. It depends on how they implement the rule,” says Roper. “It's really in the hands of the new SEC chairman.”
Mercer Bullard, president and founder of Fund Democracy, an advocacy group for mutual fund shareholders, also thinks the new rules fail to protect investors. “The SEC rolled over for the industry,” says Bullard, who worked at the agency when the exemption was drafted. He plans to file an amicus brief with the court in support of the FPA lawsuit. “Congress didn't write the Advisers Act to have the SEC turn around and ignore it.”
Whether or not the lawsuit prevails, FPA executive director Marvin Tuttle feels it has at least brought the issue to the attention of consumers. “At the end of the day, there needs to be a bright line for consumers to distinguish between financial planning and brokerage,” says Tuttle.
And perhaps b/ds could work on new advertising campaigns.