The Coming War Between Brokers & RIAs Over Personalized Financial Advice

(April 2012) There is a war coming between the different types of financial advisors, the outcome of which has the potential to dramatically alter the future of personalized financial advice.

Ground Zero of this battle  is something known as the uniform fiduciary standard, which would legally require both Brokers and Registered Investment advisors (RIAs) to place their client’s interests ahead of their own.  (Don’t know the difference between an RIA and a Broker?  You’re not alone.  Read our article on the subject here first.)

In a recent conversation with the host of popular Radio program “The Truth About Money with Ric Edleman”, I asked Ric what he thought would happen if there was a uniform fiduciary standard which required financial advisors of all types to have a plain language disclosure of any conflicts of interests.  This was his response:

“If a fiduciary requirement requiring plain language disclosure of conflicts of interest was put in place, I bet two-thirds of mutual funds and 80% of annuities would disappear”.

Ric Edelman is not just a popular radio host. He also runs a well known financial advisory firm which oversees in excess of $7 billion in client assets.  Ric is also a Registered Investment Advisor, currently the only type of financial advisor with a Fiduciary standard legallying requiring them to put their client’s interests ahead of their own.


Dodd-Frank Changes Everything

The 2008 financial crisis inspired Congress to propose sweeping reforms in the world of financial services, including limiting the risk financial companies can take, and creating additional protections for retail investors. Passed in the middle of 2010, Section 913 of Dodd Frank directed the Securities Exchange Commission  to study the need for creating a uniform fiduciary standard for both RIA’s and Brokers. If the study showed there was a need for a new standard, the SEC was given the authority to create it.

All major industry participants including Brokers and RIA’s publicly endorse having a fiduciary standard in place, so it’s no surprise that the SEC’s study came back in favor of one as well.  What has created the divide is the word “uniform” and exactly what that means to who.


The RIAs vs. The Brokers

RIAs strongly advocate making the Fiduciary standard they currently operate under, the uniform standard for Brokers as well.  While there is no one document which spells out the RIA Fiduciary standard, it has developed over the last 50 plus years and is understood to mean the following:

“to serve the best interests of its clients, which includes an obligation not to subordinate the clients’ interests to its own . . .make a reasonable investigation to determine that it is not  basing its recommendations on materially inaccurate or incomplete information. . .to eliminate, or at least expose, all conflicts of  interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested”

-Study of Investment Advisors and Broker-Dealer by the US Securities and Exchange Commission, January 2010

The large majority of RIAs are compensated exclusively through time-based fees or as a percentage of the money that clients invest with them.  RIAs therefore have no financial incentive to direct clients to products which are not in their best interest.  This fact, combined with the fact that RIAs have already been operating with a fiduciary standard for 50 years, means RIAs are  generally viewed as more on the side of investors.


What do the Brokers Want?

The brokerage industry as represented by SIFMA (Securities Industry and Financial Markets Association) says that the fiduciary standard under which RIA’s currently operate is not appropriate for Brokers.  While they are not against being subject to a fiduciary standard as well, they argue that a new uniform standard should be developed.  In addition to requiring that Brokers act in their client’s best interest, SIFMA feels that the new standard should also subject RIAs to oversight similar to what brokers currently operate under.

In a recent conversation with SIFMA’s general counsel Ira Hammerman, he made the argument that brokers are, in many ways, already being held to higher standards than RIAs.  Their current suitability requirement, which requires Brokers to only recommend “suitable” products, is not the same as a Fiduciary standard which would require them to put their client’s best interests ahead of their own.  However,  in terms of level of oversight, enforcement, and accountability, Mr. Hammerman says that retail investors have been better served by the legal standards applied to Brokers. Specifically, Brokers are audited by FINRA regularly, and part of the examination reviews whether or not brokers are in compliance with the suitability requirement.

On the other hand, large RIAs are subjected to an audit by the SEC only once every 11 years. Furthermore, a retail client that wins a claim against a broker for violating the suitability requirement can get damages, i.e. losses that occurred because they were put into an unsuitable investment. A client of an RIA can only get back the fees paid to the RIA.  Mr. Hammerman describes the lobbying efforts to advance using the RIA fiduciary standard as politically motivated. In his view, RIAs are trying to maintain the status quo and avoid greater specificity, transparency, and accountability.


Is a Fiduciary Standard for Brokers a Catch 22?

There is no question that commissions, particularly when a Broker has an incentive to promote a particular product, do provide a conflict of interest.  When Congress passed Dodd-Frank however they explicitly stated the new fiduciary requirement was not to eliminate or prohibit existing business models, such as sales based compensation.  It is therefore likely that rather than having to eliminate conflicts of interests altogether, Brokers will be required to disclose them.


A focus on disclosure

So the real question is how and when will a Broker be required to disclose to their clients that they have a conflict of interest?

Rule Based Solutions

The Brokerage industry is likely to argue for a rules based solution, which might require a one time disclosure that the client signs off on as a part of the account opening process.  This way it can be lumped in with the many other pages of text that most clients simply glance over and sign off on, to avoid having to read a book’s worth of text before they open an account.

Another less likely possibility is that the Broker will be required to disclose any conflict of interest at the time it arises.

Here is an Example of what that would look like:

Lets take the example of a broker who has determined their client should have a portion of their assets in the PIMCO Total Return Bond Fund, which is the largest mutual fund in the world.  The broker gets paid a 3.75% load for any money the client invests in the fund, so $3,750 goes to the Broker if the client invests $100,000.

PIMCO has also recently launched an ETF which is designed to track the PIMCO Total Return fund.  Since their new ETF trades like a stock however, the broker only makes his standard commission for stock trades on any money invested in the ETF.  For many brokers that is around $50, and rarely more than a couple of hundred dollars on the high side.

Which product do you think the broker is going to recommend if he is only required to have the client sign off on the disclosure when they open their account?

Which product do you think they are going to recommend if the broker is required to disclose the above facts at the same time they recommend the investment?

Now you can understand why when I asked Ric what would happen if financial advisors of all types were required to provide a plain language disclosure, his response was:

“I bet ⅔ rds of mutual funds and 80% of annuities would disappear”.

Principal Based Solutions

Ric has another solution to the disclosure issue which is a principal based solution, rather than a rules based solution.  In his view the broker should tell the client: “What Would You Want To Know?” before investing in a product.

For example, most retail investors would want to know the following:

  • How much is the broker getting compensated for selling the product?
  • Are there similar products that have lower fees?
  • Are there similar products which have a better historical performance?

The list of questions would change depending on the client, the advice, and the product being sold.

“What Would You Want to know? “ is a principle based standard. There is a general guiding idea which would be interpreted and applied to specific circumstances. RIAs currently work under a principle based system, while brokers work under a rules based system.


What’s my View?

Currently most individuals who work with a Broker do so because they feel he or she will operate with their best interests in mind.  It is my belief however that a large percentage of Brokers are basing their recommendations at least in part on how much they are going to make, rather than what is best for the client.

This is a problem that needs to be solved, and in my opinion either a principal based solution like Ric recommends, or a plain language disclosure at the time of purchase would do so. Unfortunately what is more likely to happen is the brokerage industry wins, and a few more lines are added to your account opening documents.

Have thoughts on the subject?  The comments section is open.

Writer’s Note: I would like to thank Michael Kitces of The Nerd’s Eye View blog  for sharing his thoughts for this article. While not explicitly mentioned, I valued his feedback.


  1. Bonnie Sewell says

    The general counsel for Sifma failed to mention a big advantage for the broker model-clients often believe they are being charged nothing. The commission is not on the page as a fee would be listed and the client is not writing a check for ‘services’. It happened again last week. A broker told their client they were not being charged. After 20+ years, I have seen many unsuitable investments sold. The arbitration process is not for the faint of heart and so these folks that didn’t “pay” the broker openly, paid dearly through the purchase of an expensive (commissioned) inferior product.

  2. Rich says

    I hear you. 10+ years ago my conservative parents (both in their 80’s) attended a free dinner where they were sold annuities and principal protected products, because plain stocks were too risky. Well, those things have now matured, and Dad has passed away, so Mom (in her 90’s now) and I were invited to the advisor’s office to discuss what to do with the money. They suggested investing the proceeds into basically mutual funds, roughly 50/50 stocks/bonds. I was astonished. If it wasn’t my parents life savings I would have laughed at him.

  3. HST says

    The biggest misperception, shared by the author, is that an investment advisor compensated by taking a percentage of the money a client invests “has no financial incentive to direct clients to products which are not in their best interest.” It is easily seen that the converse is true when you recognize that the “managed money platform” or “fee-based account” is in itself a product that is ill-suited for almost all investors. What these products do is allow advisors to shuffle off the responsibility of managing/monitoring client portfolios so they can go about finding more clients (who will pay them more fees for basically doing nothing).

    A commission-based broker earns money only when he works for his client. Good commission-based brokers have significant assets under management that have been invested in the same solid blue-chip companies for years and decades. Over that time their clients have cashed a lot of dividends, but paid zero “management” fees. Sure there are bad-apple brokers who churn client accounts, but check our your average “advisory account” turnover.

    Anyone who has had access to a large number of investment advisors ROA (return on assets), that is the revenue generated from his book of clients (AUM-assets under management) knows this to be true. A typical 64-year old commission-based broker with $100 million in AUM generates between $300,000 and $500,ooo per year in revenue. A typical 35-year old fee-based advisor turns that revuenue out of well less than half the assets under management. Which of these truly has his customers best interest at heart?

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