With investment advice, one size does not fit all

The financial services industry is experiencing a period of unprecedented regulatory reform. But as the focus has turned to the issue of harmonizing standards and practices between broker-dealers and investment advisers, both segments of the industry have begun to engage in a dangerously reductive argument that takes the form of a false choice: Either everyone abides by the same standard of conduct toward the investing public in all circumstances or consumers suffer. In no other area of harmonization has this false choice been more heatedly debated than with respect to the “fiduciary standard” and the question of who should be required to abide by it.

But this debate belies common sense. A regulatory structure that offers rigorous investor protections and disclosures, and rationally applies that standard of conduct to the right services, without resorting to a “one size fits all” approach, ultimately will provide investors with the best protection. Since consumers of retail financial services have markedly varying needs and goals, such a structure in large part will protect investors by preserving the choices and flexibility they deserve and desire.

Thorny issues

The real task, therefore, lies in defining a specific standard of conduct for all financial services providers across the broker-dealer and investment adviser marketplace. While the existing regulatory framework has no remaining defenders, some thorny issues remain.

The Securities and Exchange Commission is able and prepared to sort through these issues. And it appears that Congress may provide the SEC with the opportunity to do exactly that. We believe that in evaluating the topic, the SEC should achieve three goals:

First, it should adopt a universal standard of conduct for broker-dealers and investment advisers who provide personalized investment advice to retail investors. We believe this standard — as the Obama administration has suggested — should be based on the fiduciary -principle.

Second, the SEC should significantly enhance the disclosures to the investing public required of broker-dealers and investment advisers.

And third, the SEC should apply the standard in a way that allows investors flexibility so they may make informed decisions about the financial services that best suit their needs and goals.

As to the first point, a report by Rand Corp. confirmed that investors “do not have a clear understanding of the boundaries between investment advisers and broker-dealers.” And when it comes to standards of conduct, why should they?

Retail investors have a right to expect their advisers — regardless of their label or license — to adhere to a consistently high standard in providing investment advice.

But suggesting that all players abide by the fiduciary standard is still just a first step. Questions remain about exactly how that standard of conduct should be defined and applied. It is critical that the SEC contemplates the varied circumstances under which investors receive advice, and that it allow investors to set the terms of service with their financial services provider. We believe that the standard should apply to the provision of all types of personalized investment advice. A sensible application of the standard, however, must account for differing circumstances.

For example, consider that retail investors who use a discount-brokerage firm make their own specific investment decisions. Investors do not expect brokers at such firms to monitor and manage their portfolios actively. But they should expect that in executing trades on their behalf, the broker adheres to the highest standard of care for that activity. On the other hand, in a discretionary account, a broker-dealer is responsible for generating advice, as well as for making and implementing investment decisions and monitoring the investor’s account. The fiduciary standard should apply to all of these services.

Investment services typically cost more than brokerage services, in part because the investor is paying the adviser for acting solely in his or her best interests. This is as it should be in the provision of advice. But that is not a sensible standard to apply to a brokerage firm executing a trade. The firm can take another side of a trade and can still be acting in the best interests of the client and the broker in doing so. As long as there is full disclosure, this is an application of the standard that is reasonable and protective of investors.

Acknowledging such distinctions in applying the standard will offer investors a high level of protection and the comfort of knowing that their financial services providers are bound to work in their best interests. It will also reflect the realities — indeed, advantages — of a marketplace in which investors are free to set the terms of their contract for services with their provider.

The second key issue we believe the SEC should address is that of disclosure. While the systems governing regulation of broker-dealers and investment advisers both require many disclosures, such disclosures should be standardized, strengthened and made more relevant to investors. For instance, broker-dealers and investment advisers should disclose — in plain terms — the various services they offer, the costs for obtaining these services, what conflicts may exist between the provider and the investor, and what duties and obligations are owed to investors in each circumstance.

Improved disclosure in the area of compensation is critical. Given that many investors have virtually no idea how their broker-dealers and investment advisers are paid, it is important that financial services providers disclose how they are compensated, as well as any conflicts of interest and how their firms manage such conflicts.

Finally, while the Rand report revealed understandable confusion on the part of investors, it did make another important point: Investors are generally satisfied with the services they personally receive from their financial services providers. We believe that this reflects the value investors place on having choices in services and providers. Investors seek the type and amount of financial services help they desire, and evaluate these services in light of their particular needs. Investment advisory services often cost more than brokerage services. While some people wish to manage their own portfolios and neither want nor need to pay for customized and continuing investment advice, others are happy to assume those costs in exchange for investment counsel.

There is no arguing the fact that the regulatory framework governing broker-dealers and investment advisers needs significant reform. The cumbersome dual frameworks now in place must be harmonized and clarified to give greater protection to investors and to ensure that all who provide personalized investment advice, no matter what licenses they hold, are held to a single, robust standard of conduct. But in pursuing this laudable aim, policymakers must recognize that when it comes to personal investing, one size definitely does not fit all.