There’s been an ongoing debate about changing financial rules to unify the standards applied to financial professionals across roles in ways that align with the Investment Advisers Act of 1940. While this seems like a simplifying reform, industry professionals often allege that it would change the nature of investment work in a way that fundamentally alters the entire industry for the worse. They say the new rule would cause firms to manage the risk of a possible breach of duty by only working with larger investment accounts.
The government and reform lobbies are skeptical of this position, but so far, every new rule that has been attempted has been derailed by a lawsuit. That has led to some states enacting their own rules, which means the passive and aggressive investing landscape are no longer consistent nationwide. Some states have regulatory restrictions that make it harder to operate there, and more changes to the industry that are even less predictable than a national rule change may continue if there isn’t a resolution.
Currently, there are two standards applied to financial professionals, one for brokers and people whose job it is to sell financial products and one for RIAs, people whose job it is to sell investment advice designed to make your business deals more effective.
- Suitability is the key for brokers and others whose main job is selling and whose main income comes from commissions. Products must be suitable for the client’s investment needs, and they can’t function in a way that runs contrary to those needs. This keeps brokers from selling products designed to fail, but it doesn’t keep them from making their own investments, even if those investments are counter to their clients’ interests. For example, a broker can not sell you an investment designed to fail, but he can take a short position against you.
- Fiduciary Duty is the standard that is applied to RIAs, people who sell investment advice instead of selling investment products. They can’t take actions contrary to client interests, so they are not allowed to invest in ways like those described in the previous example. They must conduct themselves as people who have a duty to promote the interests and prosperity of their clients, not just as honest salespeople.
On the surface, applying the fiduciary duty to brokers seems like it might help investors with small investments, but since the proposed rule changes only offer civil lawsuits as a remedy, the risk could change investment firm behavior in ways that marginalize small investors.
What Happens When Rules Are Thrown Out?
There have been two big pushes for a rule that will work that each took multiple years because of tensions in negotiation. Both have been stopped by lawsuits. The result has been several states moving to enact their own individualized rule revisions. This trend is likely to continue if there is no consensus reached on a national rule change. Current fiduciaries wonder if this will confuse investors more, leading to a situation where it is difficult for new investors to understand which rules apply to them based on their own locality and the home location of their investment brokers.
The best way to navigate the uncertainty introduced by the prospect of these changes is to understand exactly what they will mean and who they will affect. If you’re already getting your investment advice from an RIA and using your broker as a means to execute over the counter trading, then you’re already getting the information you need to offset any competition you get from that broker’s investments. If you’re not, it might be time to consider how much better your portfolio would be performing if you did invest in one.