Marketplace Scratch Pad

In the mind of a broker

Scott Jagow Mar 5, 2010

When you sit down with a broker or a financial adviser, it helps to understand their motivations. How are they being compensated? Are they incentivized to really look out for your best interests or just sell you whatever they can? It’s an issue being debated with the financial regulatory reform in Congress.

The New York Times has a piece about the current standard for a broker-client relationship. Most brokers are only required to steer clients to financial investments “suitable” for them. In his draft of financial reform, Senator Chris Dodd proposed strengthening the standard to “fiduciary duty”, which would require brokers to put their customers’ interests first.

The Times spoke with current and former brokers about how the current system is easily abused:

All said their jobs depended less on giving advice and more on closing sales. The more money they brought in, the more they, and their firms, would earn.

“I learned a lot about being a good salesman at Merrill,” said David B. Armstrong, who left Merrill Lynch after 10 years and with partners started an advisory firm in Alexandria, Va. “The amount of training I sat through to properly evaluate investment opportunities was almost nonexistent relative to the training I got on how to sell them.”

Wall Street, of course, is lobbying against the fiduciary standard:

Senator Tim Johnson, a South Dakota Democrat on the Banking Committee, has proposed an 18-month study of the brokerage and investment advisory industries, an effort that would replace Senator Dodd’s provision…

“In my opinion, the Johnson study is a stalling tactic that will either substantially delay or totally prevent a strong fiduciary standard from being applied,” said Kristina Fausti, a former S.E.C. lawyer who specialized in broker-dealer regulation.

“The S.E.C. has been studying issues related to investment-adviser and broker-dealer regulation and overall market conditions for over 10 years,” she said. “It’s puzzling to me why you would ask an agency to conduct a study when it is already an expert in the regulatory issues being discussed.”

I think she meant predictable rather than puzzling. Securities analysts suggest a stricter standard would cost brokerage houses hundreds of millions. Jeff Brown from PBS’s Nightly Business Report writes:

If you went searching for an adviser, it’s a safe bet that all your candidates would claim they put the client’s interests first, anyway. So why does the financial-services industry oppose a stronger rule? You’ll hear a lot of arguments about how it would invite frivolous complaints and costly litigation, make advisers overly cautious and so forth. But, let’s be honest, the industry makes money – lots and lots of it – by charging fees and commissions. The Dodd proposal threatens the bottom line.

Industry defenders also argue that market forces compel advisers to put customers’ interests first. It’s in the adviser’s interest to keep the customer happy, and so forth. Unfortunately, there are just too many cases of this breaking down. The financial crisis of the past few years shows how even Wall Street’s brainiest can put immediate profits ahead of long-term interests. And if market forces provided a perfect guarantee of quality, you’d never get a bad meal in a restaurant, a poorly made article of clothing or a car with a faulty accelerator.

Registered Rep talked to a lobbyist who says:

… the story line about the fiduciary duty is unfairly biased: “If you’re working for someone that is getting paid a commission, they’re obviously a crook and I think that’s more than a little simplistic and misleading and inaccurate. I don’t think it’s the way someone is compensated or registration status that determines the content of their character. There is fine work done by commission-based sales people and investment advisers alike.”

Surely. But if everyone’s already working in the best interests of their clients, why shouldn’t that be the standard?

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