Unless you only watch the Cartoon Network, you've probably seen the television commercials where stockbrokers try to be your best buddy. In one spot, a broker eloquently toasts a client's daughter at her wedding, while another runs like a maniac along a soccer field as she roots for a client's kid. Yet another broker shares a quiet moment in the great outdoors with a couple and promises he can find the cash to build their vacation home by juggling their investments.
Wow! If I signed up, I wonder if my broker could load my dishwasher and get my kids to clean up their rooms.
What is more interesting, however, is what you won't see advertised. Wall Street brokerage firms will never advertise what's been nicknamed the Merrill Lynch rule, which potentially affects millions of Americans. This rule is far more relevant to investors than who a broker socializes with after the New York Stock Exchange's closing bell.
The buddy commercials and the contentious rule provide a glimpse into the brokerage industry's split personality. Wall Street firms, with the Securities and Exchange Commission's cooperation, are trying to have it both ways. Specifically, the brokerage giants want their employees to be regulated as brokers, but they want the public to consider them financial advisers.
The last sentence may have you shaking your head. Aren't all brokers already financial advisers? Well, no. This is one of the great misconceptions that many investors have. Historically, the broker's job has focused on processing transactions and, as such, brokers are essentially regulated as financial sales people.
Brokers can sell you a mutual fund, a bond or a bunch of IBM stock. If you bought those IBM shares, you paid a commission. If you passed on the opportunity, the broker got nothing. Obviously, this arrangement encouraged brokers to push products, which can lead to conflicts of interest.
For many brokers, however, it was a good way to make a living until upstarts like Charles Schwab, E*Trade and others began offering online trades at a fraction of the price. To save their turf, full-service firms concluded they had to do more than process trades. It was no longer enough for a broker to call you up and say, "General Motors is ready to pop. How about buying 100 shares?" This wasn't going to fly when you could buy the shares online much cheaper.
Consequently, the major brokerage firms began turning their warships in a different direction. Rather than sticking with transaction pricing, the firms began urging their sales forces to embrace fee-based pricing. With this arrangement, a broker could charge clients a flat fee or a fee calculated on the amount of cash in their brokerage accounts. While the new focus was on fees, brokers could still use commissioned products when they wanted. These accounts have been touted as a way to more closely align the interests of clients and brokers.
Wall Street figured that clients would accept this change if brokers began offering comprehensive investment advice. No longer would brokers simply call up with hot stock tips or help you sell your muni bonds. They'd provide advice, for instance, on how to structure an entire portfolio.
Seemingly overnight, something strange happened. Brokers vanished. In advertising, on business cards and in conversations with clients, brokers started calling themselves investment consultants, relationship managers, financial advisers, wealth managers or some other title. The term broker became as welcome as a four-letter word uttered in a kindergarten class.
The name change leads me to ask this question: If you call a duck a buffalo, does that make it a hairy beast with four hooves?
That's essentially what the financial planning community is screaming about. Just because a broker changes his business cards doesn't automatically make him a financial planner, who is qualified to provide comprehensive advice. While some brokers have undergone additional training to obtain financial-planning credentials, many others have not.
What's equally troubling is this: Brokers have ditched their old name, but they remain regulated the same old way. That is, regulators still treat them as if they are continuing to strictly peddle investments.
Why should you care about regulatory niceties? Because brokers are held to lower standards than financial planners and other registered investment advisers. The weaker standards permit a broker's first loyalty to be with his or her firm, not the client. So, for instance, a broker can sell stocks the firm wants out of its inventory or push particular mutual funds that will financially benefit the firm. Not all brokers would do this, but the point is that they can.
Why are investment advisers and the brokers, who now provide financial advice, treated differently? That brings us back to the so-called Merrill Lynch rule, which was proposed by the SEC after its staff met with major brokerage firms in 1999. This rule would expand the exemption, which brokers have enjoyed since 1940, allowing them to avoid becoming registered investment advisers (RIAs) and adhering to those higher standards.
Historically, brokers received an exemption from becoming RIAs because any financial advice they gave clients was considered "solely incidental" to their sales activity. In a bizarre move, the SEC proposed broadening the broker exemption in 1999 to include brokers now offering financial advice, but it never officially adopted the rule. Instead, the SEC, in essence, told the brokerage community that it could proceed as if the rule had taken effect. ---Huh?
Understandably, the SEC's action/inaction turned many investment advisers apoplectic. And consumer groups, such as the AARP and the Consumer Federation of America, were furious at the double standard.
Nearly five years later, The Financial Planners Association, a organization that represents roughly 28,000 financial planners, has filed a petition in the U.S. Court of Appeals against the SEC for allowing brokers to behave like planners but to avoid the same regulatory scrutiny. Since the suit was filed, the SEC has wavered a bit. It is asking investors to comment on the proposed rule. And the SEC says it expects to make a decision on what will happen to this controversial rule by Dec. 31.
Let's hope the SEC makes the right decision.
Lynn O'Shaughnessy is the author of "The Retirement Bible" and "The Investing Bible." She can be reached at LynnOShaughnessy@cox.net.
Brokers vs the Investment Advisors
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TTHQ Staff
, Nov 08 2004 07:20 PM
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Posted 08 November 2004 - 07:22 PM
The story at Bloomberg.com
`Merrill Rule' a Bad Deal for Individual Investors:
John Wasik
(Bloomberg) -- How do you know if an investment adviser or broker is working in your best interest?
For starters, asking the question `what's in a name,' is crucial to protecting your wealth, especially when it comes to the vague, unregulated title of ``financial adviser.''
Titles matter because all advisers aren't the same in terms of experience, education or the type of registration that could provide a greater degree of investor protection. In a proposal known as the ``Merrill Lynch rule,'' the U.S. Securities and Exchange Commission wants to exempt fee-based brokers who offer financial advice from registering as investment advisers if their guidance is ``solely incidental.''
The agency first proposed the rule in November 1999, but never acted on it, which made it a de facto regulation.
Claiming the rule allows brokers to ``operate with virtually no disclosure of conflicts,'' among other legal issues, the Financial Planning Association (FPA), which represents certified financial planners, broker-dealers, attorneys and bankers, filed suit against the SEC on July 20.
``We'd like to see the SEC drop or dramatically amend the (Merrill) rule,'' said Elizabeth Jetton, president of the FPA. (Merrill Lynch is a minority investor in Bloomberg LP, parent of Bloomberg News).
Fee-Based Follies
The FPA and other investor groups argue that not registering fee-based brokers as investment advisers gives the securities industry an unfair advantage and an under-policed route to selling advice.
Case in point: Thaddeus Wong, a Chicago-based real estate agent, was working with a Morgan Stanley representative in a fee- based account four years ago. He invested about $1 million with the broker, who proceeded to trade technology stocks and lose all of the value of the portfolio.
Alleging excessive trading, misrepresentation and breach of fiduciary duty, Wong filed an arbitration claim against Morgan and the broker, who represented himself as a ``knowledgeable financial planner and consultant.''
Wong eventually settled with the brokerage house last year for $420,000. Morgan denied the allegations, claiming it ``reasonably supervised'' its broker. Wong would not comment. When contacted, SEC spokesman John Heine said the agency would have no comment on the Merrill Rule suit, which follows the agency's policy to not discuss pending litigation.
RIAS Offer More Disclosure
While hardly an infallible safeguard, registered investment advisers must disclose conflicts, file with state securities commissions and the SEC and generally act as fiduciaries with a legal obligation to represent clients' interests above their own.
``There's no question that investor protections are far stronger for clients of (registered) investment advisers than for clients of brokers,'' says Mercer Bullard, a former SEC lawyer, assistant law professor at University of Mississippi and president of Fund Democracy, a pro-investor group.
``It's especially ironic that at the same time the SEC is extending advisory regulation to cover hedge fund managers (under a new proposal), it's seeking to exempt brokers from such regulations,'' Bullard says.
The Fee-Based Business
The securities industry maintains that brokers are already covered by a raft of federal and state laws that hold them accountable.
``Brokers are covered by extensive regulations,'' says Jim Spellman, a spokesman for the Securities Industry Association (SIA), a trade group representing securities brokers. ``So they are subject to a high level of regulatory oversight that equates or exceeds that of investment advisers.''
Brokerage houses are also scrambling to recover from the bear market of 1999-2002 and myriad industry scandals by marketing ``wealth management'' and ``financial consulting'' services that combine advice and product sales in a fee-based package.
In 2002, the SIA reported that average gross commissions and fees for its members were down 10.6 percent from 2001 (the most recent year available). That followed a 17.5 percent decline in commissions in 2001.
In a trend that has been accelerating over the past decade, fee-based products accounted for about 28 percent of a broker's average commissions in 2002, up from less than 10 percent in 1996, the SIA said. In fact, ``fee-based accounts showed faster growth than any other segment of managed accounts over the past five years,'' according to Cerulli Associates, a financial consulting firm.
Customer Complaints Up
The muddle over fee-based accounts and adviser duties has led to thousands of complaints and arbitration filings.
While complaints for all but two individual investor categories tracked by the SEC declined in 2003, the agency said the number of complaints for fees, commissions and administrative costs rose 7 percent from 1,331 in 2002 to 1,428 last year.
More to the point, the single most frequent reason for securities arbitrations in 2003 was ``breach of fiduciary duty,'' which resulted in 5,565 cases in 2003, according to the NASD, the main regulator for the securities industry.
Arbitrations are procedures that involve impartial third parties to settle disputes out of court. They are required resolution vehicles for most brokerage and investment adviser customers.
Who's a Fiduciary?
``The fiduciary issue is crucial in arbitrations,'' said Andrew Stoltmann, a Chicago securities lawyer who represents investors in arbitrations against brokers.
``Brokerage firms argue at (arbitration) hearings that their broker is nothing more than an order taker. As more investors use a fee-based broker, it is imperative that the financial advisor be held to the (higher) standard of a fiduciary.''
The highest degree of protection often comes in disclosing what a broker does and not what they call themselves.
``Brokers call their sales reps by titles that imply they are advisers,'' says Barbara Roper, director of investor protection for the Consumer Federation of America, a consumer group. ``The real issue is the SEC's failure to enforce the requirement that that brokers limit themselves to `solely incidental' advice in order to escape regulation as advisers.''
Seek Fiduciary Duty
Ideally, anyone who offers financial advice should be a registered investment adviser and put it in writing that he has a fiduciary duty to you.
``Brokers and advisers should be bound by similar fiduciary standards,'' said Arthur Levitt Jr., the former SEC commissioner (and a director of Bloomberg LP, parent of Bloomberg News), who also favors a review of the Merrill Rule by the commission.
In that spirit, adviser registration should also be required of insurance agents, consultants, hedge fund marketers and brokers who recommend mutual funds, financial plans, retirement programs or other investments.
Don't wait for any government agency to help protect your nest egg, though. Use a simple smell test.
If someone offers you a customized financial plan in minutes or days instead of months or plugs commissioned products, move on. You're getting a list of products to buy, no matter what your adviser calls himself.
`Merrill Rule' a Bad Deal for Individual Investors:
John Wasik
(Bloomberg) -- How do you know if an investment adviser or broker is working in your best interest?
For starters, asking the question `what's in a name,' is crucial to protecting your wealth, especially when it comes to the vague, unregulated title of ``financial adviser.''
Titles matter because all advisers aren't the same in terms of experience, education or the type of registration that could provide a greater degree of investor protection. In a proposal known as the ``Merrill Lynch rule,'' the U.S. Securities and Exchange Commission wants to exempt fee-based brokers who offer financial advice from registering as investment advisers if their guidance is ``solely incidental.''
The agency first proposed the rule in November 1999, but never acted on it, which made it a de facto regulation.
Claiming the rule allows brokers to ``operate with virtually no disclosure of conflicts,'' among other legal issues, the Financial Planning Association (FPA), which represents certified financial planners, broker-dealers, attorneys and bankers, filed suit against the SEC on July 20.
``We'd like to see the SEC drop or dramatically amend the (Merrill) rule,'' said Elizabeth Jetton, president of the FPA. (Merrill Lynch is a minority investor in Bloomberg LP, parent of Bloomberg News).
Fee-Based Follies
The FPA and other investor groups argue that not registering fee-based brokers as investment advisers gives the securities industry an unfair advantage and an under-policed route to selling advice.
Case in point: Thaddeus Wong, a Chicago-based real estate agent, was working with a Morgan Stanley representative in a fee- based account four years ago. He invested about $1 million with the broker, who proceeded to trade technology stocks and lose all of the value of the portfolio.
Alleging excessive trading, misrepresentation and breach of fiduciary duty, Wong filed an arbitration claim against Morgan and the broker, who represented himself as a ``knowledgeable financial planner and consultant.''
Wong eventually settled with the brokerage house last year for $420,000. Morgan denied the allegations, claiming it ``reasonably supervised'' its broker. Wong would not comment. When contacted, SEC spokesman John Heine said the agency would have no comment on the Merrill Rule suit, which follows the agency's policy to not discuss pending litigation.
RIAS Offer More Disclosure
While hardly an infallible safeguard, registered investment advisers must disclose conflicts, file with state securities commissions and the SEC and generally act as fiduciaries with a legal obligation to represent clients' interests above their own.
``There's no question that investor protections are far stronger for clients of (registered) investment advisers than for clients of brokers,'' says Mercer Bullard, a former SEC lawyer, assistant law professor at University of Mississippi and president of Fund Democracy, a pro-investor group.
``It's especially ironic that at the same time the SEC is extending advisory regulation to cover hedge fund managers (under a new proposal), it's seeking to exempt brokers from such regulations,'' Bullard says.
The Fee-Based Business
The securities industry maintains that brokers are already covered by a raft of federal and state laws that hold them accountable.
``Brokers are covered by extensive regulations,'' says Jim Spellman, a spokesman for the Securities Industry Association (SIA), a trade group representing securities brokers. ``So they are subject to a high level of regulatory oversight that equates or exceeds that of investment advisers.''
Brokerage houses are also scrambling to recover from the bear market of 1999-2002 and myriad industry scandals by marketing ``wealth management'' and ``financial consulting'' services that combine advice and product sales in a fee-based package.
In 2002, the SIA reported that average gross commissions and fees for its members were down 10.6 percent from 2001 (the most recent year available). That followed a 17.5 percent decline in commissions in 2001.
In a trend that has been accelerating over the past decade, fee-based products accounted for about 28 percent of a broker's average commissions in 2002, up from less than 10 percent in 1996, the SIA said. In fact, ``fee-based accounts showed faster growth than any other segment of managed accounts over the past five years,'' according to Cerulli Associates, a financial consulting firm.
Customer Complaints Up
The muddle over fee-based accounts and adviser duties has led to thousands of complaints and arbitration filings.
While complaints for all but two individual investor categories tracked by the SEC declined in 2003, the agency said the number of complaints for fees, commissions and administrative costs rose 7 percent from 1,331 in 2002 to 1,428 last year.
More to the point, the single most frequent reason for securities arbitrations in 2003 was ``breach of fiduciary duty,'' which resulted in 5,565 cases in 2003, according to the NASD, the main regulator for the securities industry.
Arbitrations are procedures that involve impartial third parties to settle disputes out of court. They are required resolution vehicles for most brokerage and investment adviser customers.
Who's a Fiduciary?
``The fiduciary issue is crucial in arbitrations,'' said Andrew Stoltmann, a Chicago securities lawyer who represents investors in arbitrations against brokers.
``Brokerage firms argue at (arbitration) hearings that their broker is nothing more than an order taker. As more investors use a fee-based broker, it is imperative that the financial advisor be held to the (higher) standard of a fiduciary.''
The highest degree of protection often comes in disclosing what a broker does and not what they call themselves.
``Brokers call their sales reps by titles that imply they are advisers,'' says Barbara Roper, director of investor protection for the Consumer Federation of America, a consumer group. ``The real issue is the SEC's failure to enforce the requirement that that brokers limit themselves to `solely incidental' advice in order to escape regulation as advisers.''
Seek Fiduciary Duty
Ideally, anyone who offers financial advice should be a registered investment adviser and put it in writing that he has a fiduciary duty to you.
``Brokers and advisers should be bound by similar fiduciary standards,'' said Arthur Levitt Jr., the former SEC commissioner (and a director of Bloomberg LP, parent of Bloomberg News), who also favors a review of the Merrill Rule by the commission.
In that spirit, adviser registration should also be required of insurance agents, consultants, hedge fund marketers and brokers who recommend mutual funds, financial plans, retirement programs or other investments.
Don't wait for any government agency to help protect your nest egg, though. Use a simple smell test.
If someone offers you a customized financial plan in minutes or days instead of months or plugs commissioned products, move on. You're getting a list of products to buy, no matter what your adviser calls himself.
