So who, exactly, does a broker work for? In the past, the answer to that question wasn't quite clear. Under U.S. rules, brokers were required only to steer clients toward "suitable" trades or investments, not necessarily those in their "best interests."
Among the changes already in motion from passage of last year's Dodd-Frank Act are new rules to be written by the Securities and Exchange Commission to clarify the relationship between broker-dealers and their clients.
Under the rules, brokerages will probably have to draw up new disclosures to make clear that they are putting their client's best interests first, a level of responsibility known as a fiduciary standard.
"There's no question that one of the public policy objectives will be to raise the bar for brokerage firms that provide personalized investment advice," said John Taft, the chief executive of RBC Wealth Management and chairman of the Securities Industry and Financial Markets Association, the lobbying group for the brokerage industry. "The firms that don't put their clients' interests first are going to change how they do business."
The SEC has found that many retail investors are confused by the different roles played by investment advisors and broker-dealers. Registered investment advisors follow principles outlined in the Investment Advisers Act of 1940 and must put their clients' best interests first. Broker-dealers adhere to the Securities Exchange Act of 1934 and currently have only to recommend products that meet their clients' needs when sold.
To ease confusion, the commission recommended that broker-dealers adopt a fiduciary standard "no less stringent than currently applied to investment advisors."
Under the previous suitability standard, brokers only had to recommend a product consistent with the investor's goals, strategies and risk tolerance. When offering investment options to customers under a fiduciary standard, brokers will now have to document that it is the best choice for the investor, said Barbara Roper, director of investor protection for the Consumer Federation of America in Washington.
The new standard won't necessarily require that brokers include low-cost options in their menu of offerings, Roper said.
When the new rules are written, it's expected brokers will have to both disclose more information before working with customers, and provide more transparency when recommending products that may involve conflicts, Roper said.
"No matter how it's written, if it's written right, it will raise the bar across the industry," Taft said.
The Dodd-Frank Act specifies that the uniform standard can't weaken the existing obligations for advisors, according to Ira Hammerman, general counsel for Sifma. That means the SEC should create parallel rules, which still permit transaction-based advice paid through commissions instead of fee-only advice, he said.
A new standard will likely mandate that brokers provide additional disclosures about services, compensation and conflicts of interest, said K. Susan Grafton, a former SEC attorney at Gibson Dunn & Crutcher LLP. The disclosures may be similar to those required as part of so-called ADV forms that advisors currently provide to investors.
Under a common standard, the SEC may allow principal trading, which is when firms use their own stock inventories to fulfill trades, without requiring client permission each time a trade is made, said Mercer Bullard, founder of Fund Democracy LLC, an advocacy group. "It would violate Dodd-Frank to say that no broker is ever required under the best interest standard to disclose that," Bullard said.
Other transactions that may require more guidance from the SEC include initial public offerings underwritten by the brokerage firm, Hammerman said.
"The SEC is trying to find the sweet spot to adopt something that has important protections for investors, but doesn't trigger pushback that ends up getting the regulation killed," Roper said.
