When it comes to financial advice, it isn’t always clear how, or how much, you pay for services received, a key input to assess motivation. Lack of clarity leads to lack of trust, one of the biggest barriers to working with a financial advisor. On June 30, 2020, Regulation Best Interest (Reg BI) came into force, the latest batch of rules intended to address the problem.
While the investing public sees financial advisors as a homogenous whole, there are really two distinct groups operating under different standards. In the first case are broker-dealers and their agents. Broker-dealers operate with armies of registered representatives who sell products for commissions under a suitability standard, a requirement that those products are simply suitable for the client. Such a standard was deemed appropriate since the broker was not seen to be rendering ongoing investment advice.
In the second case are Registered Investment Advisors (RIA). An RIA operates under a fiduciary standard, a legally mandated expectation that any recommendations proposed by the RIA will be made with the client’s interests first. This is a much higher standard than a suitability standard. An RIA is not paid by commission, rather an RIA is typically paid for services performed or paid based on assets under management under the umbrella of offering ongoing investment advice.
The confusion started years ago as brokers and agents began to market themselves as advisors, minimizing the sales image and suggesting a higher standard of care that may, or may not have been in place. Clouding matters further, some advisors are dually-registered, a bewildering arrangement that means they can earn revenue under a fiduciary standard as an RIA, but they can also sell products for commission as a broker or agent under a lesser standard. Dually-registered brokers are expected to disclose to clients whenever their role changes. Individual investors could be forgiven for being entirely discouraged about how to find guidance from someone who was truly working on their behalf all the time.
Reg BI will try to clarify some of these problems, but it still falls short. In one example, brokers will not be allowed to use the term advisor, except when they are acting as an advisor to anyone other than a retail client. Does that sound less confusing? As a result, several states are taking independent action to adopt heightened standards for brokers.
As an RIA since 1987, we have always acted as a fiduciary for our clients. Reg BI now requires we share a document called a client relationship summary, or Form CRS, which you can download from our home page, or click here. Yet brokers and agents have a place too for clients who want the products they sell. The thrust of Reg BI is one of additional disclosure, which is a good step. However, the key to reducing investor confusion is to understand the motivations and incentives of your broker/advisor. This understanding comes from asking two simple questions; how am I paying you, and how much am I paying you. Once you know those answers, you know whether you are talking to a sales agent, or an advisor.