Investment Advice

Background

Nearly half of U.S. households have invested in stocks or mutual funds. This has given increased importance to the role of financial professionals who offer advice. However, not all professionals may ultimately provide advice appropriate for their clients’ risk tolerance and financial goals—whether because of insufficient training or conflicting financial incentives.

Polls repeatedly demonstrate that Americans believe financial professionals offer advice, not sales, and they expect that financial professionals who provide financial advice should put the interests of their client ahead of their own and should have to disclose up-front any fees or commissions they earn, as well as any conflicts of interest.

Individuals offering financial advice may market themselves as professionals yet operate as salespeople. Many people use titles like “financial advisor,” “financial planner,” and “personal financial consultant” to gain an advantage over other sales professionals. The use of these designations is unregulated, and many such professionals have met no minimum standard requirements. Investors are often unaware of this. Many state securities and insurance regulators do not allow a financial professional to use a designation, including one with “senior” in the title unless it has been accredited by the American National Standards Institute or the National Commission for Certifying Agencies. The accreditation requirement is designed to ensure that the credential is legitimate.

In addition, those who sell investment products must be licensed or registered. These people use titles including “broker,” “registered representative,” “investment adviser,” and “insurance producer.” Brokers are not required to register under the Investment Advisers Act if their advice is “incidental to brokerage activities.”

In general investment advisers who manage $100 million or more in client assets must register with the Securities and Exchange Commission (SEC). In most cases, those who manage less than $100 million must register with the state securities agency in the state(s) where they do business.

The SEC examines investment advisers who are SEC-registered. The states are required to examine investment advisers who register under state law.

Independent investment advisers owe a fiduciary duty to their clients. They must act in their clients’ best interest. They must also properly disclose fees and other expenses, as well as any compensation the adviser may receive from sources other than the client.

Brokers and dealers, on the other hand, are held to a weaker standard. Their recommendations must be suitable to meet the client’s needs, but they do not need to put their clients’ interest first. They are not required to disclose other compensation received, including commissions.

The Financial Industry Regulatory Authority manages a database of broker registered representatives. The database lists complaints against representatives as well as other information. It also discloses the nature and resolution of those complaints. Information about investment adviser representatives who are dually registered as broker representatives can also be found there. The SEC manages a similar database on representatives of investment advisers registered with the commission. Investors must depend on individual states for information on the representatives of state-registered investment advisers.

INVESTMENT ADVICE: Policy

Regulation and licensing of professionals giving investment advice

In this policy: FederalState

Registration as a financial professional should not be limited by the type of investment advice or nature of the advising entity.

States should:

  • prevent abuses in financial advising, counseling, and planning by unqualified people or organizations and by unethical or incompetent professionals;
  • regulate advisors who use “senior adviser” or other designations by requiring accreditation;
  • require training, testing, and registration of advisers;
  • devote adequate resources (both funding and staffing) to ensure they can adequately examine and monitor investment advisors; and
  • seek to have industry fund licensing and monitoring of advisors through user fees or similar funding mechanisms.

All financial professionals giving advice should have a fiduciary duty to their clients regardless of the type of license they hold.

Sales practices that compromise the suitability of a broker’s recommendation to a customer should be banned.

Advisers should have to meet established performance standards. They should also have to adhere to a code of ethics. Enforcement should apply to advisory firms as well as to their employees.

Consumer redress for losses

In this policy: FederalState

Individuals should have adequate redress, including access to the courts and class actions. They should be given a private right of action to seek restitution for losses they sustain if their adviser violates the Investment Advisors Act (see also Chapter 12, Personal and Legal Rights—Private Enforcement of Legal Rights).

State laws should provide more effective consumer redress, and better public education on how to seek redress, of financial wrongdoing.

Penalties

In this policy: State

State laws should provide for criminal penalties against those who commit securities fraud.

States should strengthen and enforce existing laws on truth in advertising and other consumer protections.

States should provide adequate resources for enforcement.

Disclosure

In this policy: FederalState

Individuals who work for broker-dealers and sell investment products should be required to disclose relevant information and conflicts of interest, regardless of the type of license they hold. This includes disciplinary actions taken against them, commissions and compensation structure, and other potential conflicts of interest.

The Securities and Exchange Commission, Financial Industry Regulation Authority (FINRA), and state regulators should work together to improve and publicize the availability of online background checking features. States should work together to establish a single website that can be used for checking the backgrounds of state-registered investment advisers, broker representatives, and investment adviser representatives.

State laws should mandate disclosure of self-interest and conflicts of interest. This includes information on commissions.

All disclosures should be understandable and effective. They should be rigorously tested with actual consumers.