Wall Street Must Put Clients First

03/22/2010 12:28 pm EST


Terry Savage

Author, The Savage Truth on Money

What’s the most significant difference between a stock broker and an investment advisor? 

The investment advisor pledges to put his or her client’s interests first. That would require full disclosure of all costs and commissions, as well as any potential conflicts of interest. It’s a standard set by the Investment Advisers Act of 1940 and affirmed by the Supreme Court.

But stock brokers are only required to “know the customer” and offer products that are “suitable.” Brokers have been excluded from the duties required of investment advisers as long as they don’t give advice as "solely incidental" to their brokerage services.

That’s a huge distinction—and one that is little recognized by most investors, who naively assume their broker is their advocate.

That might all be changed by one provision in the financial reform legislation introduced last week by Sen. Chris Dodd (D-Conn.). It would require a study about the benefits of extending the fiduciary standard to stockbrokers.

It seems to me that very little study is required. Asking brokers to adhere to the highest standards of responsibility is hardly an issue that should raise debate. In fact, most brokers agree this is a good idea. It’s the Wall Street firms and the insurance industry that seem to be dragging their feet.

Think about it. If brokers are required to put their clients’ interest ahead of their own, they’d be selling no-load or index funds. Insurance salespeople couldn’t sell annuities that are loaded with fees, commissions, and penalties without full disclosure—and counseling their prospects on lower-cost, similar alternatives.

The new awareness would increase product competition—and bring down profit margins. That‘s hardly a revolutionary idea, nor is it one that should really threaten the Street.

Thirty five years ago, Wall Street deregulated brokerage commissions in an emotional event that was called “MayDay” not only because it occurred on May 1, 1975. The competition that ensued certainly didn’t drive the best firms out of business, as many had predicted.

More recently we’ve seen full disclosure of everything from new car costs to airline fares, and the intense competition raised by full disclosure has brought on new winners, like Southwest Airlines (NYSE: LUV). But in every case, consumers have benefited by full disclosure—a basic premise of the fiduciary standard.

The idea of putting your clients’ interests first isn’t revolutionary, either. We hope and assume that our physicians’ decisions aren’t overly influenced by drug companies or device providers, nor would they recommend an operation merely to generate a fee.

In these days of general public disillusion with Wall Street, any idea that encourages the public to feel their financial brokers are on their side is an idea that should be trumpeted instead of buried in a “study.”

We need faith in the free markets to bring our economy back into growth mode—the only way to provide jobs and all the government benefits we have promised. And we need investors in our markets to reward and benefit from that growth.

It’s time for all financial salespeople to adhere to a fiduciary standard. If we keep operating on a “buyer beware” standard, then don’t be surprised if wary buyers avoid the markets entirely.

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