Insights | 11.29.18
What’s in a Retail Investor’s Best Interest?
The typical retail customer who receives financial advice does not fully comprehend the various designations and differences among those giving said advice. And, on some level, they are unclear or ambivalent on what exactly constitutes having their best interests served. However, retail investors generally understand what kinds of behavior they should expect from professionals.
These timely observations were reported in recently released research co-authored by the RAND Corporation and the Securities and Exchange Commission’s (SEC) Office of the Investor Advocate.
The 156-page report is quick to emphasize that the research was undertaken prior to, and separate from, the SEC's release of the proposed standards of conduct rulemaking package known as Regulation Best Interest.
The research was based on focus groups targeting 35 individuals as well as a survey of 1,816 individuals.
On one hand, a significant amount (about 40 percent) of the survey's respondents agreed that dispensers of financial advice — whether brokers, financial advisors or financial planners — should be expected to avoid conflicts of interest and to disclose them.
On the other hand, what inferences are to be drawn from the flip side of that? Do nearly two-thirds of retail clients disagree with these concepts? If that is the case, what are the implications for rule makers who might take this sentiment into consideration? After all, these precise issues are at the heart of the debate over what exactly is meant by acting in a client's best interest.
The survey asked respondents, "What does best interest mean?" To glean insights, researchers presented respondents with statements with which to agree or disagree (or indicate uncertainty).
- Does acting in your best interest mean disclosing conflicts of interest?
- Does it mean avoiding certain payments (not directly from the client)?
As noted, roughly 40 percent said yes to both. As for those respondents who did not say yes to both, the bulk of these responses fell into either the "No" or "I don't know" buckets. Industry members who have argued that documenting potential conflicts is regulatory overkill that only invites more confusion might be inclined to point to this data as supporting their case.
When it comes to financial professionals' compensation, respondents were asked about how important it was that the compensation come directly from the client; about half said either “yes, important” or “extremely important.” A small number (15 percent) said that it was not important.
Some Consensus Found
Other statements pertaining to what is meant by best interest drew more of a clear consensus, particularly among those respondents currently using advisors.
For example, there was noticeable plurality in the statement that acting in a client’s best interest means the advisor "will help me choose the lowest-cost products, other things being equal.” Nearly three-fourths of respondents agreed.
As for the statement, "The advisor will disclose payments they received that may influence them," around 60 percent agreed.
A similar percentage agreed with the statement regarding an advisor acting in a client's best interest meant avoiding higher compensation when a similar, less costly product is available.
Among those survey participants who reported working with a financial professional, more than half (54 percent) reported that their service provider was an investment advisor, and 34 percent said that their representatives were “dually registered.” Just 6 percent said they worked with a broker. However, much of this self-reporting was incorrect. Researchers were able to check into the actual designations for 282 named advisors. Among those that could be “matched,” a much higher number (86 percent) were actually dual registrants.
To measure how well retail clients understand what a professional’s title (investment advisor versus broker versus financial planner) connotes in terms of the services rendered, subjects were asked to match titles with statements describing duties performed.
One such statement was “provides financial planning.” Not unexpectedly, most people (68 percent) matched that statement with the title “financial planner.” Head scratcher: Nearly one-third of respondents did not. In other words, when asked to delineate whether someone with the title financial planner did financial planning, there was a sizable number of people who failed to make this connection.
“These qualitative and quantitative data help us understand current investor views on financial advice,” the report stated.
Micah Hauptman, financial services counsel for the Consumer Federation of America, said the report “confirms what we already know regarding retail investors’ lack of knowledge about critical differences” between broker-dealers and investment advisors, according to ThinkAdvisor.
“Rather than preserving hazy distinctions between the two, which retail investors won’t be able to understand, the SEC should provide the same strong protections for brokers and advisors alike,” Hauptman said. “That standard should follow the framework Congress set out in section 913(g) of Dodd-Frank.”
Rich Blake A veteran journalist based in New York City, Blake has covered the financial world for numerous publications, including Institutional Investor, ABCNews.com and Reuters. Blake was a co-founder and executive editor of Trader Monthly magazine. The Buffalo native is the author of three nonfiction books, including “The Day Donny Herbert Woke Up,” which is currently being adapted into a motion picture. In 2004, Blake was nominated for a National Magazine Award in the Reporting category for Institutional Investor.