This post by John Rekenthaler, Vice President, Research, Morningstar, first appeared on Morningstar Blog.
Last month, the Securities and Exchange Commission, or SEC, released new rules for governing financial advice, in a document artfully entitled, “SEC Proposes to Enhance Protections and Improve Choice for Retail Investors in Their Relationships With Financial Advisers.” (The next 1,000 pages read similarly.) The SEC’s report follows a similar proposal from the Department of Labor, about which I have written in the past.
This time, I will abstain. Even as fiduciary recommendations go, the SEC’s new report is difficult to parse--to the point where even the agency’s commissioners disagree. One, Kara Stein, voted against the proposal, labeling it as “Regulation Status Quo.” A second, Hester Peirce, supported the proposal but stated that it was misnamed. The new standard should not be termed Regulation Best Interest, she said, but instead “Suitability Plus.”
If the commissioners themselves are not sure of what they passed, then analyzing their suggestions surely exceeds my competence. (Bravely, Morningstar’s director of policy research, Aron Szapiro, attempted the task.) Thus, I will take a step back and approach the topic more broadly. Setting aside the specifics of the current proposals, how should financial advice work? How should the industry look?
The outlier
The first step is to acknowledge the current state of affairs. Put the broker, doctor, and lawyer in the same sentence, and the overwhelming response from the general public will be that the first item does not belong. The reason behind that reaction answers this column’s questions.
The issue that prevents advisers from being viewed similarly to doctors and lawyers is education. Doctors attend medical school for four years, then enter residency. Lawyers undergo three years of law school. Brokers ... not so much.
(It is true that financial advice also carries a poor ethical reputation. However, although important--and to be addressed later in this column--ethics are not the primary problem. When polled, the public views lawyers as being just as ethically challenged as brokers. But if a potential client fails to show up for the initial meeting, it is the broker and not the lawyer who is likely to be on the other end.)
Muddled terms
To which it will be objected that broker is not synonymous with financial adviser. Some financial advisers have Ph.D.s in the subject. Meanwhile, brokers can be hired on the spot. Professional financial advice occupies a spectrum, which I have compressed, thereby presenting the many as if they were one.
Fair enough. But in doing so, I have spoken for the crowd. Few investors realize that one investment adviser might have several years’ worth of advanced training and that another might have almost none. How could they? Terms like broker, financial adviser, investment adviser, and so forth are hopelessly muddled.
Consider the SEC’s current proposal. It governs broker/dealer behavior, while stating in its title that it applies to ... “financial advisers.”
The solution
In clearing up the confusion and improving its reputation, the answer for financial advice is not to emulate the other two industries by creating a single and high barrier to entry. Perhaps someday that will be the answer. The history of investment services has been the history of automation. Professionally managed mutual funds have supplanted stock selection; target-date funds have reduced fund selection; robo-advisers are replacing personal meetings. Over time, the business may evolve that relatively few investors will be served by a small group of highly trained financial advisers, with the remaining investors addressed by technology.
Today, however, is not that day. Many who seek financial assistance seek the traditional method of support: a face-to-face discussion. At least for the foreseeable future, there are more such customers than there are top-end advisers to serve them.
Thus, there should be two tiers of financial advice, defined by education. The top level would likely not require as much training as a law degree and surely not as much as obtaining a medical license. For today, it would look something like the prerequisites for the Chartered Financial Analyst designation. Over time, the requirements could perhaps grow if those practitioners wished to make their field even smaller and more elite.
Ethics for all
The second, larger level of financial adviser would resemble today’s brokers, albeit with stiffer ethical standards. I see no problem with the current, modest educational requirements. Such advisers could mostly (or entirely) give solutions that were packaged by the home office. However, the fiduciary requirements would need to be raised to match those of the higher-end advisers. People don’t expect nurses to act any less in their interest than doctors do. The same logic should apply to financial advice.
The line between these two tiers must be clearly marked and made widely known to the investment public. This means that the definitions for the two tiers, ultimately, must be sanctioned and enforced by the SEC. The CFA Institute has valiantly attempted to make the everyday investor understand the difference between those who carry its Certified Financial Analyst designation and other financial advisers. In that task, it has struggled. For protecting its occupation’s brand, an industry organization can accomplish only so much.
These recommendations may sound like where the industry has already gone--with one, higher tier of financial advisers being those who assume fiduciary responsibilities, and the other being those who do not. To some extent that is true. However, there are two differences. One, I propose to couple the top tier of adviser to an educational requirement. Second, I do not believe that there is any reason to have two fiduciary standards. All financial advisers should represent the best interests of their clients.
