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Tough times in the brokerage business are about to get tougher. A difficult investment environment and damage to its reputation are threatening the industry, and now it faces regulatory challenges under Dodd-Frank as it evolves from its current sales-driven culture to a professional services culture focused on advice and the fiduciary standard. Bold leadership will be necessary to navigate this challenge; without it, the brokerage industry and their clients will suffer.
Dodd-Frank holds brokers to the same fiduciary duties and consumer protections afforded by an advisor. That portion of the legislation, unfortunately, has yet to be enforced.
An inexorable retooling of the industry is upon us. It’s triggering substantial industry pushback, with so many brokers unaccustomed to rapid change, but it must proceed; this vital transformation is essential to advance modernity, the best interests of the investing public, and the professional standing of the advisor. It will usher in extraordinary increases in advisor productivity, an unprecedented level of investment and administrative counsel and far better earnings, margins and valuation multiples for the industry.
This transformation has gone global, now that the UK has outlawed commissions effective January 1 and will hold brokers to the fiduciary standard of care. This aggressive action by the English makes the fiduciary standing of the broker – and the consumer protections it affords – a phenomenon which will determine global market leadership in an increasingly small world.
At play are two competing views of the role and responsibilities of the broker, which will ultimate determine how they are differentiated from advisors:
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The broker is just making clients aware of their investment alternatives, with no investment advice being rendered, intended or implied. This brokerage industry convention leaves the consumer to his or her own devices to determine the merits of an investment, no matter how limited his or her investment knowledge and experience may be. The industry posits that if no advice is rendered, neither the broker nor the broker/dealer firm responsible for the broker’s recommendation are subject to any fiduciary liability. The broker’s role and compensation are based on his or her ability to facilitate trade execution, not to render advice, which would in fact be a violation of the employing broker/dealer’s internal compliance protocol. The broker is not accountable for, nor has any ongoing responsibilities stemming from, any advice rendered, which is considered incidental to the clerical trade execution services provided.
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Alternatively, brokers would function as advisors and would be accountable and responsible for rendering expert personalized advice. That advice would be in the best interest of the investing public based on objective, non-negotiable fiduciary criteria, which in turn are established by statute, case law, regulatory opinion letters and best practices. Here, conflicts of interest are eliminated. An broker would provide individualized personal advice on how a recommendation affects the client’s holdings, based on criteria such as risk, return and tax efficiency.
There’s quite a disconnect. There is a big difference between sales and professional services. It is the difference between a broker who is not accountable or responsible for their recommendations and an advisor who is. Which view prevails will determine global financial services market leadership.
An international perspective
The choices are clear: The US standard of procedural prudence requires disclosure of conflicts of interest as a means to mitigate the liability of the broker not fulfilling his or her fiduciary duties. UK standards, meanwhile, offer substantive compliance, wherein the advisor fulfills a duty that is based on objective, non-negotiable fiduciary criteria.
There is no doubt that substantive compliance in support of the advisor and fiduciary standing wins global favor; consumers are having their best interests affirmatively served, not merely being notified if the broker has interests that actively contradict theirs. This disconnect has triggered extraordinary dynamics as the global financial services industry evolves. The US has reigned supreme as a global financial services market leader largely based on having the largest, broadest, deepest capital market in the world.
Though market size may be paramount in investment banking, it is far less significant in advisory services, where the depth and breadth of the advisor’s counsel determines market leadership. The UK, Hong Kong, Singapore, Australia, and others do not share the US aversion to acknowledging and supporting the fiduciary standing of the broker. Given this natural accord, it is not surprising if the rest of the world may develop a dimming view of the US brokerage industry’s standards, and a tendency to look towards the UK.
A path to higher profitability and valuations
To mitigate fiduciary liability, the US brokerage industry has placed its own self-interest ahead of the best interest of its consumers and the investing public. This undermines trust and confidence – and with it, the leadership role of the US in the financial services industry. Instead of updating its policies and practices to make it safe for the broker to acknowledge his or her fiduciary responsibilities, the US brokerage industry simply denies the broker renders any advice, which handcuffs the broker’s ability to add value for clients.
What’s more, the industry’s ingrained culture works to prevent any improvement in this precarious state of affairs. Because brokers hide behind the denial that advice is being rendered, those who speak out or push too hard for changes to better protect the interests of the investing public are tagged as working counter to strictly enforced compliance protocols that has effectively insulated them from fiduciary liability.
Quiet, internal efforts to bolster brokers’ fiduciary standing have been shot down. Those within the industry have found it to even discuss the necessary processes, technology, workflows and conflict management that would be necessary to support fiduciary standing. The leadership needed to make advice safe and easy to execute is nowhere to be found.
The old fallback of feigning ignorance – what does “in the client’s best interest” mean? – is no longer an excuse, now that fiduciary standing is required under Dodd-Frank and is acknowledged by the UK and around the world. The brokerage industry’s head-buried-in-the-sand attitude has crippled the US in advisory services, thwarting the creation of:
- expert-authenticated prudent investment processes that make advice safe to acknowledge (such as asset/liability study, investment policy, portfolio construction, monitoring and management)
- the advanced technology to facilitate transparency, modern sophisticated approaches to portfolio construction, and continuous comprehensive counsel that are required for fiduciary standing
- workflow management tied to a functional division of labor that makes expert advice scalable and easy to execute and manage as a high-margin business at the advisory level
- conflict management that aligns the best interest of the consumer with that of the broker
These resources make advice safe, scalable, easy to execute, and easy to manage. Not only are they in the best interest of the investing public, they will also streamline cost, increase margins, greatly enhance advisor productivity – enough to potentially triple valuations, by transforming multiples from the brokerage to the asset-management industry.
Huge market share will be won by doing the right thing.
The SEC has established that brokers are not responsible for creating their own infrastructure to support their fiduciary standing; instead, that is the role and responsibility of the broker/dealer. Furthermore, the SEC is now conducting interviews with the industry’s topmost executives to determine how each firm is holding brokers to the fiduciary standard.
For those firms that think they already are supporting fiduciary standing of their brokers, just ask:
- Are your brokers accountable for their investment recommendations in the context of all their client’s holdings, and do they have the necessary resources to be accountable?
- Are your brokers monitoring those recommendations, providing continuous and comprehensive counsel?
Neither of these fiduciary duties is difficult to meet, unless you are unprepared.
The US brokerage industry can no longer exculpate itself by simply insisting that the fiduciary standard is equivalent to the suitability standard.
An insular culture of inaction is making it harder and harder to meet the demands of the global investing public, which expects the brokerage industry to act in their best interests. Europe, Asia, Australia will have access to UK and UK-inspired fiduciary services. Unfortunately, the US is facing a bifurcation of the financial services industry into “professional services” adhering to the fiduciary standard and “sales” based on a lesser suitability standard. The latter permanently relegates US brokers to an inferior competitive position in the marketplace. Principled leadership and action must emerge if the US expects to lay claim to global financial services leadership in the decades ahead.
Stephen Winks is founder of The Society of Senior Consultants, publisher of Senior Consultant and chairman of PCT Research and Consulting
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