WHO’S WHO

In this book, all broker-dealers are referred to as “brokerage firms.” All financial services professionals are referred to as “financial advisors,” and to simplify for the reader, will be referred to as “he” or “him.” The term does not distinguish among retail brokers, independent brokers, investment advisors or insurance agents licensed to sell securities. “Adviser” appears only when
referencing the Investment Advisers Act of 1940.

However, industry professionals understand that retail brokers, independent brokers, and independent investment advisors operate very differently. Those crucial differences will be explained in detail in this book. Explaining those differences—in compensation, in motivation, in regulation, in expertise— is at the heart of this book. With that information, the average person can make an informed decision.

Update from the Author: March 2020
As I write this on March 26, 2020, we have seen both the U.S. stock and bond markets register new all-time highs only to suffer a 38% downturn in stocks. International markets have also experienced severe downturns.

At the same time, bond prices utterly collapsed under the weight of forced liquidation from panic selling in a rush for liquidity as opposed to benefiting from a flight to quality as we have often witnessed in past stock market corrections.

The federal reserve lowered rates to zero in response to the markets and Congress authorized a two trillion dollar relief package in part to address the spike in expected unemployment caused by layoffs and business closings, due to the Covid-19 virus. Obviously, the damage to financial markets pale in comparison to human suffering caused by Covid-19.

Commodity prices also collapsed—especially crude oil—as the global economic picture worsened. Even gold, which one might expect to be a safe haven, sold off violently. We now face the likelihood of the first recession in over a decade.

In response to monetary stimulus from the Fed as well as fiscal stimulus from Congress, stocks and bonds experienced significant price improvement only days after making new lows.

In my thirty-five years in the securities industry, I have experienced the 1987 stock market crash, the dot-com crash in 2002, the 2008 financial crises as well as other severe corrections in both stocks and bonds, but never anything like what I have witnessed—and traded through—in the past thirty-five days. Reporters have been searching for explanations. This week alone, I was interviewed by both the Wall Street Journal about municipal bonds, and Business Insider about high-yield savings accounts.

History may not repeat itself, but it often rhymes and human nature does not change. In challenging market conditions, it is important to keep things in perspective.

The following exhibits are intended to offer this perspective. They are also intended to serve as a reminder of the importance of having a sensible financial plan—one that reflects your true risk tolerance—and sticking to it in times of market turmoil. This is when advisors should earn their keep.

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Aside from recent market turmoil, there have been some other significant developments since I first wrote this book in 2012:

• Commissions for stocks and exchange-traded funds (ETFs) are now at zero, as well as the operating expenses for certain ETFs. Fees have even fallen a bit for certain actively-managed open-end mutual funds.
• The original Department of Labor Rule (DOL Rule) was introduced in 2017, imposing a fiduciary legal obligation upon all professionals advising retirement accounts to always place their clients’ interests first.
• In 2018, the DOL rule was overturned in court.
• In October 2019, the new Certified Financial Planner (CFP®) Board practice standard took effect.
• Also in 2019, the SEC voted on a new set of rules as well as guidance for the so-called Regulation Best Interest (or Reg BI).
Barbara Roper’s September 2019 article in NAPFA Advisor magazine is the most cogent and succinct summary that I know of. Barbara is the director of investor protection for the nonprofit Consumer Federation of America. Her article is reprinted on the next page.

It should go without saying that nobody’s financial picture is complete without a solid financial plan. Not a cookie-cutter plan that merely checks the boxes as part of some quota system or a plan done as a means of selling financial products. I am referring to a solid, comprehensive financial plan that encompasses every facet of your life, all contingencies and variables as well as stress-testing for efficacy.

Effective planning is a collaborative effort between planner and client. The result, including periodic updates, should be greater peace of mind.

Hopefully, you are already working with a CFP®. By all means, you should be working with a fiduciary. How do you know if the advisor is always acting as fiduciary and therefore, always placing your interests first? Insist that they sign the Fiduciary Oath found on page 34. If they refuse to sign it, find an advisor who already adheres to it at NAPFA.org. There are only a few thousand NAPFA members nationwide, but it’s well worth the effort to find one in your area.

How to Protect Investors When The SEC Won’t

Amid great fanfare, the SEC voted in June 2019 on a package of rules and guidance that it claimed would significantly enhance and clarify the standards that apply when broker-dealers and investment advisors provide advice and recommendations to retail investors. While securities lawyers will be parsing the words of the new standards for many months, it is apparent that, under the new rules, neither brokers nor advisors will be required to recommend the investments they reasonably believe are the best available
option for the client.

As a result, instead of strengthening protections for investors, the new standards will place them at greater risk—misled into expecting best interest advice that the rules do not require. Particularly shocking to many observers is that the SEC weakened the Investment Advisers Act of 1940’s fiduciary standard, instead of raising the bar on broker-dealer conduct.

The good news is that many financial professionals, include NAPFA members, take seriously their obligations as professionals to do what’s best for their clients. As investor advocates, our job in the coming months will be to help steer investors toward advisors who voluntarily adhere to a higher standard than the SEC is willing to impose.

One way to accomplish that will be to steer investors toward those financial professionals who design their practices to minimize conflicts of interest. Eliminating conflicts associated with revenue-sharing payments, differential compensation, 12b-1 fees, and the like is obviously easier for investment advisors than for broker-dealers, though advisory accounts at dual registrant firms in particular are not immune to such conflicts. NAPFA’s Fee-Only commitment will make it a critical resource in our investor education efforts going forward.

While the challenge for brokers to rein in conflicts is greater, a well-meaning brokerage firm could go a long way toward reducing particularly problematic conflicts of interest. It could do so by adopting some of the reforms and inno-vations, such as “clean shares,” that had begun to take hold before the DOL fiduciary rule was overturned in court.

Voluntary certifications will also play a role in our investor education efforts. These include the CEFEX certification, which documents adherence to a set of fiduciary best practices, as well as the new CFP® Board practice standards taking effect October 1. The CFP® Board standard takes a tougher stance on conflicts than either Regulation Best Interest or the SEC‘s interpretation of the Advisers Act fiduciary standard. It makes clear that, even after conflicts of interest have been disclosed and consented to, the CFP® certificant still has an obligation to set those conflicts aside and put the client’s interests first. That’s what investors reasonably expect from someone pledged to act in their best interests.

Because the CFP® standard is compensation neutral, it offers broker-dealers a way to demonstrate that their commitment to a best interest standard is more than just lip service. On the flip side, however, if a firm were to prohibit its reps from using their CFP® credentials, as some have reportedly considered doing, that would be a huge red flag for investors. Similarly, investors can ask their investment professional to sign a fiduciary oath, since a willingness to put that fiduciary commitment in writing will be another way to identify professionals whose commitment to client best interest isn’t just for show.

Ultimately, an investor education campaign is not enough. Investors need the protections that only a strong legal standard can provide. So, our long-term strategy will combine reaching out to FINRA and the states to encourage the strongest possible enforcement of the new standard, supporting adoption of stronger state laws, and laying the groundwork to reopen the SEC rules in a new administration.

When the time comes to reopen this debate, we will look to NAPFA members to work with us, as they have in the past, to ensure that brokers and advisors alike are held to the high standards investors expect and deserve from the advisors they trust with their financial well-being.

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Written by Barbara Roper, as seen in the September 2019 issue of NAPFA Advisor magazine. Barbara Roper is director of investor protection for the nonprofit Consumer Federation of America. Since publishing a report on financial planning abuses in 1987, she has sought to strengthen protections investors receive when they turn to investment professionals for advice.

Barbara Roper’s article on the previous page mentioned that some brokerage firms have reportedly considered prohibiting their reps from using their CFP® credentials, adding that such behavior would be a “huge red flag for investors.” Why would a brokerage firm do such a thing? And why now? Because the new CFP® Board standard takes a tougher stance on conflicts or interest than Regulation Best Interest, which can make it much more difficult for brokerage firms to sell their products. Once investors are made aware of all the conflicts, they may choose not to purchase what the brokerage firm is selling, or may even seek a new firm—perhaps a Fee-Only registered investment advisor and fiduciary.

Morever, a December 2019 article in Financial Planning magazine—A Path to Disclosure—reports that “CFPs at Northwestern Mutual have a template to follow in explaining their conflicts of interest to planning clients.” “The insurer and broker-dealer has created a disclosure document intended to comply with the CFP® Board’s new code of ethics and standards of conduct. In the document, advisors tell planning clients outright that they’re incentivized to ‘sell’ Northwestern Mutual insurance to a client often, and for the highest possible commissions.”

There are more than 1,000 CFPs affiliated with Northwestern Mutual, and over 85,000 in total. Compare this situation to a Fee-Only registered investment advisor and fiduciary that offers insurance products—an advisor whose guidance is not conflicted by commissions or sales quotas.

“An investment in knowledge pays the best interest.”
~Benjamin Franklin

Have a question? Contact Ed Mahaffy.

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