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Whose Interests Does Your Financial Advisor Serve?
 

 
In last month’s edition of Financial Insights, we let you know that a U.S. Court of Appeals had struck down the so-called "Merrill Lynch rule." The court ruled that the Securities and Exchange Commission (SEC) had exceeded its authority in exempting fee-based brokerage accounts from the Investment Advisers Act, which, among other things, requires advisers to act in the best interest of their clients. The SEC has until May 14 to appeal the ruling, and Wall Street firms are pressing the SEC to appeal the decision to the U.S. Supreme Court. To help you better understand why so much is at stake for the brokerage industry, let’s delve into the history of the Merrill Lynch rule a bit further.

Stockbrokers are regulated by the Securities Exchange Act of 1934, which essentially requires them to know, and sell only investments that are suitable for, their clients (this is known as the "suitability" standard). Any investment advice that brokers provide must be incidental to their role as brokers, unless they are also registered as investment advisers. Brokers are traditionally compensated by commissions on transactions they process for their clients.

Registered Investment Advisers (RIAs), on the other hand, provide investment advice and are regulated by Investment Advisers Act of 1940, which requires them to make recommendations that are in the best interest of their clients (this is commonly known as a "fiduciary" standard of care). Investment advisers are traditionally compensated by fees, often based on a percentage of assets under management.

There used to be a clear distinction between brokers and investment advisers. But over the years, brokerage firms have blurred the lines between the two professions. Stockbrokers often refer to themselves as "financial advisors" and offer a wide array of financial products and services, including fee-based brokerage accounts.

When the brokerage industry introduced fee-based brokerage accounts in 1999, brokerage firms convinced the SEC to allow brokers to be compensated by clients with fees – an arrangement that until then was available only to investment advisers – but avoid being regulated as investment advisers under the Investment Advisers Act of 1940. Investment advice dispensed by brokers would have to be incidental to their brokerage services. The SEC rule, officially entitled "Certain Broker Dealers Deemed Not to be Investment Advisers," has become commonly referred to as the Merrill Lynch rule.

So why has Wall Street fought to keep the Merrill Lynch rule in place? Because the rule allows brokerage firms to supplement commissions they receive with fee-based accounts and to position brokers as holistic advisors, while avoiding the basic consumer protection standards that apply to Registered Investment Advisers.

In reality, brokers continue to act as salespeople and are highly motivated to steer clients toward certain investments that generate higher commissions. And while the SEC requires investment advisers to always act in their client’s best interest, a broker can choose an investment that is just good enough ("suitable") but pays a higher commission than the investment that would have been "best" for the client.

For the benefit of all consumers, we hope the SEC will take this recent court decision as an opportunity to adopt rules that, without exception, hold both brokers and investment advisers to the same standard: a "fiduciary" standard of care that puts the interests of the client first.

As an independent, fee-only Registered Investment Adviser, Grand Wealth Management offers financial and investment advice with one purpose in mind: to empower our clients to achieve their goals. Because we are compensated only by fees from our clients and never by commissions or transactions, and because we sell no products, there are no conflicts of interest between us and our clients. You can be assured that the guidance provided by Grand Wealth Management will be objective, based on sound principles, and tailored to our clients’ unique circumstances and goals.



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