The Future of Financial Advice: Eliminating the False Distinction between Brokers and Investment Advisers

36 Pages Posted: 12 Jul 2015 Last revised: 26 Jun 2019

See all articles by Christine Lazaro

Christine Lazaro

St. John's University - School of Law

Date Written: January 5, 2013

Abstract

Individuals who offer financial advice to the public are regulated at several levels — by federal statute, by state law, and by rules of federal regulators, including the Securities and Exchange Commission (“SEC”) and self-regulatory organizations such as FINRA. Following the stock market crash of 1929, Congress began to enact a federal framework of regulation of the individuals working within the securities markets. Initially, Congress focused on brokers, the individuals who were paid to effectuate securities transactions. Next, Congress focused on investment advisers, the individuals who were paid for the advice they gave in connection with securities transactions.

As a result, the regulatory schemes associated with brokers and investment advisers are separate and distinct. The obligations each has to their clients are different. While this may have made sense at the time the regulation were enacted, over time, the distinctions between brokers and investment advisers have blurred. Effectuating transactions and offering advice are no longer distinct activities conducted by different individuals. Now, an individual offering financial advice may be both a broker and an investment adviser and offer different levels of service to different clients. This individual will be governed by the regulations associated with brokers when acting in the capacity of a broker and will be governed by the regulations associated with investment advisers when acting in the capacity of an investment adviser. This has blurred the distinctions even further, as the same person may be both.

Concerned that the distinctions between brokers and investment advisers have blurred too far, a number of studies, including several commissioned by the SEC, have examined an investor’s comprehension of the distinctions. The studies have consistently demonstrated that investors do not understand the different roles of brokers and investment advisers. Investors do not understand that the conduct of brokers and investment advisers are governed by different regulatory schemes and by different standards of care. Investors do not always understand with whom they are doing business.

This Article proposes that the best course of action at this point is to adopt new legislation — a Financial Advice Act. While the distinctions between brokers and investment advisers have blurred, there remain distinctions. A one-size-fits-all regulatory structure will disregard the realities of the marketplace. Different clients have different needs and expectations from their financial professionals and want different fee structures which reflect the different services. Accordingly, the Financial Advice Act would not harmonize the standards applicable to brokers and investment advisers. It would eliminate the artificial distinctions between brokers and investment advisers as they now exist, and replace them with new definitions more closely tied to the services actually offered by the financial professional. It would recognize that there are varying levels of financial advice with different compensation associated with them. It would create standards of care that are more closely related to the advice and the expectations created by the financial professional. Clients would have the option of choosing to do business with a full range of financial professionals from discount to full service, and would receive a corresponding level of protection.

In order to set the stage for the discussion of this Article’s proposal, this Article first examines the legislative history of the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940, and second, the judicial history of both. The circumstances in which each Act was formed explain why the Acts were initially distinct and inform the discussion of why those distinctions are no longer applicable. Next, this Article examines how the SEC has attempted to deal with the blurring of the distinctions in a way that would permit the financial professionals to offer various advice models to clients. By ensuring that there remain definable distinctions between brokers and investment advisers, the courts have further blurred the landscape.

Next this Article examines Congress’s attempt to deal with this blurring of roles, and the effect Dodd-Frank has had on this landscape. It will explore the Study conducted by the SEC pursuant to Dodd-Frank and the recommendations made by the staff of the SEC. Lastly, this Article will describe a proposal for a new securities act, which would modify the existing legislation in such a way to eliminate the artificial distinctions between brokers and investment advisers.

Keywords: Broker, Investment Adviser, Fiduciary Duty, investment advice, FINRA, SEC

JEL Classification: K22

Suggested Citation

Lazaro, Christine, The Future of Financial Advice: Eliminating the False Distinction between Brokers and Investment Advisers (January 5, 2013). St. John's Law Review , Vol. 87, No. 2, 2013, St. John's Legal Studies Research Paper No. 15-0040, Available at SSRN: https://ssrn.com/abstract=2629390

Christine Lazaro (Contact Author)

St. John's University - School of Law ( email )

8000 Utopia Parkway
Jamaica, NY 11439
United States

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