Seeking Financial Advice? Be Careful Where You Look

On this episode of The Long View, Micah Hauptman, director of investor protection at the Consumer Federation of America, discusses financial advice, crypto, and social media.

Here are a few excerpts from Hauptman’s conversation with Morningstar’s Christine Benz and Jeff Ptak.

Financial Advice in 2023

Christine Benz: I want to go back to the topic of investment advice, which you mentioned previously. If you think about the landscape for people seeking financial advice, investment advice, and you had to give it a grade from A to F in terms of how easy it is to find an advisor and figure out what you’re paying and so forth—if you had to give it a grade from A to F, the landscape currently for consumers, where would you put it?

Micah Hauptman: Well, I’m feeling particularly optimistic today, so I’m going to give it a D.

Benz: Oh boy. Sounds like you’re pretty downbeat. It’s a confusing area, I would agree. Can you discuss why you think the landscape isn’t as good as it could be, and why some of the regulations currently in effect maybe aren’t as strong for the consumer as they should be?

Hauptman: I mentioned that the Department of Labor rule was struck down. So, we have reverted back to the rules that applied in 1975. And basically, there are several loopholes in the definition of who is fiduciary. So, if you don’t want to be a fiduciary, you don’t have to be. In the wake of the DOL fiduciary rule being struck down, the SEC under Jay Clayton stepped in and finalized Reg BI, Regulation Best Interest, for brokers, providing recommendations to retail customers. And while it’s not a fiduciary rule, the SEC has said it is drawn from key fiduciary principles that include an obligation to act in the retail investors’ best interest and not place their own interests ahead of the investors’ interest. And that sounds great, but the evidence to date suggests that it hasn’t really changed anything.

The Effect of Regulation Best Interest

Jeff Ptak: And what sort of evidence would you be looking for to determine whether or not Regulation Best Interest was changing things for the better?

Hauptman: There are a couple of places. First, state securities regulators have published several reports highlighting the fact that many broker/dealer firms still place their financial interests ahead of their customers’. The state securities regulators said that most firms are operating in the same manner as they were under the previous suitability rule, especially when it comes to harmful compensation conflicts, and that firms continue to sell what the state securities regulators’ report refers to as complex, costly, and risky products and they’re speaking of leveraged and inverse products, private placements, variable annuities, and nontraded REITs.

Finra also put out a recent exams report and found that firms are failing to comply with their obligations under the rule. Specifically, Finra found that firms are making recommendations without a reasonable basis to believe that they’re in the best interest of retail customers. Their firms are not identifying or addressing all potential conflicts of interest relevant to the firm’s business model. Firms are not providing retail investors with full and fair disclosures, and they’re failing to adopt written policies and procedures that are reasonably designed to achieve compliance with Regulation Best Interest.

And most recently, there was an SEC risk alert highlighting deficiencies found during exams, as well as examples of weak practices that could result in deficiencies. Specifically, they found firms did not have reasonably designed policies and procedures to comply with various parts of the rule. And in addition to compliance failures, staff observed instances where broker/dealers failed to understand the recommended product, failed to obtain or consider the customer’s investment profile, and failed to understand the potential risks and costs associated with the recommendation. Meanwhile, there’s only been one enforcement action for violation of Reg BI. So, the evidence to date is disturbing, it may be too early to tell, but we’re losing time to make the rule real and meaningful, and retail investors are paying the price.

Can Regulation Best Interest Be More Effective?

Benz: What steps would you, in an ideal world, take to make Regulation Best Interest more effective and really do what it set out to do?

Hauptman: Well, given the lack of enforcement, that’s the place I’d start. In my view, strong enforcement has the greatest potential to put meat on the bones of what is a very principles-based standard. Particularly as far as what the rule permits and what it prohibits in practice. I also believe that strong enforcement has the greatest potential to provide real teeth to the rule and meaningful protections to retail investors. So, in my view, the goal should be to make clear that the best-interest standard is a substantially stronger standard than the Finra suitability rule that it replaces. And to ensure that firms aren’t permitted to encourage and reward bad advice, no matter how profitable it is to them. And ensuring that the rules requirements to consider costs and reasonably available alternatives is not merely a box-checking exercise.

Advice for Investors Seeking an Advisor

Benz: What should consumers do in light of where the regulation stands currently? What should they look for if they’re seeking a financial advisor?

Hauptman: The best advice I can give is look for an advisor who minimizes conflicts of interest in their business model. And the best place to look is with a fee-only advisor. The only way they get paid is directly and transparently from the investor, and that minimizes conflicts of interest. And you can find a fee-only advisor on NAPFA’s website, the National Association of Personal Financial Advisors. In addition, the CFP board has stronger fiduciary standards than the SEC, and you might consider looking for a CFP professional, and you can go to their website to find one. I think it’s important to note that investors can pay for services a variety of ways, whether it’s assets under management or hourly, or by engagement, or monthly subscription. And so that should cater to a variety of retail investors’ needs.

What Should the SEC Focus on Next?

Ptak: I wanted to go back to your optimistic D, so to speak, and we talked about Regulation Best Interest and how it’s been somewhat toothless to this point. I have to think, though, that there’s maybe some other reasons for your optimistic D that go beyond Reg BI. So, I guess if one wanted to address the state of the state in terms of consumer-friendly regulatory priorities, what are other things that you would want to see the SEC or others focused on to lift that D to hopefully an A someday?

Hauptman: I think it goes back to enforcement, strong and meaningful enforcement to give the rule real teeth. And I think that sends a powerful message to the industry that they have to meaningfully change conduct. They need to minimize conflicts of interest. They need to ensure that they are really considering costs and reasonably available alternatives that it’s not just a box-checking exercise and that their job is to serve investors, not themselves. And I think you can do that through zealous enforcement of the law.