RAND Report Confirms Investor Confusion Regarding Roles and Responsibilities of Brokers Versus Advisers

By James Eccleston

AND Corporation recently released its report entitled, "Investor and Industry Perspectives on Investment Advisers and Broker-Dealers" (the "Rand Report"). The Securities and Exchange Commission (SEC) commissioned RAND to conduct a study of brokerage firms (known as broker-dealers) and investment advisers.

The distinctions between the two are important to investors. That's because the SEC commissioned the report on the heels of a court decision that had overturned the SEC's rule excepting certain broker-dealers offering fee-based accounts (in lieu of commission-based accounts) from having to register as investment advisers. The effect of that rule had been to allow such broker-dealers to avoid the more stringent regulatory and fiduciary duties that investment advisers owe investors.

The RAND Report answers the two questions that the SEC had posed: (1) what are the current business practices of broker-dealers and investment advisers; and (2) do investors understand the differences between and relationships among broker-dealers and investment advisers? Let's examine the key findings.

Current Practices of Broker-Dealers and Investment Advisers

The RAND Report finds that there is a "growing complexity in the financial services market." On the one hand, the RAND Report finds that the entire financial services industry is "extremely heterogeneous in terms of size, services offered, activities of affiliated firms and nearly every other dimension that we examined." On the other hand, as the economic scope of a financial services firm grows, RAND researchers conclude that "it engages (unsurprisingly) in a much fuller range of services and consequently is either affiliated with other financial services firms or conducts a significant amount of business in both the investment advisory and brokerage fields." In sum, the RAND Report concludes that, "Partly because of this diversity of business models and services, investors typically fail to distinguish broker-dealers and investment advisers along the lines defined by federal regulations."

RAND researchers examined business documents from the financial services firms, conducted interviews and reviewed their websites. On the basis of that research, a second major finding emerges. That is, "[i]f prospective clients were exposed to the documents we received and the Web sites we reviewed, they would likely obtain a very uneven understanding about these firms." The RAND researchers find that investors either would face "a flood of information, only some of which could possibly be processed", or they would receive "only a trickle of information." But, in either case, investors "would likely be left to turn to individual professionals to summarize the key aspects of the prospective relationship."

Investor Understanding of the Differences Between and Relationships Among Broker-Dealers and Investment Advisers

On the basis of several surveys and focus groups, the RAND Report concludes that investors neither understand the differences between nor the relationships among broker-dealers and investment advisers.

First, RAND researchers find that "many survey respondents and focus-group participants did not understand key distinctions between investment advisers and broker-dealers - their duties, the titles they use, the firms for which they work, or the services they offer." Indeed, the RAND Report finds that "[i]n general, the roles of broker-dealers and investment advisers are confusing to most survey respondents and focus-group participants." While they have a "general sense of the differences in services offered", they nonetheless are "not clear about their specific legal duties." Worse still, RAND researchers find, is the confusion created as to the role of financial professionals who use generic titles, such as "financial advisor" and "financial consultant."

Second, RAND researchers learned from interviews with broker-dealer and investment adviser study participants that investors "rarely read the disclosures they provide, regardless of how digestible they make these documents." Specifically, "many" of those participants told RAND researchers that: (1) disclosures "are not written in a way that is easily understandable to the average investor, and the information they provide is inadequate"; (2) "the financial service provider does not do enough to help investors understand disclosures - that is, they present the required disclosures without taking time to explain them"; and (3) "investors do not take the necessary time and effort to fully read and understand disclosures."

In response, RAND researchers "made attempts in our focus-group discussions to explain fiduciary duty and suitability in plain language." The result was not encouraging: "participants struggled to understand the differences between the standard of care." Still more troubling, RAND researchers learned that "[e]ven after explaining to them that a fiduciary duty is generally a higher standard of care, focus-group participants expressed doubt that the standards are different in practice."

In conclusion, the findings of the RAND Report are disturbing. The SEC must act now to protect investors.

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James Eccleston, an attorney specializing in adviser and broker-dealer issues, is a partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston in Chicago.