Under the Hood on High Regulation

A combination of recent regulatory changes and our own recent audit by the Securities Exchange Commission (SEC) caused us to reflect on the regulations that govern our work and that of our industry. Inspired Financial is a registered investment advisor (RIA).  A quick review of each word in that title offers a clear summary of the regulatory environment that guides us. It also provides a stark contrast with the duties and standards required of a broker. Let’s look under the hood at the high regulation of investment advisors.

Registered – An investment advisor will register with either the SEC or the state securities regulator (e.g., California Department of Business Oversight) to legally provide investment advice to their clients.  Because of the size of our firm, Inspired Financial is registered with the SEC. Both the SEC and the state securities commissions have various requirements for maintaining an advisor’s registration including annual disclosure filings (called Form ADV), a robust compliance program within the firm, and periodic unannounced audits from the commission. Inspired Financial just finished an SEC audit which was a grueling, six-month exercise for our team to prepare the auditors’ requested documents, calculations, and reconciliations.  All good auditors must find something “wrong” and among the few items mentioned during our exit interview, one was that we “over-disclosed.”  We said that we do comprehensive financial planning in two areas of our Form ADV and we were admonished to only say it once. Noted!

Investment – In this context, investment refers to securities like stocks, bonds, mutual funds, and options—generally, any items traded on national exchanges or over-the-counter markets. This clarifies exactly on what we are advising. Of course, our work extends well beyond investment advice for our clients but that is a subject for another blog.

AdvisorAdvisor refers to both the firm (the RIA) and the individuals in the firm (investment advisory representatives).  By definition, an advisor is a firm or person who “for compensation, is engaged in the act of providing advice, making recommendations, issuing reports, or furnishing analyses on securities.”

The requirement to register with the SEC was created by the Investment Advisers Act of 1940 (the ’40 Act) and the duties have been further defined by case law.  Under the ’40 Act, an RIA firm is held to a fiduciary standard which means that the advisor must put their own interests below that of the client.  The duties of loyalty and care for a client under this standard are demonstrated by:

  • Giving advice using accurate and complete information
  • Conducting a thorough and accurate analysis
  • Providing “best execution” on transactions which is a combination of low cost and efficient execution
  • Avoiding conflicts of interest, and when they exist, disclosing and mitigating those conflicts

 

In contrast with an RIA, a broker must meet a suitability standard when serving their clients. The broker “must reasonably believe that any recommendations made are suitable for clients, in terms of their financial needs, objectives, and unique circumstances.”  A broker’s first duty of loyalty is to their broker-dealer (similar to the way an insurance agent is a legal agent of the insurance company, not their client) and the interests of the broker-dealer come first.

We believe that the suitability standard of a broker is fine for a purely transactional relationship like placing a buy or sell order for a stock, but when a client is receiving personalized financial advice, a fiduciary standard should govern the relationship. On June 5th, the SEC issued new regulations governing our industry including a regulation called Regulation Best Interest: The Broker-Dealer Standard of Conduct.  While it strengthens a broker’s duty to their client, it falls short of the fiduciary standard of care.

In fact, Evelyn, in her capacity as the President of the Financial Planning Association, attended this SEC hearing on June 5th and Commissioner Clayton was very clear in that hearing that the rule was to be “fiduciary like” but was not intended to be a fiduciary standard of care.

The intent behind all this high regulation is to provide an environment where investors are clear about what kind of relationship to expect from their advisor vs. their broker and where they’re confident that they’re protected from bad actors. Inspired Financial fully embraces our fiduciary duty as both an RIA providing investment advice and as our client’s trusted advisor providing financial planning to achieve their life’s goals. Regardless of what’s under the regulatory hood, we’re proud to uphold this standard and to be on our clients’ road to success.

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