Investor and Industry Perspectives on Investment Advisers and Broker-Dealers

230 Pages·2008·1.28 MB·English

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Investor and Industry
Perspectives on
Investment Advisers
and Broker-Dealers
Angela A. Hung, Noreen Clancy, Jeff Dominitz,
Eric Talley, Claude Berrebi, Farrukh Suvankulov
Sponsored by the United States Securities and Exchange Commission
INSTITUTE FOR CIVIL JUSTICE
LRN-RAND Center for Corporate Ethics, Law, and Governance
The research described in this report was conducted by the LRN-RAND Center for
Corporate Ethics, Law, and Governance within the RAND Institute for Civil Justice and
commissioned by the U.S. Securities and Exchange Commission (SEC).
Library of Congress Cataloging-in-Publication Data
Investor and industry perspectives on investment advisers and broker-dealers / Angela K. Hung ... [et al.].
p. cm.
Includes bibliographical references.
ISBN 978-0-8330-4403-7 (pbk. : alk. paper)
1. Securities—United States. 2. Securities industry—Law and legislation—United States. 3. Investment
advisors—Legal status, laws, etc.—United States. 4. Stockbrokers—Legal status, laws, etc.—United States.
I. Hung, Angela K.
KF1070.I58 2008
346.73'0922—dc22
2008002124
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Preface
In recent years, the evolution of the financial service industry has blurred traditional distinc-
tions between broker-dealers and investment advisers and made it difficult to design appro-
priate regulatory schemes for their professional services. To better understand the industry’s
dynamics and its effects on individual investors, the U.S. Securities and Exchange Commis-
sion (SEC) commissioned RAND to conduct a study of broker-dealers and investment advis-
ers from two perspectives: first, examine investment advisers’ and broker-dealers’ practices in
marketing and providing financial products and services to individual investors; and second,
evaluate investors’ understanding of the differences between investment advisers’ and broker-
dealers’ financial products and services, duties, and obligations.
The research on which this document reports was conducted within the LRN-RAND
Center for Corporate Ethics, Law, and Governance within the RAND Institute for Civil
Justice.
The LRN-RAND Center for Corporate Ethics, Law, and Governance
The LRN-RAND Center for Corporate Ethics, Law, and Governance is committed to improv-
ing public understanding of corporate ethics, law, and governance and to identifying specific
ways in which businesses can operate ethically, legally, and profitably at the same time. The
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iii
iv Investor and Industry Perspectives on Investment Advisers and Broker-Dealers
Robert Reville, Director Michael Greenberg, Research Director
RAND Institute for Civil Justice LRN-RAND Center for Corporate Ethics,
1776 Main Street, P.O. Box 2138 Law, and Governance
Santa Monica, CA 90407-2138 4570 Fifth Avenue, Suite 600
310-393-0411 x6786 Pittsburgh, PA 15213-2665
Fax: [phone] x4648
Email: [email protected] Fax: [phone]
Email: [email protected]
Contents
Preface ........................................................................................................... iii
Figures ........................................................................................................... ix
Tables ............................................................................................................ xi
Executive Summary ..........................................................................................xiii
Acknowledgments ............................................................................................ xxi
Abbreviations ................................................................................................ xxiii
CHAPTER ONE
Introduction ..................................................................................................... 1
Background ....................................................................................................... 2
Purpose of the Study ............................................................................................. 2
Approach .......................................................................................................... 3
Organization of This Report .................................................................................... 4
CHAPTER TWO
Regulatory and Legal Background .......................................................................... 7
Regulation of Broker-Dealers ................................................................................... 7
Registration Requirements .................................................................................... 8
Suitability ....................................................................................................... 9
Reasonable Basis ............................................................................................... 9
Prohibition of Excessive Markups ............................................................................ 9
Prohibition of Excessive Trading Activities ................................................................. 9
Supervision of Registered Representatives .................................................................10
Best Execution .................................................................................................10
Record-Keeping Requirements ..............................................................................10
Broker-Dealers and Fiduciary Duties .......................................................................10
Regulation of Investment Advisers ............................................................................12
Registration Requirements ...................................................................................12
Fiduciary Duties ..............................................................................................13
Record-Keeping Requirements ..............................................................................13
Other Requirements ..........................................................................................14
The Dividing Line Between Investment Advisers and Broker-Dealers ...................................14
Policy Response to Blurring of the Line ......................................................................16
Stakeholder Concerns with Proposed Changes ..............................................................17
Limited Investor Understanding ............................................................................18
Trends Blurring the Distinction Between Broker-Dealers and Investment Advisers .................19
v
vi Investor and Industry Perspectives on Investment Advisers and Broker-Dealers
Questionable Value of Disclosures ..........................................................................19
Assessment of the Current Regulatory Structure ........................................................ 20
Need for Greater Financial Literacy ....................................................................... 20
Conclusion ...................................................................................................... 20
CHAPTER THREE
View of the Industry from Published Sources ........................................................... 23
Characteristics of Firms ....................................................................................... 24
Structure of the Financial Service Industry ............................................................... 24
Other Firms .................................................................................................. 24
Fee Structures Associated with Services ................................................................... 24
Revenue Streams of Financial Service Firms ..............................................................25
Marketing of Financial Service Firms ..................................................................... 27
Disclosure Practices .......................................................................................... 28
Internal-Monitoring and Compliance Practices ...........................................................29
Compensation Structures of Investment Professionals ...................................................29
Investor Perceptions and Expectations of Financial Service Providers ....................................31
Conclusion .......................................................................................................32
CHAPTER FOUR
Insights from Industry Data .................................................................................35
Overview of Firms in the Data: 2001–2006 ................................................................ 36
Investment Advisers ............................................................................................ 38
Attributes of Investment Advisory Firms: Fourth Quarter of 2006 ................................... 38
Comparison of Investment Advisory Firms by Dual and Affiliated Activity Classification .........41
Broker-Dealers .................................................................................................. 50
Attributes of Broker-Dealers: Fourth Quarter of 2006 .................................................. 50
Comparison of Brokerage Firms by Dual and Affiliated-Activity Classification ..................... 54
Conclusions ......................................................................................................59
CHAPTER FIVE
Documentation and Information Provided by Firms ...................................................63
Document-Collection Methodology ..........................................................................63
Document Collection and Review ......................................................................... 64
Methodology for Firm Interviews .............................................................................67
Interview Approach ...........................................................................................67
Results from Document Collection, Web Data Collection, and Firm Interviews ................... 68
How Firms Interact with Clients........................................................................... 68
How Firms Provide Services and Affiliate with Other Firms ............................................73
What Firms Disclose About Their Services and Affiliations with Others ..............................75
Firms’ Perspectives on Policy Issues ........................................................................78
Broker-Dealers from the Volunteer Sample ............................................................... 80
Illustrative Examples ............................................................................................81
Investment Advisers in the Registered-Representative Classification ...................................82
Broker-Dealers in the Affiliated-Activity Classification ..................................................83
Conclusions ..................................................................................................... 84
Contents vii
CHAPTER SIX
Investors’ Level of Understanding ......................................................................... 87
Household Survey .............................................................................................. 87
Investment Experience ...................................................................................... 88
Beliefs About the Differences Between Investment Advisers and Brokers .............................89
Characteristics of Respondents Who Use Financial Service Providers ................................ 90
Job Titles and Firm Types of Financial Service Providers............................................... 90
Experiences with Financial Service Providers .............................................................93
Reasons Not to Use a Financial Service Provider ....................................................... 103
Relative Inclination to Seek Services from Brokers or Investment Advisers ......................... 104
Types of Assistance That Respondents Would Like with Financial Matters ........................ 104
Focus Groups .................................................................................................. 105
Methods ...................................................................................................... 106
Investment Experience ..................................................................................... 106
General Impressions of the Financial Service Industry ................................................. 107
Investor Decisionmaking and Experience with Financial Service Professionals .................... 107
Perceived Differences Between Investment Advisers and Brokers ..................................... 108
Differences Between the Experienced and Inexperienced Groups .................................... 112
Other Comments ........................................................................................... 112
Conclusion ..................................................................................................... 112
CHAPTER SEVEN
Conclusions ................................................................................................... 115
What Are the Current Business Practices of Broker-Dealers and Investment Advisers? .............. 116
Do Investors Understand the Differences Between and Relationships Among Broker-Dealers and
Investment Advisers? ..................................................................................... 117
APPENDIXES
A. Descriptions of Regulatory Filings, Data Sets, and Use of the Data to Identify Dual
and Affiliate Activity ................................................................................... 119
B. Other Retail Providers of Financial Services ...................................................... 127
C. Attributes of Investment Advisers and Broker-Dealers .......................................... 129
D. Additional Detail on Sampling Method of Document Collection ............................ 153
E. Disclosures by Type and Information Source ..................................................... 161
F. American Life Panel .................................................................................... 165
G. Detailed Results of Household Survey and Focus Groups ...................................... 167
H. Supplemental Analysis of Industry Data from 2001 to 2006 .................................. 185
References ..................................................................................................... 199