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What the SEC’s "best interest" rule for advisers won't do for investors

How some investment firms target the poor

Many financial institutions worked furiously to overturn the "fiduciary" rule promulgated by President Barack Obama's Department of Labor, and now they may be quietly relieved with the recently proposed "best interest" rule from the U.S. Securities and Exchange Commission (SEC). Should investors also be relieved -- or wary?

The proposed SEC standard, if finalized in its current form, could make shopping for financial advice trickier for unsuspecting investors. The rule would require brokers to act in the best interest of their customers when making recommendations regarding insurance or investment products. But it doesn't provide specifics about exactly how brokers are supposed to act in their customers' best interest.

The proposal also relies on brokers to disclose potential conflicts of interest to their customers, which assumes customers will be able to understand these disclosures and make informed choices.

That's a pretty significant -- and potentially naïve -- assumption. Imagine a potential professional giving you a four-page disclosure full of fine print and legalese and saying "Please sign this disclosure, and we can get started." It's tempting to let your eyes glaze over and go right to the end and sign on the dotted line.

The SEC's proposal really blurs the distinction between an adviser who acts as a fiduciary on your behalf and a broker who's supposed to act in your best interest. The fiduciary standard requires advisers to put their clients' interest ahead of their own, which usually makes it difficult for a fiduciary to receive commissions on selling investment and insurance products. 

It's not clear, however, that the SEC's best interest rule would end commissioned-based compensation for brokers, which can provide a financial incentive to steer clients to insurance and investment products that can pay high compensation to the broker.

Tech stocks in your retirement plan

Suppose you think you're a savvy investor who asks if a financial professional will serve as a fiduciary and act in your best interests. The broker responds "Yes, I will comply with the SEC's requirements and act in your best interest." But that's not the same as an adviser who will act as a fiduciary on your behalf.

Under the SEC's best interest proposal, it's still buyer beware. You have to be the best person to act in your own best interest.

Start by asking any potential adviser this question: "Will you serve as a fiduciary on my behalf and put my interests ahead of your interests?" If the adviser dodges the fiduciary question and only says he'll act in your best interests, that could be a red flag.

Tim Chen, CEO of consumer finance website NerdWallet, advises that you "ask advisers to clearly spell out how they get paid." You can do that with these questions:

  • How are you paid? Avoid advisers who'll make a large commission by investing your retirement savings. They might be motivated to sell you products rather than make recommendations in your best interest.
  • Do you receive any type of compensation in addition to the fees I'm paying you? For example, are you receiving a commission from an insurance company or mutual fund company that could create a conflict of interest when you recommend a particular product?
  • Are you dual-registered? Some advisers are registered as both investment advisers and broker-dealers. Usually a broker-dealer is acting as a salesperson. If your adviser is also a broker-dealer, ask what role he or she is assuming when providing advice to you.

Another question: Have you ever been cited by a regulatory or professional body for disciplinary reasons?

Whatever you do, don't be shy. It's simply smart to ask questions and be a savvy shopper. A financial pro who'll serve as a fiduciary will be proud to give you straight answers to these questions. If instead you see squirming and deflections, or attempts to confuse you with the answers, that's a sign to look for someone else.

Remember, it's your money and your retirement at stake. You deserve to ask questions of advisers -- and institutions -- who'll be profiting from your business.

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