TRANSPARENCY IN THE INVESTMENT INDUSTRY: PUBLIC PERCEPTION OF
BROKERS AND INVESTMENT ADVISERS
Leisa Flynn†
University of Southern Mississippi
G. Wayne Kelly††
University of Southern Mississippi
Patrick A. Lach†††
Eastern Illinois University
Abstract
This study investigates two components of investment advice that are largely absent in the
debate over imposing a fiduciary standard on brokers: transparency and broker/adviser
education. We find that individuals are confused by titles used by investment professionals and
remain confused regarding the differences between Investment Advisers and brokers, even
after being educated on the different legal standards that apply to each. Sampled individuals
were better able to identify the responsibilities of a "broker" relative to more ambiguous titles,
such as "financial advisor" and "financial planner." Respondents overestimated the education
required to become a broker or Investment Adviser: more than half believed that brokers
should have a college or graduate degree and 70 percent reported Investment Advisers should
have a college or graduate degree. Based on these results, we believe that regulators should
focus on regulating transparency first so that consumers can make an informed decision when
hiring an investment professional.
Current Draft: April 7, 2016
JEL Classification: G18: G20; G28
Keywords: Government Policy & Regulation; Market Transparency; Retirement Savings;
Financial Literacy
† Leisa Flynn is a Professor of Marketing at the University of Southern Mississippi. Address: Department of
Marketing and Merchandising, Joseph Greene Hall, 306, 118 College Drive #5091, Hattiesburg, Mississippi, 39406.
Office Phone 601.266.4627. Office Fax: 601.266.4630. Electronic Mail: [email protected].
†† G. Wayne Kelly is a Professor of Finance and Department Chair at the University of Southern Mississippi.
Address: Department of Finance, Real Estate and Business Law, Joseph Greene Hall, 314, 118 College Drive #5076,
Hattiesburg, Mississippi, 39406. Office Phone 601.266.4443. Office Fax: 601.266.6707. Electronic Mail:
††† Contact Author: Patrick A. Lach is an Associate Professor of Finance at Eastern Illinois University. Address:
School of Business, Eastern Illinois University, 600 Lincoln Avenue, Charleston, Illinois, 61920–3099. Office Phone:
217.581.5957. Office Fax: 217.581.6247. Electronic Mail: [email protected].
TRANSPARENCY IN THE INVESTMENT INDUSTRY: PUBLIC PERCEPTION OF
BROKERS AND INVESTMENT ADVISERS
Abstract
This study investigates two components of investment advice that are largely absent in the
debate over imposing a fiduciary standard on brokers: transparency and broker/adviser
education. We find that individuals are confused by titles used by investment professionals and
remain confused regarding the differences between Investment Advisers and brokers, even
after being educated on the different legal standards that apply to each. Sampled individuals
were better able to identify the responsibilities of a "broker" relative to more ambiguous titles,
such as "financial advisor" and "financial planner." Respondents overestimated the education
required to become a broker or Investment Adviser: more than half believed that brokers
should have a college or graduate degree and 70 percent reported Investment Advisers should
have a college or graduate degree. Based on these results, we believe that regulators should
focus on regulating transparency first so that consumers can make an informed decision when
hiring an investment professional.
1. Introduction
How Americans receive investment advice has become a topic of great interest since the
2008 recession. In particular, debate often centers on how investment professionals are
compensated and the standard of care owed to the client. For example, some investment
professionals are required to act in the best interest of the client (the fiduciary standard), while
others only have to provide advice that is suitable for the client (the suitability standard).
Additionally, some investment professionals are compensated solely through commissions
received from products they sell while others derive compensation only through fees charged
directly to clients (e.g. hourly or annual retainer fees).
Two types of investment professional are available to the general public in the United
States: brokers and Investment Advisers (IAs). The Investment Advisers Act of 1940 requires
individuals who provide investment advice for compensation to register with the Securities and
Exchange Commission (SEC) as an Investment Adviser. To be considered an Investment Adviser,
a person must give advice regarding securities, be in the business of giving advice, and receive
compensation for doing so (15 USC § 80b - 2 (a) (11))1. The Act of 1940 also created several
exclusions to this rule such as professionals like lawyers and accountants whose advice is
incidental to their profession. This same exclusion extends to Brokers.
The standards of care that brokers and Investment Advisers must provide differ
significantly. Brokers are held to a suitability standard, meaning that any recommendations
they make must be reasonable based on the client's investment objectives. Investment Advisers
1 http://www.law.cornell.edu/uscode/text/15/80b-2
TRANSPARENCY IN THE INVESTMENT INDUSTRY 2
are required to act as fiduciaries, meaning they must put the interests of the client ahead of
their own.
While the Investment Advisers Act of 1940 does not contain the word "fiduciary," the
Supreme Court concluded in 1960, "The Investment Advisers Act of 1940 thus reflects a
congressional recognition 'of the delicate fiduciary nature of an investment advisory
relationship,' as well as a congressional intent to eliminate, or at least to expose, all conflicts of
interest which might incline an investment adviser— consciously or unconsciously—to render
advice which was not disinterested."2
Given the significant difference in the standards of care Investment Advisers and
brokers owe to their clients, recent efforts have emerged to hold brokers to the fiduciary
standard. This debate began in earnest via discussion of including a uniform fiduciary standard
in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Ultimately, a
uniform fiduciary standard was left out of the Dodd-Frank Act, but the act required the SEC to
examine, among other things, retail investors’ understanding of the differences between
brokers and Investment Advisers and whether or not the exclusion for brokers should be
eliminated from the Investment Advisers Act of 1940. This study cited several pieces of
evidence suggesting individual retail investors are unaware of the differences between brokers
and Investment Advisers, and the standards of care each group owes to their clients. The SEC
study cited multiple examples of investors showing confusion about the different titles that
brokers and Investment Advisers use.3
2 S.E.C. v. Capital Gains Research Bureau, 375 U.S. 180 (1963).
3 The entire 208 page study can be found at http://www.sec.gov/news/studies/2011/913studyfinal.pdf.
TRANSPARENCY IN THE INVESTMENT INDUSTRY 3
While much of the current debate in the U. S. centers on the fiduciary standard, serious
debate is taking place in other countries regarding the ways investment professionals are
compensated for advice. On January 1, 2013 the United Kingdom implemented the Retail
Distribution Review mandating a fee-for-service model that prohibits commissions from the
sale of financial products.4 On July 1, 2013, Australia followed suit with reforms known as the
Future of Financial Advice.5 In addition to compelling investment professionals to adopt a fee-
for-service model, the Retail Distribution Review and the Future of Financial Advice required
investment professionals to follow a fiduciary standard of care.
While the United Kingdom and Australia banned commissions and implemented
fiduciary standards, the brokerage community in the U.S. strongly resists the uniform fiduciary
standard and the issue remains unresolved. One criticism raised by the brokerage industry is
the cost of compliance with a new fiduciary standard.6 Others, including speaker of the House,
Paul Ryan,7 extend that argument saying that many brokers would discontinue work with small
retail clients due to increased costs of compliance and a reduction in revenue.
Commissions can have a significant impact on the broker incentives, imposing huge
agency costs on consumers. Although agency costs in corporate settings have been discussed at
length in academic literature (most notably by Jensen and Meckling (1976)), relatively little has
been written about the agency costs arising between brokers and their clients. While Barber,
Odean, and Zheng (2005) find that mutual fund inflows decrease as the size of the sales load
(commission) increases, Christoffersen, Evans, and Musto (2013) find that mutual fund inflows
4 See http://www.fca.org.uk/firms/firm-types/sole-advisers/rdr.
5 See http://futureofadvice.treasury.gov.au/content/Content.aspx?doc=home.htm.
6 See http://www.investmentnews.com/article/20130705/FREE/130709966.
7 See http://www.speaker.gov/general/dictionary-definition
TRANSPARENCY IN THE INVESTMENT INDUSTRY 4
increase as the percentage of the sales load paid to a broker increases. The results of
Christoffersen, Evans, and Musto (2013) show the influence that brokers' incentives have on
the products they recommend to clients. This creates a conflict of interest between the broker
and the client resulting in agency costs. Unfortunately, the consumer is often unaware of this
conflict because brokers very seldom use the term "broker" as their title and instead use terms
such as "financial advisor," "wealth manager" or "financial planner."
While regulators and Brokers debate the merits of a uniform fiduciary standard, the
profusion of professional titles that Brokers use when offering services to the public has been
generally ignored. Section 3(a)(4)(A) of the Securities and Exchange Act of 1934 defines a
Broker as "any person engaged in the business of effecting transactions in securities for the
account of others.” Since Brokers are in the business of completing securities transactions, an
exception from the Investment Advisers Act of 1940 excludes "any broker or dealer whose
performance of such services is solely incidental to the conduct of his business as a broker or
dealer and who receives no compensation therefore" (15 USC § 80b). Although Brokers do not
have to register as Investment Advisers since their investment advice is often considered
"incidental" to the process of selling securities, many brokers use titles that suggest otherwise.
For instance, many brokers will use the term "financial advisor," which implies that they are in
the business of providing financial advice, rather than the business of completing securities
transactions.
In a joint report to the SEC, Siegel & Gale, LLC and Gelb Consulting Group found that
participants were confused regarding titles such as "financial planner," "financial advisor," or
TRANSPARENCY IN THE INVESTMENT INDUSTRY 5
"investment adviser."8 The RAND Institute for Civil Justice conducted an SEC-sponsored study
which found that investors were confused by titles like "financial advisor," "financial advisor,"
and "financial consultant."9 Interestingly, the RAND study found that even financial
professionals were confused by the titles used by other investment professionals. Furthermore,
a study by Cerulli Associates found that over 60 percent of investors are either unsure of how
their financial professional charges for advice, or they think that the advice is free.10
Since
investment professionals seldom provide advice free of charge, this implies that more than half
of investors are not sure how they pay for advice, suggesting widespread opacity in the
investment industry.
Although the RAND and the Siegel, Gale, and Gelb studies found that individual
investors are confused by titles such as "financial advisor," to our knowledge, no study has
suggested alternative titles for brokers and investment in order to help the public understand
the compensation structure and the standard of care owed the client. We investigate a title for
brokers that is seldom used in practice, "investment sales representative," to see whether or
not that designation helps consumers identify a financial professional who acts as a fiduciary.
We find that, when presented with a list of titles commonly used by investment professionals,
consumers are more likely to identify an "investment sales representative" or a "broker" as one
who is in the business of buying or selling investment products relative to titles such as
"financial advisor" or "wealth manager." Also, consumers are less likely to identify an
8 The title of this report is Results of Investor Focus Group Interviews About Proposed Brokerage Account
Disclosures and is available at http://www.sec.gov/rules/proposed/s72599/fcrpt031005.pdf. 9 The title of this report is Investor and Industry Perspectives on Investment Advisers and is available at
http://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf. 10
http://www.forbes.com/sites/cfainstitute/2012/04/05/four-ways-of-paying-your-investment-professional/
TRANSPARENCY IN THE INVESTMENT INDUSTRY 6
"investment sales representative," or a "broker" as someone who is in the business of providing
financial advice or is a fiduciary.
We emphasize the term "financial advisor" since anecdotal evidence suggests this is the
most common term used by brokers when offering services to the public. We find that
consumers are more likely to identify a "financial advisor" as a fiduciary compared to an
"investment adviser" or an "investment adviser representative." In other words, an Investment
Adviser, who is required by law to act as a fiduciary, and who correctly claims to be an
"investment adviser representative" is less likely to be viewed by a consumer as a fiduciary
relative to a broker using the unregulated, marketing term "financial advisor."
Brokers are exempt from the Investment Advisers Act of 1940 as long as investment
advice they provide is "solely incidental." However, more than half of our respondents reported
that the primary job function of a "financial advisor," a title often used by brokers, is providing
investment advice. Regulators are currently debating whether and how they should regulate a
broker's business structure by forcing them to abide by a fiduciary standard. Based on our
results, we believe that regulators should first focus on regulating transparency so that
consumers can make an informed decision when hiring an investment professional.
Transparency of investment professionals’ titles is important for regulators to consider
in the contentious debate about designating brokers as fiduciaries. One major argument from
the brokerage side of the debate is the cost of compliance, which ranges from creating and
storing “best interest contracts “ to the outright prohibition of some products and services.
Given cost-based objections to the implementation of a fiduciary standard, requiring more
transparent titles for brokers presents a far more cost-effective alternative to implementing a
TRANSPARENCY IN THE INVESTMENT INDUSTRY 7
fiduciary standard. Furthermore, more transparent titles could be implemented swiftly, unlike
the debate over a fiduciary standard, which began in the summer of 2010 and still has not been
resolved.
Besides unclear professional titles, the minimum education required of investment
professionals is another issue that has been overlooked in the debate over a fiduciary standard.
In most states, no formal education is required to become a broker or an investment adviser
except for passing one or more exams, typically the Series 7 and 65 exams. The Series 7 exam
can be passed with as little as three weeks of study according to Keir Educational Resources,
one of the leading providers for study materials for professional certification exams.
11Furthermore, according to FINRA, "The Series 7 Examination is designed to assess the
competency of entry-level General Securities Representatives."12
Similarly, according to the
North American Securities Administrators Association (NASAA), "The Series 65 is a test of a
candidate’s competency as an entry-level investment adviser representative."13
Little debate
has addressed whether or not managing investments, and in some cases and individual's life
savings, should require additional education beyond three weeks of study for an exam designed
for an "entry-level" employee. In addition, to our knowledge, the public's understanding of
these education requirements has not been investigated. Requiring an investment professional
to act in the best interest of an investor may be a trivial pursuit if the investment professional
lacks the education or training to be able to judge what is best for the client.
11
See http://www.keirsuccess.com/FINRA-Securities-Licensing-Exam-Study/Series-7-FAQs 12
http://www.finra.org/web/groups/industry/@ip/@comp/@regis/documents/industry/p124292.pdf 13
http://www.nasaa.org/industry-resources/exams/exam-faqs/
TRANSPARENCY IN THE INVESTMENT INDUSTRY 8
Our respondents seem to agree with this sentiment. When asked what level of
education they think is required of a broker, more than half responded with a college or
graduate degree. When respondents were asked what level of education they think is required
to be an investment adviser, more than two-thirds believed that a college or graduate degree is
required for an individual to become an investment adviser. Respondents were also asked what
the minimum education level should be for brokers and investment advisors. More than 70
percent of respondents thought that brokers should have a college degree or higher, while 82
percent thought investment advisers should have a college degree or higher.
Jackson Nickerson of the Olin Business School at Washington University has found that
when a government entity sets out to solve a problem, they fail to correctly identify the
problem 90 percent of the time. The current debate at the Department of Labor and Securities
and Exchange Commission appear to support Dr. Nickerson's rule. Regulators appear to be
debating the question "Should all investment professionals be required to make investment
decisions that are in the best interests of their clients?" Based on the results of our survey, a
more appropriate type of question would "Does a high school drop-out who passes an exam
designed for entry-level securities professionals have the education, training, and experience to
make a distinction as fine as 'good, better, and best' in an area as complex as modern
investment theory?"
2. Background and Hypotheses
After the Standard & Poor's (S&P) 500 declined by more than 43 percent between
March 1, 2008 and February 28, 2009, regulators began to scrutinize how Americans receive
investment advice. This process began in the early stages of drafting the Dodd-Frank Wall
TRANSPARENCY IN THE INVESTMENT INDUSTRY 9
Street Reform and Consumer Protection Act of 2010. This Act did not mandate a uniform
fiduciary standard, but called for the SEC to conduct a study to determine, among other things,
whether investors are confused between the standard of care required of brokers and
investment advisers. This report cited three studies from the Chartered Financial Analyst
Institute, RAND Institute for Civil Justice, and a joint study from Siegel & Gale, LLC and Gelb
Consulting Group (Henceforth, SSG).
2.1 Titles Used by Investment Professionals
The RAND and SSG studies both showed investors were confused by the numerous titles
used by brokers and investment advisers. This is not surprising since even the Financial Industry
Regulatory Authority (FINRA) has acknowledged the ambiguity of job titles used by investment
professionals. They warn investors to "be aware that Financial Analyst, Financial Adviser
(Advisor), Financial Consultant, Financial Planner, Investment Consultant or Wealth Manager
are generic terms, and may be used by investment professionals who may not hold any specific
credential."14
Additionally, all three studies cited by the SEC indicated that investors did not
know which groups are held to a fiduciary standard and which are not.
While the RAND and SSG studies both documented investor confusion with titles
currently used by investment professionals, to our knowledge, no study has proposed a
solution to this confusion. In this study, we gauge investor understanding of different job titles
identified by FINRA. Next, we provide respondents brief descriptions of what brokers and
investment advisers do and an explanation of the standards of care required of each, and then
we test respondent’s understanding of the descriptions with follow-up questions. In addition,
14
http://www.finra.org/Investors/ToolsCalculators/ProfessionalDesignations/RulesandResources/
TRANSPARENCY IN THE INVESTMENT INDUSTRY 10
we explain to the participants the level of care owed to clients by each titular category. We
expect to find individual investors unable to significantly distinguish which titles belong to
brokers and which belong to investment advisers, even after being given the definitions of both
positions. This expectation is informed partly by the RAND study, which noted that even
professional investors were confused by the titles used by brokers and investment advisers.
This leads to the first hypothesis of the study:
H1: Participants will be confused by the titles financial advisor, financial planner, and wealth
manager, which are often used by brokers
To mitigate this confusion we propose a less ambiguous title, investment sales
representative, to test whether investors are able to more easily classify these individuals as
brokers. This leads to our second hypothesis:
H2: Participants are more likely to associate the title investment sales representative with a
broker relative to an investment adviser.
Anecdotal evidence from the investment industry shows that brokerage firms often use
the term "investment sales representative" when recruiting potential employees. However, the
same firms will use the title "financial advisor" when marketing to clients. In other words, it
appears that the phrase "investment sales representative" is meant to give potential employees
an idea of what will be required of them as brokers, while the title "financial advisor" is meant
TRANSPARENCY IN THE INVESTMENT INDUSTRY 11
to build trust between a brokerage firm and potential clients. We believe respondents given a
list of potential job functions will view the primary job function of a financial advisor as
providing investment advice. This leads to our next hypothesis:
H3: Participants will select "providing investment advice" as the primary job function of a
financial advisor.
2.2 Professional Education
In most states, the minimum level of education needed to become a broker or an
Investment Adviser is lower than the education requirement needed to become a hairdresser
or an electrician.15
Electricians are required to complete several years of apprenticeship work
under the supervision of a licensed electrician while brokers and investment advisers face no
such requirement.16
Most states do not require a high school diploma or a Graduate
Equivalency Degree (GED) to become a broker or an investment adviser. No minimum
education requirement exists to qualify to sit for the Series 7 or Series 65 exams. Furthermore,
the Series 7 and 65 exams are both designed to prepare individuals for "entry-level" positions
and tasks although many people who work one-on-one with clients do not attain education
beyond this level. When asked to describe the minimum education level of brokers and
investment advisers, we expect participants in our study will overstate the requirements. This
leads to the fourth hypothesis:
15
See http://www.kbhc.ky.gov/licenseinfo/requirements/, http://www.njatc.org/training/apprenticeship/ for
more information on the requirements to become an electrician or a hairdresser in the Commonwealth of
Kentucky. 16
http://www.njatc.org/training/apprenticeship/
TRANSPARENCY IN THE INVESTMENT INDUSTRY 12
H4: Participants overestimate the education requirements needed to become a broker or an
investment adviser.
We also expect that participants in our study will respond that an investment adviser
needs a higher level of education than a broker, consistent with investors thinking a higher
education level is needed for an investment to serve the best interests of the client, rather than
simply suitable for a client. Subjects will believe that more education is required to plan the
financial future of a family, for example, rather than to execute a stock trade. This leads to a
fifth hypothesis:
H5: Participants characterize an investment adviser as being held to a higher education level
than a broker after being educated on the requirements of each.
We also ask participants to indicate their opinion of what the minimum education level
ought to be to become a broker or an investment adviser. We believe that participants will
answer that brokers and investment advisers should have a college degree or higher, leading to
our next hypothesis:
H6: Participants will report that they believe brokers and investment advisers should be
required to have a college degree or higher.
Finally, participants provide their opinions regarding the minimum level of education
needed to become a broker or an investment adviser, relative to that of a Certified Public
TRANSPARENCY IN THE INVESTMENT INDUSTRY 13
Accountant (CPA). We use the CPA credential as a benchmark because it is widely recognized
and because CPAs, like investment advisers, often assist people in making financial decisions.
The education needed to become a CPA varies between states but typically requires a college
degree and 150 credit hours, as well as 12 - 27 credit hours of accounting. We expect that
respondents will view CPAs, brokers, and investment advisers similarly, and agree that brokers
and investment advisers should be held to education standards similar to CPA. Therefore, our
final hypothesis is:
H7: Participants will agree that brokers and investment advisers should be held to a level of
education comparable that of Certified Public Accountants.
3. Methodology
The survey was developed from an existing, validated scale and from newly created
items. The Perceived Knowledge scale is a brief, summated measure that can be adapted to any
knowledge category and gauges a person’s sense of how much they know about that category.
A sample question reads, “Among my circle of friends, I'm one of the "experts" on investing and
investments,” (Flynn and Goldsmith (1999)). It has been shown to be reliable and valid through
many studies. The rest of the items were developed for the survey for the first time. The first
group of new items was designed to measure how the subjects understood titles that are
commonly used by financial industry workers and what the primary job functions of financial
advisors are. An example was, “Which of the following receives a fee or commission for buying
or selling an investment for a client? Check all that apply.” The response categories were
TRANSPARENCY IN THE INVESTMENT INDUSTRY 14
“Financial Advisor,” “ Investment Adviser,” Certified Financial Planner,” “Broker,” “Wealth
Manager,” “Investment Sales Representative,” “Financial Planner,” and “Investment Adviser
Representative.” The response categories were randomized for each question.
After a baseline of actual knowledge was obtained the survey presented descriptions of the
actual job functions of both brokers and investment advisers as follows:
A broker is a person who is paid a fee for making financial securities transactions on
behalf of their clients. For example, a broker may receive a commission to purchase a
mutual fund for a client's account.
A broker is generally not held to a fiduciary standard which means that they are free to
act in their own interest and not the best interest of their clients. For instance, a broker
can recommend an investment which pays a high commission even if there are
investments that are nearly identical which pay a lower commission or no commission at
all.
An investment adviser is a person who is paid a fee by a client for providing advice
about or conducting analysis on financial securities. For example, an investment adviser
may review someone's investments for an hourly fee.
An investment adviser is a fiduciary and is required by law to consider and act in the
best interest of their clients at all times.
Questions following this “educational section” tested to see if the subjects’ answers to
the first group of questions had changed. In other words, we tested to see if the subjects’
understanding of financial workers and how their jobs work had improved. This group of
TRANSPARENCY IN THE INVESTMENT INDUSTRY 15
questions included, “Which of the following receives a fee or commission for buying or selling
an investment for a client? Check all that apply.” The answers here were limited to “Broker”
and “Investment Adviser.” We also asked subjects to indicate which of the list of titles from the
first section reflected a financial worker’s position as either a broker or investment adviser.
The third section of the paper asked about how much formal education the subjects
believed was required for a person to be hired as or to hold themselves out as a broker or
investment adviser. We also asked about how much education these workers should have to
give advice about important investment decisions.
The survey was delivered through Qualtrics’ panel to US adults in the early spring of
2016. The survey set quotas for age and for gender; otherwise subjects were self-selected and
given a small reward for completing the entire survey. The survey contained an item which read
“This is an attention check. If you read this question please leave it blank.” Respondents who
checked an answer for this question were deleted from the final sample.
When all the quotas were met we had 994 people log on to the survey and 534 were
removed because of being too young, failing the attention screener, finishing the survey in too
little time or being over quota. The final sample included 460 subjects. Of these, men and
women were each 50% of the sample. Ages ranged from 18 to 84 with an average of 45.7 years.
4. Results
4.1 Titles Used by Investment Professionals
Results for the first two hypotheses relating to investor confusion over titles used by
brokers and investment advisors are found in Tables 1 through 4. The terms 'investment
TRANSPARENCY IN THE INVESTMENT INDUSTRY 16
adviser' and 'investment adviser representative' were both used as response options in these
survey items. Although the SEC states, "An investment adviser is an individual or a firm that is in
the business of giving advice about securities to clients,17
" some state-level regulatory bodies
prohibit individuals from calling themselves "investment adviser." For instance, in Kentucky the
title "investment adviser" can only be used for a firm and the term "investment adviser
representative" is reserved for an individual. So, if John Doe opened a Registered Investment
Advisory firm called Doe Wealth Management, the state of Kentucky would require that the
term "investment adviser" be used to describe the firm as a whole. John Doe would be
permitted to call himself an "investment adviser representative" but not an "investment
adviser."
Consistent with the first hypothesis, the results in Tables 1−4 show that the participants
in this study were confused by common titles used by brokers such as “financial advisor,”
“financial planner,” and “wealth manager.” In the first question, participants were asked,
"Which of the following is held to a ’fiduciary standard‘ by law meaning they are expected to
behave with the highest standard of care and in the best interests of their customers? Check all
that apply." This question has only two correct answers: an Investment Adviser and Investment
Adviser Representative. A Certified Financial Planner (CFP) is held to a fiduciary role only under
limited circumstances. The Certified Financial Planner Rules of Conduct Section 1.4 states, "A
certificant shall at all times place the interest of the client ahead of his or her own. When the
certificant provides financial planning or material elements of financial planning, the certificant
owes to the client the duty of care of a fiduciary as defined by the CFP Board." For instance, if a
17
See "Investment Advisers: What you Need to Know Before Choosing One" available at
https://www.sec.gov/investor/pubs/invadvisers.htm.
TRANSPARENCY IN THE INVESTMENT INDUSTRY 17
Certified Financial Planner is registered as a broker, that individual is not held to a fiduciary duty
when selling investments.18
***Insert Table 1 About Here***
Certified Financial Planner was the top response to the first question. While 59 percent
of participants selected Certified Financial Planner, the second highest response was financial
advisor, which was selected by 55 percent of participants. Interestingly, broker was the third
highest response with 51 percent of participants selecting this option. Forty-seven percent of
participants chose financial planner, a higher percentage than those who correctly identified
that an investment adviser is held to a fiduciary duty (44 percent). Oddly, investment adviser
representative was the second to least popular response, with only 34 percent of participants
correctly identifying that an investment adviser representative is held to a fiduciary obligation.
The only title chosen less than investment adviser representative was investment sales
representative, which was chosen by 29 percent of participants.
The Table 2 results are for the question "Which of the following is in the business of
providing financial advice? Check all that apply." Financial advisor was the top response at 77
percent, but this could have been due to the use of the phrase "financial advice." Consistent
with our second hypothesis, the terms broker and investment sales representative were the
bottom two responses. In fact, consumers were less likely to identify an investment sales
representative (26 percent of respondents) as someone who provides financial advice relative
to a broker (35 percent of respondents). Interestingly, a financial planner (64 percent) was
18
To get an idea of the percentage of CFP certificants registered as brokers, we analyzed all Certified Financial
Planners within a 25-mile radius of Mississippi's state capital in Jackson. This search yielding 44 practitioners, 34 of
whom were registered as brokers.
TRANSPARENCY IN THE INVESTMENT INDUSTRY 18
perceived to be more likely to provide financial advice than a Certified Financial Planner (58
percent) by the participants.
***Insert Table 2 About Here***
Responses to question three further support H1 and H2. Sixty-two percent of
respondents correctly identified brokers when asked, "Which of the following is in the business
of selling investments or financial products? Check all that apply." The term investment sales
representative was a close second with 58 percent of respondents selecting this option.
Surprisingly, the term investment adviser was the third most-selected option, albeit a distant
third with 36 percent of participants selecting this option. The term financial advisor was seen
as less likely to be in the business of selling financial products relative to investment advisers
and investment adviser representatives, even though the term financial advisor is an
unregulated term typically used by brokers. In other words, a broker who correctly self-
identifies is more than twice as likely to be correctly labeled as someone in the business of
selling products than a broker who uses the generic term financial advisor. Table 3 shows that
allowing a broker to use the terms financial advisor, wealth manager, or financial planner only
serves to increase confusion among American investors. It is likely this confusion is intentional
since, as we will show in Section 4.2, we find that consumers have a strong preference towards
investment advisers relative to brokers with investors preferring to work with an investment
adviser relative to a broker to a margin of 4 to 1 before learning the differences between the
two, and a margin of nearly 8 to 1 after learning the differences.
***Insert Table 3 About Here***
TRANSPARENCY IN THE INVESTMENT INDUSTRY 19
Next, participants were asked "Which of the following is paid to provide advice
regarding investments? Check all that apply." Again, perhaps due to the presence of the words
"advice" and "investments" the top choice was investment adviser at 65 percent. Financial
advisor, a term commonly used by brokers who are prohibited from offering investment advice
unless it is solely incidental to the business of effecting transactions, was a very close second at
62 percent. Half of the participants believed that brokers are in the business of providing
investment advice. However, participants were clearer about the title investment sales
representative, with only 34 percent of respondents selecting this incorrect answer.
***Insert Table 4 About Here***
Anecdotal evidence suggests that “financial advisor” is one of the most commonly used
terms for brokers. Additionally, when piloting the survey used in this study, “financial advisors”
were viewed as most likely to be held to a fiduciary standard. Therefore, participants were
asked to identify the primary job function of a financial advisor. As shown in Table 5, more than
half (54 percent) of the respondents in the study identified ‘investment advice’ as the primary
function of a financial advisor, consistent with the third hypothesis (H3). In addition, 17 percent
responded that ‘retirement planning’ is the primary function of a financial advisor. Therefore,
while the Investment Advisors Act of 1940 provides an exemption to brokers as long as their
investment advice is solely incidental to their position as brokers, a broker’s reference to
himself or herself as a financial advisor sends a misleading signal to the public according to our
survey results where more than half of the respondents believed that investment advice is the
primary function of a financial advisor, not something that is solely incidental.
***Insert Table 5 About Here***
TRANSPARENCY IN THE INVESTMENT INDUSTRY 20
4.2 Differences between Investment Advisers and Brokers
As shown in Section 4.1, there is confusion regarding the different titles used by
investment professionals. The next section of the survey provided respondents with the
following information about the differences between brokers and investment advisers:
A broker is a person who is paid a fee for making financial securities transactions on
behalf of their clients. For example, a broker may receive a commission to purchase a
mutual fund for a client's account.
A broker is generally not held to a fiduciary standard which means that they are free to
act in their own interest and not the best interest of their clients. For instance, a broker
can recommend an investment which pays a high commission even if there are
investments that are nearly identical which pay a lower commission or no commission at
all.
An investment adviser is a person who is paid a fee by a client for providing advice
about or conducting analysis on financial securities. For example, an investment adviser
may review someone's investments for an hourly fee.
An investment adviser is a fiduciary and is required by law to consider and act in the
best interest of their clients at all times.
After providing participants with the above information, (henceforth, “educational
paragraph”), we asked a series of follow-up questions. The first, shown in Table 6, was “Given
what you have just learned, which you would rather choose to manage your investments?”
TRANSPARENCY IN THE INVESTMENT INDUSTRY 21
with three response categories “Investment adviser,” “Broker,” and “It makes no difference to
me.” This was a repeat of the same question asked at the beginning of the survey. The
repetition was to gauge the extent to which subjects learned from the educational paragraph.
After reading the educational paragraph, 78 percent of participants chose “investment adviser,”
only 10 percent chose “broker,” and the remaining 11 percent responded “It makes no
difference to me.” Before reading the educational paragraph, only 54 percent had a preference
for investment advisers, and 13 percent had a preference for brokers, while the remaining 33
percent had no preference. Consumer preference towards an investment adviser relative to a
broker appears to increase after the consumer is educated on the job responsibilities of brokers
and investment advisers.
***Insert Table 6 About Here***
After the educational paragraph, participants were once again asked the questions from
Tables 1 through 4, but this time, they were only given the options “broker” and “investment
adviser.” As shown in Table 7, after reading the educational paragraph, 85 percent of
participants correctly identified that an investment adviser is held to a fiduciary standard, up
from 55 percent before the educational paragraph. Only 20 percent identified brokers as
fiduciaries after the educational paragraph, a decrease from the 51 percent who identified
brokers as fiduciaries before reading the educational paragraph.
***Insert Table 7 About Here***
Results for the next question, found in Table 8, repeats the question from Table 2, with
the narrowed response set and asks participants to identify who is in the business of providing
financial advice. After reading the educational paragraph and with only two response choices,
TRANSPARENCY IN THE INVESTMENT INDUSTRY 22
the percent of respondents who choose investment adviser increased from 58 percent to 91
percent. The percent of participants who chose broker dropped from 35 percent to 28 percent.
The educational paragraph also helped consumers identify financial professionals who are in
the business of selling investments or financial products, as shown in Table 9. Before the
educational paragraph, only 62 percent believed that brokers were in the business of buying or
selling financial or investment products, but this number increased to 86 percent after the
educational paragraph. Interestingly, there was only a small decline in the proportion who
believed investment advisers buy and sell investment products after the educational paragraph
with a decline from 36 percent to 33 percent.
***Insert Table 8 About Here***
***Insert Table 9 About Here***
Finally, Table 10 replicates the results of Table 4 and shows how the educational
paragraph increased participants’ understanding of who is in the business of providing advice
regarding investments. Sixty-five percent correctly identified an investment adviser as someone
who is paid to provide advice regarding securities. After the educational paragraph, this
number increased to 87 percent. Likewise, 50 percent incorrectly believed that brokers are paid
to provide advice regarding investments before reading the educational paragraph. After the
educational paragraph, only 31 percent still incorrectly believed that brokers are paid to
provide advice regarding investments. Tables 7 through 10 show that although investor
education can help to mitigate misunderstanding that investors have regarding the different job
functions and responsibilities of investment professionals, the confusion is not completely
eliminated through education.
TRANSPARENCY IN THE INVESTMENT INDUSTRY 23
***Insert Table 10 About Here***
4.3 Education of Investment Advisers and Brokers
Respondents in our study were also asked about the levels of education required of
brokers and investment advisers. Table 11 reports the results of the question asking
respondents what level of education is required to become a broker. Fifty-three percent of
respondents believed a broker must be a college graduate or have a graduate education. When
asked the same question regarding Investment Advisers, this number jumped to 68 percent, as
shown in Table 12. Table 11 (Table 12) shows that only 5 percent (2 percent) correctly identified
the actual level of formal education required to become a broker (investment adviser) by
choosing the option “less than high school graduate.” These results are consistent with fourth
hypothesis (H4) since most of the participants overstated the requirements needed to become
a broker or an Investment Adviser. Although most states require that a broker or an investment
adviser pass the Series 7 exam, typically no formal education requirement is needed to sit for
this exam. These results are also consistent with our fifth hypothesis (H5) since respondents
characterized the amount of education needed to become an investment adviser as higher than
the education needed to become a broker.
***Insert Table 11 About Here***
***Insert Table 12 About Here***
Table 13 shows the response results where participants were asked “In your opinion,
what is the minimum level of education that someone should have in order to be a broker?”
Consistent with our sixth hypothesis (H6) 74 percent responded that they believed a broker
TRANSPARENCY IN THE INVESTMENT INDUSTRY 24
should have a college or graduate degree and 82 percent thought the same of investment
advisers (as shown in Table 14.) These results are also consistent with H4 and H5.
***Insert Table 13 About Here***
***Insert Table 14 About Here***
Participants were asked to compare the education requirements of brokers and
investment advisers to those of a Certified Public Accountant (CPA). Those results are reported
in Tables 15 and 16. The CPA license was chosen for comparison to brokers and investment
advisers because all deal with financial issues and because the CPA license is widely recognized.
According to a study by Ipsos commissioned by the Certified Financial Planner Board of
Standards, Inc., the CPA license was recognized by 94 percent of study participants.19
The licensure requirements needed to become a CPA vary from state to state but most
states require work beyond a baccalaureate degree with 150 college credit hours, and 12 to 27
credit hours in accounting. For example, according to “This Way to CPA” sponsored by the
American Institute of Certified Public Accountants, in Kentucky, a candidate needs 120 credit
hours and a bachelor’s degree to sit for the exam, and 150 credit hours, including 27 semester
hours in accounting, to obtain the CPA license.20
As shown in Tables 15 and 16, participants in our study thought that the education
requirements of brokers and investment advisers are similar to those of CPAs. Table 15 (Table
16) shows that 61 (76) percent of participants believe the education needed to become a
broker (Investment Adviser) is the same or higher than to become a CPA, consistent with H7.
19
See http://www.cfp.net/news-events/latest-news/2015/05/19/awareness-of-cfp-certification-leaps-ahead 20
https://www.thiswaytocpa.com/exam-licensure/state-requirements/KY/
TRANSPARENCY IN THE INVESTMENT INDUSTRY 25
Only 16 (7) percent responded that the education needed to become a broker (investment
adviser) is much lower than a Certified Public Accountant.
***Insert Table 15 About Here***
***Insert Table 16 About Here***
4.4 Comparison Tests
In Table 17, participants are asked "Which of the following best describes your
experience working in the investments industry?" Three percent of the participants in our study
currently work in the industry while five percent (four percent) do not currently work in the
investments industry, but have done so in the last five years (ten years). An additional three
percent reported that they do not currently work in the investments industry, but worked in
the industry more than ten years ago. In total, approximately 14 percent of participants had
experience in the investments industry while the remaining 86 percent have no investment
industry experience.
***Insert Table 17 About Here***
Table 18 presents the results of an F-test comparing the responses of people with
industry experience to those without industry experience. Table 18 takes the results presented
in Tables 1 and 4 and breaks the responses down by industry experience. Participants were
assigned a score to each question: they received one point for each correct answer and the lost
one point for each incorrect answer. For the questions presented in Tables 1 and 4, there are
only two correct answers: Investment Adviser and Investment Adviser Representative. Certified
Financial Planner was not accepted as a correct answer because, as explained in Section 4.1,
TRANSPARENCY IN THE INVESTMENT INDUSTRY 26
Certified Financial Planners are not required to act as a fiduciary unless they are providing
comprehensive financial planning advice. Therefore, a broker who holds the CFP credential is
not held to a fiduciary standard. In addition, only an Investment Adviser and Investment Adviser
Representative are legally permitted to provide investment advice for compensation.
Panel A of Table 18 shows the average score for the question " Which of the following is
held to a "fiduciary standard" by law meaning they are expected to behave with the highest
standard of care and in the best interests of their customers? Check all that apply." The average
score for all participants was −2.0478, meaning that on average, the number of incorrect
responses chosen by each participant exceeded the number of incorrect responses by 2.0478,
which shows that the participants in our study had difficulty identifying who is held to a
fiduciary standard and who is not. While those with industry experience scored slightly higher
than those without industry experience (−1.8030 versus −2.0888), the number of incorrect
responses from participants with industry experience exceeded the number of incorrect
responses by 1.8030. Even more disturbing is that respondents with industry experience did not
outperform those without industry experience by a statistically significant margin.
***Insert Table 18 About Here***
Panel B of Table 18 shows the average scores to the question " Which of the following is
paid to provide advice regarding investments? Check all that apply." Again, under the
Investment Advisers Act of 1940, only an Investment Adviser or an Investment Adviser
Representative is permitted to receive compensation for providing investment advice. The
remaining possible answers given in Table 4 are incorrect since they may be used by brokers.
Similar to Panel A, the average score for all participants was negative, meaning the number of
TRANSPARENCY IN THE INVESTMENT INDUSTRY 27
incorrect responses exceeded the number of incorrect responses. The average score for all
participants was −1.7478, and the average score for those with industry experience was
−1.4545 versus −1.7970 for those without industry experience. Although parZcipants with
industry experience scored better than those without, the difference was not statistically
significant.
5. Conclusion
At the time of this writing, it appears that the Department of Labor (DOL) will soon
require that brokers act as fiduciaries when managing retirement accounts. Currently, the
Securities and Exchange Commission (SEC) has not publicly released any plans that it will hold
brokers to the fiduciary standard when managing non-retirement investment accounts. Some
brokerage firms have complained about the high cost of complying with such a rule. However,
the results of this paper suggest that a more cost-effective solution to the problem of conflicted
advice in the United States is to focus on the education requirements of brokers and
investment advisers and to increase transparency of brokers by requiring them to hold
themselves out to the public as brokers or investment sales representatives.
Currently, brokers are free to use terms such as “financial advisor” when holding
themselves out to the public. Our results show that participants are likely to associate a
“financial advisor” as a fiduciary who is in the business of providing investment advice. In fact,
more than half of the respondents reported that the primary job function of a financial advisor
is to provide investment advice and 55 percent reported that a financial advisor is held to a
fiduciary standard. One way the SEC could mitigate the problem of conflicted investment advice
TRANSPARENCY IN THE INVESTMENT INDUSTRY 28
in the United States is to prohibit the use of misleading terms such as “financial advisor” or
“financial planner.”
Although this is not the first study to document investor confusion with titles used by
investment professionals, it is, to our knowledge, the first study to propose a more descriptive
title for brokers – “investment sales representative.” Our results show that participants are
more likely to associate the job responsibilities of a broker with an “investment sales
representative.” Participants are less likely to identify an “investment sales representative” as a
fiduciary in the business of providing investment advice relative to the job title "broker."
Prohibiting brokers from using unregulated job titles such as “financial advisor” and requiring
brokers to present themselves to the public as “investment sales representatives” would be a
cost-effective way for the SEC to mitigate the cost of conflicted advice.
In addition, a discussion of the education standards has been absent from the
discussions about a fiduciary standard. Our results show that 95 percent of consumers
overestimate the amount of formal education needed to become a broker and 98 percent
overestimate the amount of education needed for investment advisers. While we do not argue
that someone with a master's degree will provide better advice than someone with a bachelor's
degree, we believe that the amount of education, training, and experience needed to enable
financial professionals to act as fiduciaries and to be able to make a distinction as fine as good
versus better versus best in an area as complex as investment theory requires more training
beyond that required of an "entry-level" financial professional. Furthermore, a recent study
from Egan, Matvos, and Seru (2016) show that approximately 7 percent of brokers and
investment advisers have a record of misconduct. Worse, they find that in some firms, more
TRANSPARENCY IN THE INVESTMENT INDUSTRY 29
than 19 percent of employees have a record of misconduct. In our opinion, increasing the
amount of formal education needed to become a broker or an investment adviser will increase
the negative consequences for misconduct and could serve to mitigate the high rate of
misconduct currently observed in the market for investment advice in the United States.
TRANSPARENCY IN THE INVESTMENT INDUSTRY 30
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TRANSPARENCY IN THE INVESTMENT INDUSTRY 32
Table 1:
Which of the following is held to a "fiduciary standard" by law meaning they are
expected to behave with the highest standard of care and in the best interests of their
customers? Check all that apply.
Certified Financial Planner 272 59%
Financial Advisor 252 55%
Broker 233 51%
Financial Planner 218 47%
Investment Adviser 204 44%
Wealth Manager 192 42%
Investment Adviser Representative 155 34%
Investment Sales Representative 134 29%
Table 2:
Which of the following is in the business of providing financial advice? Check all that
apply.
Financial Advisor 355 77%
Financial Planner 294 64%
Investment Adviser 269 58%
Certified Financial Planner 267 58%
Wealth Manager 186 40%
Investment Adviser Representative 179 39%
Broker 159 35%
Investment Sales Representative 121 26%
Table 3:
Which of the following is in the business of selling investments or financial products?
Check all that apply.
Broker 285 62%
Investment Sales Representative 266 58%
Investment Adviser 165 36%
Investment Adviser Representative 149 32%
Financial Advisor 134 29%
Wealth Manager 130 28%
Financial Planner 119 26%
Certified Financial Planner 117 25%
TRANSPARENCY IN THE INVESTMENT INDUSTRY 33
Table 4:
Which of the following is paid to provide advice regarding investments? Check all that
apply.
Investment Adviser 301 65%
Financial Advisor 283 62%
Financial Planner 236 51%
Certified Financial Planner 234 51%
Broker 230 50%
Investment Adviser Representative 215 47%
Wealth Manager 182 40%
Investment Sales Representative 155 34%
Table 5:
Which of the following is the primary job function of a financial advisor? (select one):
Investment advice 247 54%
Retirement planning 76 17%
Budgeting 69 15%
Debt management 30 7%
Investment sales 16 3%
Insurance planning 11 2%
Tax planning 9 2%
Insurance sales 2 0%
Table 6:
Given what you have just learned, which would you rather choose to manage your
investments?
Broker 48 10%
Investment Adviser 361 78%
It makes no difference to me 51 11%
Table7:
Which of the following is held to a "fiduciary standard" by law meaning they are
expected to behave with the highest standard of care and in the best interests of their
customers? Check all that apply.
Broker 90 20%
Investment Adviser 393 85%
TRANSPARENCY IN THE INVESTMENT INDUSTRY 34
Table 8:
Which of the following is in the business of providing financial advice? Check all that
apply.
Broker 129 28%
Investment Adviser 419 91%
Table 9:
Which of the following is in the business of buying or selling investments or financial
products? Check all that apply.
Broker 397 86%
Investment Adviser 150 33%
Table 10: Which of the following is paid to provide advice regarding investments? Check all that
apply.
Broker 141 31%
Investment Adviser 399 87%
Table 11:
Please select the minimum level of education you believe is actually required for
someone to be licensed as a broker
1 Less than high school graduate 21 5%
2 High school graduate 114 25%
3 Some college 85 18%
4 College graduate 196 43%
5 Graduate education 44 10%
Mean 3.28
TRANSPARENCY IN THE INVESTMENT INDUSTRY 35
Table 12:
Please select the minimum level of education you believe is actually required for
someone to be licensed as an investment adviser
1 Less than high school graduate 10 2%
2 High school graduate 62 13%
3 Some college 77 17%
4 College graduate 252 55%
5 Graduate education 59 13%
Mean 3.63
Table 13:
In your opinion, what is the minimum level of education that someone should have
in order to be a broker?
1 Less than high school graduate 2 0%
2 High school graduate 41 9%
3 Some college 77 17%
4 College graduate 273 59%
5 Graduate education 67 15%
Mean 3.79
Table 14:
In your opinion, what is the minimum level of education that someone should have
in order to be an investment adviser?
1 Less than high school graduate 1 0%
2 High school graduate 22 5%
3 Some college 59 13%
4 College graduate 290 63%
5 Graduate education 88 19%
Mean 3.96
TRANSPARENCY IN THE INVESTMENT INDUSTRY 36
Table 15:
Relative to a Certified Public Accountant, the level of education needed to become a
broker is
1 Much lower 74 16%
2 Somewhat Lower 103 22%
3 About the Same 135 29%
4 Somewhat Higher 105 23%
5 Much Higher 43 9%
Mean 2.87
Table 16:
Relative to a Certified Public Accountant, the level of education needed to become
an investment adviser is
1 Much lower 33 7%
2 Somewhat Lower 80 17%
3 About the Same 180 39%
4 Somewhat Higher 123 27%
5 Much Higher 44 10%
Mean 3.14
Table 17:
Which of the following best describes your experience working in the investments
industry?
I work in the investments industry right now 13 3%
I do not currently work in the investments industry, but I have
worked in the industry within the last 5 years 22 5%
I do not currently work in the investments industry, but I have
worked in the industry within the last 10 years 18 4%
I do not currently work in the investments industry, but I worked in
the industry more than 10 years ago 13 3%
I have never worked in the investments industry 394 86%
TRANSPARENCY IN THE INVESTMENT INDUSTRY 37
Table 18:
This table presents the results of Tables 1 and 4, by industry experience. Participants received one point
for correctly identifying "Investment Adviser" or "Investment Adviser Representative" and lost one point
for all other incorrect responses. The mean represents the average score for each group.
Panel A: N Mean F P-value:
Which of the following is held to a
"fiduciary standard" by law meaning they
are expected to behave with the highest
standard of care and in the best interests
of their customers? Check all that apply.
Some Experience 66 -1.803 2.089 0.149
No Experience 394 -2.0888
Total: 460 -2.0478
Panel B:
Which of the following is paid to provide
advice regarding investments? Check all
that apply.
Some Experience 66 -1.4545 2.010 0.157
No Experience 394 --1.797
Total: 460 -1.7478