20160407a transparency in the investment industry as the percentage of the sales load paid to a...

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:

[email protected]

††† 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.


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


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


"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/


"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


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/


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


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/


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


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/


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


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


“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


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


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.


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.


perceived to be more likely to provide financial advice than a Certified Financial Planner (58

percent) by the participants.


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.



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.


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.



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?”


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.


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.


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,


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.



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.



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.



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


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.



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/


Only 16 (7) percent responded that the education needed to become a broker (investment

adviser) is much lower than a Certified Public Accountant.



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.


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,


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.


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


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


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


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.


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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.







Broker 159 35%


Table 3:

Which of the following is in the business of selling investments or financial products?

Check all that apply.

Broker 285 62%









Table 4:

Which of the following is paid to provide advice regarding investments? Check all that

apply.





Broker 230 50%




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%


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%



Table 8:

Which of the following is in the business of providing financial advice? Check all that

apply.

Broker 129 28%


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%


Table 10: Which of the following is paid to provide advice regarding investments? Check all that

apply.

Broker 141 31%


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


Table 12:

Please select the minimum level of education you believe is actually required for

someone to be licensed as an investment adviser






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?






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?






Mean 3.96


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%


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

20160407a transparency in the investment industry as the percentage of the sales load paid to a...

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