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Will new SEC regulations protect investors from churning?

How do you know when a financial advisor has your best interest at heart? It’s a question worth considering, especially as you draw near retirement and want to maximize the value of your portfolio.

It’s also a question that new SEC rules should help you answer. They help clarify the distinction between financial advisors and broker-dealers. They also require broker-dealers to file disclosures and act in their clients’ best interests. But as Forbes reports, these new rules aren’t perfect, largely because they don’t clearly define your “best interests.”

The difference between financial advisors and broker-dealers

One of the key changes in the new SEC rules is that broker-dealers will no longer be able to call themselves “financial advisors.” Financial advisors and broker-dealers have different legal responsibilities and make their money in different ways. New disclosures should help investors better understand the differences:

  • Financial advisors (also “financial advisers”): These people have a fiduciary duty to act in your best interest. These are the people you might ask to help you create an investment plan. They provide regular, ongoing advice for your whole portfolio and usually work with a fixed rate or fee-based model that rewards them for helping you meet your larger goals.
  • Broker-dealers: These investment professionals are far more transactional. They typically work for commission, buying and selling the specific pieces within an investor’s portfolio.

What is churning?

Churning is an illegal practice that the SEC identifies by the “excessive buying and selling of securities in a customer’s account chiefly to generate commissions that benefit the broker.”

The new SEC regulations aim to shut down churning, by forcing broker-dealers to meet three standards for care as they recommend sales and purchases:

  • General best interest: Recommendations must reasonably serve the best interests of at least some clients.
  • Specific best interest: Recommendations must fit reasonably within a client’s investment profile, considering risk, goals, liquidity and other factors.
  • Serial best interest: Recommendations must make sense as a pattern, not just individually. The SEC put this standard into place specifically to fight churning.

While these standards may go a long way to protect investors from bad broker-dealers, they still leave much to be desired. The definitions of “reasonable” and “best interest” leave a lot of room for interpretation, and the SEC choose not to assign broker-dealers any fiduciary duties.

Time will lead to further clarification

As Forbes suggested, how well the new standards protect investors will depend largely on the definition of “best interest.” That’s a term the SEC left vague within its rules but that will become more specific as the courts weigh different cases. In the meantime, the changes should help you better understand who you’re working with, what their interests are, and whether they align with yours.

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