The SEC shouldinclude a strong enforcement mechanism by allowing investors to sueadvisers who scam them. When someone is cheated by their doctor orlawyer, they can go to court. There's no reason that familiesshouldn't have the same option when their life savings are atstake. (Photo: Diego M. Radzinschi/ALM)

(Bloomberg Opinion) –Your lawyer can't take money from youropponent to give you bad legal advice. If you're on Medicare, yourdoctor can't take kickbacks from drug manufacturers for prescribingtheir drugs. But, under current law, your broker-dealer canreceive monetary rewards and other perks for recommending certaininvestment products, even if those products aren't in your bestinterest.

Each year, Americans lose billions of dollars because of brokerswho are looking out for their own financial interests instead oftheir clients'. The Securities and Exchange Commission recentlyproposed a new set of rules, supposedly to address this problem —but the SEC has fallen far short of giving American families theprotection they need and deserve.

The SEC's proposal claims to address the brokerconflict-of-interest problem by stating that brokers must act inthe “best interest” of their clients. But the proposal doesn'tdefine what that means, creating confusion for investors andbrokers and leaving the possibility that judges and corporatelawyers will chip away at the standard over time.

Instead of eliminating many of the worst conflicts, the proposalonly requires brokers to mitigate and disclose them.

So, for example, harmful practices like quotas for the sale ofin-house products or contests for hitting certain sales thresholdscould continue, even though they encourage brokers to push subparproducts so they can collect their rewards from the companiesselling them.

The proposal has another problem: If a broker violates thebest-interest rule, there is no explicit authorization forinvestors to sue brokers in court. If the people who get hurt can'tsue, the odds of these standards being enforced drop sharply.

The SEC can fix its flawed proposal before it issues its finalrule. The Commission should make four main changes:

First, the final rule should make absolutely clear that allfinancial professionals must act in their clients' best interest byapplying a fiduciary standard to the brokerage industry.

That is what the Department of Labor did with its 2016 rulerequiring all financial professionals giving advice onretirement-savings plans to put client interests ahead of theirown. Corporate lawyers representing the financial-services industrypersuaded a federal court to strike down this rule on technicalgrounds earlier this year.

A fiduciary relationship is a defined legal concept. Investmentadvisers already owe a fiduciary duty to their clients when theyprovide investment advice. There's little reason not to apply thesame standard to brokers who are providing similar advice.

SEC Chairman Jay Clayton says the new SEC proposal “isdefinitely a fiduciary principle,” but if that is the case,the SEC should say so explicitly in the final rule, rather thanusing a vague best-interest standard that isn't currentlydefined.

Second, the SEC should explicitly ban the most obvious forms ofconflicted advice, like sales contests and quotas that encouragebrokers and agents to make bad recommendations. The SEC must attackconflicts of interest at their source: the problematic incentivesthat companies use to push underperforming, money-losing oroverpriced products on unsuspecting customers.

By requiring brokers only to mitigate conflicts of interest, andthen deferring to the brokerage firms on how they do so, the SEC'sproposal would allow these conflicts to continue.

Third, the SEC shouldn't rely on disclosure alone to protectcustomers. A number of studies have shown that disclosure fails toreduce the harm caused by conflicted advice, and brokers have everyincentive to make the disclosures as ineffective as possible. Alawyer can't represent his client's opponent just because thatconflict was disclosed, and the same should be true of abroker.

Finally, the SEC should include a strong enforcement mechanismby allowing investors to sue advisers who scam them. When someoneis cheated by their doctor or lawyer, they can go to court. There'sno reason that families shouldn't have the same option when theirlife savings are at stake.

Yet the SEC's proposal would force investors to rely onarbitration at the Financial Industry Regulatory Authority — aso-called self-regulatory organization funded by brokers themselves— or enforcement by the SEC, which takes only a few hundredenforcement actions each year. Regulating the worst practices inthe brokerage industry will mean little if savers have no way to goafter the companies that rip them off.

The SEC claims its proposal is as strong as the DOLconflict-of-interest rule issued during the Obama administration,and was set to go into effect last year. But companies that hadresponded to the DOL rule by transitioning to more transparent,lower-fee products — which even they described as “intended toaddress … conflicts” — are quietly rolling back those changes nowthat the DOL rule has been tossed out and they have seen the weakerSEC proposal. Wall Street might be excited about a greenlight to cheat working families, but it's a bad sign forconsumers.

With wages flatlining for many families and the cost of healthcare, housing, education and child care skyrocketing, it's hardenough to save money. The last thing the average Americansaver needs is to lose money because of conflicted advice fromtheir brokers.

If the SEC doesn't make these four concrete improvements to itsproposal, it will have failed to fix this huge problem — and withit, failed to substantially “increase[e] investor protections andthe quality of advice,” as Chairman Clayton once promised he woulddo.

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