Broker-Dealers and Investment Advisers: A Behaviorial-Economics Analysis of Competing Suggestions for Reform

Authors

Polina Demina, University of Michigan Law School

Abstract

For the average investor trying to save for retirement or a child’s college fund, the world of investing has become increasingly complex. These retail investors must turn more frequently to financial intermediaries, such as broker-dealers and investment advisers, to get sound investment advice. Such intermediaries perform different duties for their clients, however. The investment adviser owes his client a fiduciary duty of care and therefore must provide financial advice that is in the client’s best interests, while the broker-dealer must merely provide advice that is suitable to the client’s interests—a lower standard than the fiduciary duty of care. And yet these divergent standards are not necessarily evident to the average investor. As a result, investors run the risk of being placed into suboptimal investments by broker-dealers. Two competing solutions to this issue have been proposed: a higher fiduciary standard for both broker-dealers and investment advisers and a less burdensome disclosure standard in which broker-dealers would inform their clients that they are not fiduciaries. This Note analyzes these potential reforms using a traditional economics analysis as well as new behavioral-economics research. It concludes that a fiduciary standard more effectively protects investors and that a disclosure standard would actually have the perverse effect of making investors more susceptible to behavioral biases that can impair their ability to invest properly.

Recommended Citation

Polina Demina, Broker-Dealers and Investment Advisers: A Behaviorial-Economics Analysis of Competing Suggestions for Reform, 113 Mich. L. Rev. 429 (2014).
Available at: https://repository.law.umich.edu/mlr/vol113/iss3/3