The Debate Over A Fiduciary Standard

| August 2, 2015 | 0 Comments

Back in April of this year, the Department of Labor (DOL) issued a proposed rule that would require investment advisors to retirement plans to follow a Fiduciary Standard. The proposed rule has sparked a fierce debate in the industry, as brokers who do not want to be held to this standard argue that the new rules would be too burdensome. Meanwhile, investors are generally now aware there are different standards, or what they mean in practice. But as you’ll see, the differences can result in very different recommendations.

The Investment Advisers Act of 1940 (“1940 Act”) created the regulatory framework for people who give advice about which securities a client should own. Investment Advisers are legally required to act under a Fiduciary Standard in which the client’s best interests come first. Someone acting as a fiduciary is legally required to disclose any conflicts of interest which might color their advice, and to set aside such conflicts in order to give advice to the client that is the best for that client. A Fiduciary Standard also requires an advisor to act with prudence (with the skill, diligence and care of a professional) and prohibits misleading clients.

Brokers, on the other hand, don’t generally fall under these rules. The Securities Exchange Act of 1934 created what is now called the Financial Industry Regulatory Authority (FINRA). FINRA serves a dual function as both a trade group for securities firms and a regulator of the brokerage industry. Brokers are legally agents of their employer firms, which means that they actually have a duty to act in the best interest of their employer. Brokers are required to recommend investments that are “suitable” for that client, but as you’ll see, that’s a pretty low bar.

Consider the following example from, in which a financial advisor determined that an S&P 500 Index fund was an appropriate investment for his client.

• Acting as a broker under a suitability standard, he could legally recommend a proprietary fund that pays him a 5 percent commission and charges the client a high ongoing annual fee, with no requirement to disclose either the higher fees or the commission, or that there are better options available.

• A Registered Investment Adviser acting under a Fiduciary Standard would be required to fully disclose the fees paid to him and to find the best fund available with the same objective (S&P 500 Index), likely resulting in much lower overall expenses to the client.
Note that a Fiduciary Standard doesn’t mean that adviser can’t be paid for his advice. It simply requires that the amount and nature of the compensation be disclosed to the client, and that any recommendations that are made must be in the best interest of the client.

Adding to the confusion, under current rules, brokers can be dually registered as both brokers and advisors. Bizarrely, this allows them to be fiduciary advisors while they determine that the client needs that S&P 500 fund to meet their goals. But they are then allowed to change hats and sell the same client that high commission fund as a broker. No wonder people can’t tell the difference!

The Department of Labor, as part of their responsibility to regulate corporate retirement plans, has twice attempted to implement a Fiduciary Standard for those who give financial advice to retirement plans. Not surprisingly, FINRA and several other organizations representing insurance companies and brokerage firms have been fighting the rules with everything they’ve got.

When you’re looking for advice, wouldn’t you like to know what filters that advice is passing through, and what incentives are affecting you advisor’s recommendations? That’s why the CFP® Board, Financial Planning Association and National Association of Personal Financial Advisors, along with AARP and the Consumer Federation of America, have all been supporting the DOL’s push for a stronger Fiduciary Standard. It’s not about new regulation; it’s about holding everyone who is providing the same service to the same standards.

(Full Disclosure: My firm, Blankinship & Foster, LLC, is a Registered Investment Adviser under the Investment Advisers Act of 1940, and is held to a Fiduciary Standard of care.)

This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director and chief investment officer with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Brooks can be reached at (858) 755-5166, or by email at Brooks and his family live in Mission Hills.

Tags: , ,

Category: Business

About the Author ()