Should Financial Advisers Be Fiduciaries?

Posted by: Lauren Young on July 9, 2009

The already-hot debate about the fiduciary responsibility of financial advisers is scorching.

Registered investment advisers, who are regulated by the Securities & Exchange Commission as well as individual states, are legally bound to put their clients’ interests first, known in industry-speak as a “fiduciary duty” or “fiduciary responsibility.” Brokers, who are regulated by the Financial Industry Regulatory Authority, or Finra, can recommend what is considered “suitable,” but not necessarily best, to clients. The term most used to describe this connection is a “suitability standard.”

Now a group known as the Committee for the Fiduciary Standard is asking two securities attorneys to look at how Congress can best put investors’ interests first.

The committee is targeting Thomas P. Lemke, managing director at Legg Mason, Inc., and Steven W. Stone, a partner at Morgan Lewis & Bockius in Washington D.C. These two attorneys wrote an article in the June issue of Wall Street Lawyer concluding that a so-called “harmonized” standard should replace the fiduciary standard for investment advisers, and the suitability standard for brokers. In other words, they argue, fiduciary and suitability standards are more similar than different.

Harmonization is long overdue, and this laudable effort’s overriding goal should be to ensure that investors receive a uniform level of professionalism and accountability from the financial professionals they deal with, whether they choose to use a broker-dealer or an investment adviser. An additional benefit of harmonization would be the increased potential that future Madoff scandals could be prevented or, at least, identified and stopped sooner.

The group, whose members include well-respected financial advisers such as Harold Evensky, Sheryl Garrett, and Ronald W. Roge, has created an online petition and is looking to collect signatures from 1,000 investors to make sure that new laws or regulations about the fiduciary standard meet what they deem are the requirements of an “authentic fiduciary standard.”

For tips on choosing an adviser, check out this BusinessWeek story, Finding An Adviser You Can Trust.

What do you think about these distinctions? Is there a difference between the fiduciary standard and sustainability requirements or can they be harmonized? Do you prefer one over another? Why?

Reader Comments

Dylan

July 9, 2009 7:39 PM

Hi Lauren,

Here is an easy way to illustrate the difference between the two standards. Let's say an adviser determines that 50% of a client's portfolio should be invested in an S&P 500 Index Fund.

The fiduciary standard requires the adviser to actually advise in the client's best interest, placing the client's interest ahead of his own. The adviser is compelled to advise the client to use the best S&P 500 Index fund available to the the client, likely at a cost of around 0.1%.

Under the suitability standard used by brokers, the 50% allocation to S&P 500 Index fund must be suitable. But from there on, it is also suitable for the broker to recommend any S&P 500 Index fund on his employers platform. The brokers options might have expenses ranging from 0.4% to over 1%. It's entirely at the broker's discretion as to which fund he recommends. But you can't expect the broker to recommend a better, lower cost option from a fund family that his firm doesn't have a sales agreement with.

The broker can also recommend a more expensive fund because he wants to have enough sales to qualify for an all expense paid, "due diligence" trip that the fund company is sponsoring in Las Vegas, or maybe he's just one more sale away from getting a nice Cutter & Buck golf shirt that has the fund company's logo on it with the words, "Top Producer." It doesn't actually matter what the incentive is; it doesn't effect suitability.

Even if the fiduciary advisor charges you $200 for that one little piece of advice, the annual expense on $50,000 invested with a 0.1% expense ratio is $50. Whereas, the broker's "free" advice to buy a fund with a 1% expense ratio is $500 per year.

So what's the difference between fiduciary and suitability? Well, In this case it's $250 the first year and $450 every year after. (It actually becomes increasingly more expensive as the investment grows or new contributions are made. When you get to $500,000, just add another zero to make that annual difference $4,500!)

BL

July 10, 2009 6:23 AM

People would be well-advised to also check out what the Financial Planning Coalition is doing on this important issue. The Coalition is comprised of the industry's three main financial planning organizations - NAPFA, FPA and the CFP Board of Standards.

Kennon Grose

July 10, 2009 4:39 PM

Legally, brokers are not fiduciaries. They don’t have the obligation of a fiduciary, which is to put the customer’s interest first. Instead, brokers have what the legal world terms as an “arm’s-length” relationship. This allows them to downplay conflicts of interest with simple statements, such as: “Our interests may not always be the same as yours.”

The brokers’ primary loyalty is still to his or her firm. The customer’s interest can still be sacrificed to the business interests of the firm. Brokers do not have the same loyalty and obligation to the investor as investment advisors. Penn, Schoen & Berland Associates released a study about brokers with the following results;

- 58 percent of customers incorrectly believe brokers are required to act in the investor’s best interests in all aspects of the financial relationship;
- 63 percent of customers incorrectly believe brokers are required to disclose all conflicts of interest prior to providing financial advice.

Like hidden compensation schemes, undisclosed conflicts of interest are part of the financial service industry's dirty laundry. For example; proprietary funds, house owned bond issues, house owned securities, etc.

Customer friendly financial relationships are built on full disclosure.

Norman Pappous

July 15, 2009 6:12 PM

the real point is "Are advisors or brokers adding value for their fees or just depleting the portfolio?"

There is only one internet website that answers that question - www.evaluatemyadvisor.com

Morris Armstrong

July 24, 2009 11:49 AM

Lauren

I think that anyone who is managing money on a discretionary basis must be operating as a fiduciary. I think that what also needs to be done is terms clearly defined such as "advice" and also what the responsibilities of the fiduciary are.

One of your readers used an expense ratio of a fund as an example of a decison that a fiduciary may approach differentlt than a broker. Does a standard require that the expense rratio be the lowest or that it fall within the top 50%? I know that when I obtained my AIF designation that the standard was that it not be in the bottom 25%.

The words that are being tossed around all sound important but it is the definitions which are, in my opinion, the more critical aspect.

The petition that is linked seems to have five fairly clear principles behind it and that is a good step.

Morris Armstrong

July 24, 2009 11:49 AM

Lauren

I think that anyone who is managing money on a discretionary basis must be operating as a fiduciary. I think that what also needs to be done is terms clearly defined such as "advice" and also what the responsibilities of the fiduciary are.

One of your readers used an expense ratio of a fund as an example of a decison that a fiduciary may approach differentlt than a broker. Does a standard require that the expense rratio be the lowest or that it fall within the top 50%? I know that when I obtained my AIF designation that the standard was that it not be in the bottom 25%.

The words that are being tossed around all sound important but it is the definitions which are, in my opinion, the more critical aspect.

The petition that is linked seems to have five fairly clear principles behind it and that is a good step.

Pat

October 7, 2009 5:15 PM

The entire banking industry has shown that it cannot be trusted. Yet, articles like this continue to pander to the desire for trust in bankers to cultivate the option that they may be trusted. Madoff couldn't agree.

Financial Advisors if they are trustees and beneficiaries have built in incentive to favor themselves, and knowing that income is discretionary, and remainders cannot object, are in a perfect situation of trust abuse - and freely avail themselves of the opportunity given the costs of litigation.

No greater sham exists than that because one is a fiduciary, they are reproachable. It hasn't happened in a thousand years that they are trustworthy. That's why they are trustees to begin with, and not clergy.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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