Chapter 2

Fiduciary: The “Gold Standard” Of Care

What is a fiduciary or a fiduciary relationship?

A fiduciary is a person or organization that owes to another
the duties of good faith, trust, confidence, and candor.
This special relationship of trust established by law is similar to the relationship one has with an attorney or doctor. When an advisor acts in a fiduciary capacity, that advisor is legally obligated to maintain an allegiance of confidentiality, trust, loyalty, disclosure, obedience and accounting to his or her clients. All NAPFA members must sign and abide by the NAPFA Fiduciary Oath. Source: NAPFA

Chapters 3, 4, and 5 provide an historical perspective of the landscape prior to Regulation Best lnterest (Reg BI), which took effect in 2019. lt requires somewhat better disclosure on the part of broker-dealers. However, Reg BI fails to require brokers to meet the fiduciary standard, or anything close to it. Although chapters 3, 4, and 5 now serve the purpose of providing an historical perspective, the past and the present are not too far afield. Again, Barbara Roper, Director of lnvestor Protection for the nonprofit Consumer Federation of America stated the following regarding Reg BI: “lnstead of strengthening protections for investors, the new standards place them at greater risk—misled into expecting best interest advice that the rules do not require.”

Although Reg BI may not provide better protection for investors, it will however succeed in giving brokerage firms a new catch phrase to use in their advertisements, as they will no doubt attempt to suggest that Reg BI is somehow on par with the fiduciary standard. Do not be fooled. lnsist your advisor sign a fiduciary oath like all NAPFA advisors are required to sign.

Chapter 3:
What Standard of Care Applies?

Many, if not most investors believe that all financial services professionals are held to the same standard of client care. Unfortunately, it’s not true. Some advisors (and the firms that employ them) have a legal obligation to place the client’s interests first at all times. This is known as a “fiduciary” legal obligation, or fiduciary duty. Your attorney, as well as your doctors, are examples of “fiduciaries.” A trustee would be another example. Other advisors don’t—they are actually allowed to place their interests and the interests of their firms ahead of the interests of their clients.

Almost all financial advisors and firms today profess to place their clients’ interests first, but only a fraction of them are legally obligated to do so. Fighting through the advertising and vague promises to identify those fiduciary advisors can be a daunting task. It’s not as if the other firms take out ads that assert “We sometimes act in your best interests,” or “We always place our stockholders’
interests first, your interests place a distant second.” Ads claiming to put clients first are not necessarily untrue. The question is, how often does the firm really put their clients’ interests first? I submit that anything less than always is not often enough, because it only takes a momentary lapse of the fiduciary standard to be sold a product rife with conflicts of interest, and high operating expenses needed to cover hefty hidden recurring commissions. What is not widely known is that there are two very different standards of client care required by financial services professionals, depending upon what type of account you maintain:

The Fiduciary Standard, as defined in the Investment Advisers Act of 1940*, which imposes a legal requirement that the financial advisor always act in clients’ best interests and fully disclose all sources of compensation, as well as any potential conflicts of interest.

The Suitability Standard, which requires only that recommendations are suitable—not necessarily the best or most cost-effective.
Imagine if there were two different standards of care among doctors. One standard is stringent, requiring that your doctor always act in your best interests. The other standard allows the doctor to benefit from hidden financial incentives that are not aligned with your interests. You would no doubt insist that your doctor be required to meet the higher standard when he is treating you. Shouldn’t you do the same when you seek financial advice?

What’s the practical impact of the suitability standard? Under the suitability standard, the investment recommendations you receive may be influenced by which financial products pay higher commissions, or by certain revenue-sharing arrangements between the issuers and the firms that sell their products. Also, the law doesn’t require that you be given the specific details that may influence your advisor’s recommendation. You’re operating in the dark.

In 2011, Cerulli Associates released a survey of 7,800 households:
• Thirty-three (33) percent said that they didn’t know how they paid for the investment advice that they received.
• Thirty-one (31) percent indicated that they thought their financial
advisor or broker provided investment advice for free.
• Sixty-four (64) percent believed that their financial advisor was held to the fiduciary standard. Sixty-three (63) percent of clients of the largest broker-dealers also believed that their financial advisor was acting as a fiduciary.

Other studies reveal that a relatively small percentage of investors understand the term ‘fiduciary’ or how it may affect them. This situation can make it challenging for a registered investment advisor firm like ClientFirst Wealth Management, a fiduciary, to effectively communicate its value proposition.

In 2010, financial-reform legislation empowered the Securities & Exchange Commission (SEC) to change the law. It directed the SEC to study whether broker-dealers—who employ the majority of financial advisors in the nation—should be required to meet a fiduciary standard instead of the suitability standard under which they now operate. As of this writing in March 2012, the SEC has not made any changes, so the two standards still exist as they have since the Investment Advisers Act of 1940 was signed into law.

Understandably, Wall Street is opposed to meeting the higher standard of client care. Certain financial products, which have very lucrative fees and hidden sales charges, become much more difficult to recommend when the fiduciary standard is required. The fiduciary standard also raises the bar significantly with respect to potential legal liability.

Moreover, one should pay attention to whether the firm is publicly held. Who wins, when attempting to balance shareholder demands for greater profits and your need for objective, cost-effective advice? If you maintain a brokerage account with such a firm, an account that imposes no fiduciary obligation to act in your best interests, whose interests do you believe will come first, yours or the shareholders?

Barron’s published an article that I wrote on this subject in August 2010 entitled “Regulating the Givers of Advice.” In the article, I stated:

It stands to reason that all financial services professionals offering personalized investment advice should be required to meet the fiduciary standard described in the Investment Advisers Act of 1940. Anything less would continue to shortchange some investors, as recommendations would continue to be influenced by unidentified conflicts of interest.

To accept any argument to the contrary is to believe that failing to always act in clients’ best interests is an acceptable practice. All medical doctors are required to meet the same standard of care, as are all attorneys. Why not all professionals providing personalized investment advice?

At a minimum, all Americans seeking investment advice should be afforded the peace of mind associated with transparent investment recommendations.

Of course, if a broker or insurance professional isn’t providing personalized investment advice—if they are simply engaged in the sale of products—there is no need to impose the fiduciary standard.

Obviously, rules alone are not enough to eliminate abuses. There are numerous examples of investment advisors cheating and stealing from their clients. Broker-dealers with a history of fair dealing and regulatory compliance should applaud the extension of the fiduciary standard. Conversely, those firms with less impressive records may find it more difficult to defend themselves in the future.

Surprisingly, the same financial advisor can treat your account differently, and can be held to a different standard of care depending on what type of account you maintain. This strange state of affairs benefits Wall Street, not its retail customers. At some point, the SEC or another regulatory body might clean up the problem, but until that happens, it’s up to each investor to become educated about the alternatives.

It is important to note that the broadest definition of a fiduciary is found in the Investment Advisers Act of 1940. Other definitions may be watered-down and limited in scope. Don’t settle for “fiduciary lite.” Require that your advisor hold a Series 65 or Series 66 securities license, regardless of any professional designations he may hold. Have your advisor sign the fiduciary oath found in chapter 5.

In the next chapter, I explain how to make sure your account provides you with the greatest possible protection.

*Investment Advisers Act of 1940 is the proper spelling of this legislation.

Have a question? Contact Ed Mahaffy.

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