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Congress Drops the "F-Word" (Fiduciary)

by Gary D. Halbert
May 4, 2010


1.  Fiduciary Standard of Care vs. Suitability

2.  Why Does it Matter?

3.  Goldman Hearings Revitalize the Fiduciary Discussion

4.  Fiduciary Standard Isn’t Infallible

5.  There’s No Substitute for “Due Diligence”


No, I’m not writing an E-Letter that you’re going to have to hide from your kids.  The F-word discussed in today’s issue is “fiduciary.”  As you probably know, financial regulatory reform has been getting a lot of attention in the financial press lately.  Unfortunately, many investors do not know that fiduciary duty was an early casualty of the financial reform effort, thanks largely to Wall Street’s lobbying efforts.  

As I will discuss in this week’s E-Letter, there are some investment professionals who are bound to exercise fiduciary duty in relation to your investments, while others are held only to a suitability standard.  However, many investors do not know what a fiduciary standard of care is, or how the absence of this duty can affect their investments.

Fiduciary Standard of Care Vs. Suitability

A common definition of the term “fiduciary” is a person or entity that holds assets for another in a position of trust.  Think of a trustee of a minor child’s trust.  The trustee has a fiduciary duty to do what is right for the child without the thought of personal gain.  However, fiduciary duty does not always involve actually holding assets on behalf of a third party.  In the case of a Registered Investment Advisor (RIA), fiduciary duty means to act in such a way as to put the client’s interests above those of the Advisor. 

Suitability, on the other hand, is defined as making sure that an investment is in line with your financial goals, risk tolerance and financial situation.  This standard is also called the “know your customer” rule in the brokerage industry.  As a general rule, financial product sales professionals such as life insurance agents and broker/dealer registered representatives (brokers) are not fiduciaries in regard to the investment advice and recommendations they dispense.   

Fiduciary duty is the highest standard of conduct in regard to investment advisory activities, while suitability is a lower standard.  Some say that fiduciaries are the only true Investment Advisors and non-fiduciaries are merely glorified salesmen.  However, some investors don’t want a fiduciary account, seeking rather to simply buy and sell securities and pay a commission. 

Unfortunately, a Rand study released by the Securities and Exchange Commission in 2008 indicated that “Consumers don’t know the difference between registered reps (who have a suitability standard of care) and RIAs (who have a fiduciary duty).”  Not knowing what standard of care should be expected in a financial transaction can cause problems for all concerned.

Before going further in the discussion about fiduciary duty vs. the suitability standard, let me say that I know many insurance and brokerage professionals who do the best job for their clients and put their clients’ interests above their own.  This discussion is not intended as a criticism of their practices.  Instead, the focus is on a difference in standards that allows some sales professionals to put their own interests or those of their employer above those of their clients.  While some brokers may try to do what’s in their clients’ best interests, they are not required to do so and you have little or no legal recourse against them if they don’t.

What’s the Difference?

So, what does this mean to you as an investor?  Aren’t fiduciary duty and the suitability standard pretty much the same?  The answer is an emphatic NO!  If the financial-reform package is passed in its current state as this is written, it means that some of the professionals you look to for investment advice will be required to have your best interests in mind, and others will not.  Those not covered by a fiduciary standard will not be required to act upon or even notify you of any conflicts of interest they may have.

Professionals licensed as Registered Investment Advisors, either nationally or at the state level, are required to exercise a fiduciary standard so that your interests are paramount, not those of the advisor or advisory firm.  Registered representatives of a brokerage firm, on the other hand, must only make sure the investment is suitable for you.  Here are a few examples of the differences between these two concepts:

  1. Duty – In a nutshell, a fiduciary has the duty to do what’s in your best interest while a non-fiduciary broker is free to suggest investments that may benefit the broker or the broker’s firm at the expense of the client, as long as the investments are suitable.  The following example from the Indiana Secretary of State’s office offers an excellent example:

    Two products exist that are both suitable to a client's needs. Product A gives the client a better return on their investment but Product B gives the financial services professional a higher commission. Acting under the suitability requirement, the financial services professional might offer Product B. However, under fiduciary duty, the financial services professional must offer Product A.

    Non-fiduciary brokers are also able to sell securities to you from their brokerage firm’s own account rather than buying and selling on the open market.  These sales, known as “principal trades,” sometimes have considerable undisclosed markups and can benefit the firm’s bottom line at the expense of the client.

    Principal trades may even involve securities that the brokerage firm wants to get rid of because they are expected to go down in value.  As long as such sales are suitable and trade confirmations disclose the brokerage firm as the “principal,” there is no requirement that any potential conflicts of interest be avoided or even disclosed.  Fiduciary advisors can also engage in principal trades, but they must put the client’s interests before their firms’ and complete disclosure is required, as discussed below.

  2. Disclosure – Fiduciaries are also responsible for comprehensive disclosures about how they do business, how they are compensated and any potential conflicts of interest that may exist.  Generally, this disclosure is known as a Form ADV, Part II.  Non-fiduciary brokers are not required to produce any such disclosure.

    The importance of disclosure cannot be overstated.  While it may be a chore to read through pages of disclosures, having them assures you that you can determine if any conflicts of interest exist and, if so, ask your financial professional about them.  If no disclosure is even required, then it’s very unlikely that you’ll think to ask about every kind of possible conflict that may exist when dealing with a non-fiduciary salesperson.

  3. Recourse – The fiduciary standard is a legally-enforceable duty that can be pursued in the courts.  Fiduciaries have the legal obligation to offer unbiased objective advice that is in your best interest and to completely disclose all sources of compensation and any conflicts of interest.  Failure to do so can lead to legal remedies for the investor.  If a client sues for breach of fiduciary duty, the burden of proof is on the Investment Advisor to show that it did not breach its duty.

    Suitability, on the other hand, is a much less stringent standard of duty and is, therefore, subject to a lot of interpretation.  In fact, one of the arguments voiced by the brokerage community against making brokers subject to the fiduciary standard is that it could lead to “frivolous complaints and costly litigation,” as one article put it.  Under the current rules, if a client brings action against a broker/dealer, the burden of proof is on the client to prove that the broker/dealer owes a fiduciary duty to the client. 

Adding to the confusion of selecting the right financial professional is the fact that some sales professionals are licensed as both Investment Advisors and Registered Representatives (brokers).  In such cases, the duty owed to the client generally depends upon the product or service being presented.  A fiduciary duty may be owed when developing a financial plan, for example, but suitability rules may control when determining which variable annuity to purchase.

Congress Drops the Ball

The recent debate regarding financial reform has been quite interesting, but has centered on the large area of regulation having to do with banks that are “too big to fail.”  However, Senator Dodd’s financial reform bill originally included a provision that required ALL investment professionals to exercise a fiduciary standard when dealing with clients.

Unfortunately, if Congress has anything to say about it (and they do), the public would have stayed in the dark concerning fiduciary duty.  Shortly after Senator Dodd released the latest version of his financial reform bill in mid-March, the fiduciary requirement was dropped from the bill.  The Investment News online publication put it this way:

“The financial-reform package introduced last week by Senate Banking Committee Chairman Christopher Dodd, D-Conn., dropped an earlier provision that would have imposed a fiduciary duty on anyone offering advice on investments, dealing a blow to those who support the standard.”

Read another way, it only took a week for the fiduciary standard to become an early victim of Wall Street’s relentless lobbying effort to have it stricken from the Dodd financial reform bill.  This intense lobbying should make you wonder why the big Wall Street brokerage firms feel it is so important that brokers not be held to a fiduciary standard. 

As with most issues related to Wall Street, it comes down to a matter of dollars and cents.  Brokerage firms make millions of dollars in commissions and fees from brokers exercising only the suitability standard in regard to client accounts.  If subjected to a fiduciary standard, much of this largesse would either have to come to an end, or be disclosed so prominently that competitive pressures could soon make them a thing of the past.

An Investment News headline probably said it best when it proclaimed, “Wall Street wins big as Dodd drops fiduciary provision.”  If Wall Street wins big, who loses?  Be careful – it just might be you.

Think about it, just a week after introduction of the revised Dodd financial reform bill, extending the fiduciary standard to brokers had been relegated to the trash bin.  Don’t you find it interesting that Congress is so intent to increase regulation on the financial industry yet tossed out the one provision that would likely have had the most effect on investors’ day-to-day relations with financial professionals?

I’m sure you’ll be happy to know, however, that the Dodd bill did retain a provision calling for the SEC to do a year-long study of whether stockbrokers should be held to a fiduciary standard when providing investment advice to clients.  There’s more of our tax dollars at work and, if the past is any indicator, an SEC endorsement of the fiduciary standard for brokers won’t be a slam dunk.

That’s because back in 1999, the SEC proposed a rule that would exempt stockbrokers from fiduciary status, even if they performed the same duties and were compensated the same as investment advisors.  This rule, called the “Merrill Rule” because Merrill Lynch was a primary beneficiary, was finally adopted by the SEC in 2005 but was later struck down by DC Circuit Court of Appeals in 2007. 

More recently, however, SEC Chair, Mary Shapiro, has been receptive to a uniform fiduciary standard for all investment advisors.  Still, this is no guarantee that one will ever make it into law even if the SEC report recommends that brokers be held to a fiduciary standard.  The negative media coverage of the Goldman hearings will soon fade from memory, but the megabucks from Wall Street lobbyists will hang around a lot longer.

Goldman Hearings Revitalize Fiduciary Discussion

If you have been watching the Congressional hearings featuring current and former Goldman Sachs executives, I’m sure you’ve found them to be highly entertaining.  It seems that the public likes to see these guys who once earned multi-million dollar bonuses squirm under the glaring eye of Congress and the press.

However, one of the side benefits of these hearings has been the reintroduction of fiduciary duty in the discussion about financial reform.  What the industry had so quickly lobbied out of the bill may again become part of a final solution as a number of influential lawmakers have called for a fiduciary standard for all investment professionals to be reintroduced into the bill.

Considering the above discussion about doing what’s best for the client versus what’s best for the firm, it’s clear to see why the large brokerage firms sought to exclude fiduciary liability for their sales staffs.  After all, certain types of transactions were extremely profitable, even if they did constitute a conflict of interest.

I think the discovery that many of the actions taken by Goldman Sachs for its own good that were contrary to the advice being given to its clients has shown the American public that there is a need for change in the way certain types of financial firms relate to their clients.  If not a fiduciary standard, then certainly a requirement to disclose all conflicts of interest should be mandatory.  Either would help put all financial professionals on a more even footing.

The Fiduciary Standard Isn’t Infallible

While the fiduciary duty requirement leads to a higher standard of care, it’s a sad fact that some Investment Advisors do not live up to the ideal.  Many of the Ponzi scheme operators unmasked in 2008 and 2009 were licensed as Registered Investment Advisors, including Bernie Madoff’s scam that cost investors billions of dollars.

In fact, some broker/dealer organizations point out that the Financial Regulatory Authority (FINRA) shows that in 2008, there were actually more arbitration claims made for breach of fiduciary duty (2,838) than for violations of the suitability rules (1,181).  The broker/dealers claim that this shows the fiduciary duty is flawed.  What it actually shows, however, is that investors have a much clearer legal course of action against an Investment Advisor than they do a stockbroker.

Even so, there’s no doubt that investor vigilance is necessary in evaluating any financial advisory relationship.  I have written about how to select financial professionals many times in the past, but the information bears repeating.  Here are just a few tips for selecting the right advisor for the job:

  1. Determine Your Needs – The first and most obvious direction is to determine whether you want just a salesperson to execute a transaction or a financial professional who can give you investment advice with your best interests in mind.  There are many situations where the suitability rule is sufficient for the transaction involved.  Remember, however, that you should be wary of any investment alternative sponsored by the firm represented by the sales person or offered from its inventory in a “principal trade.”

    If you need unbiased financial advice, however, it’s best to seek out an Investment Advisor who has a fiduciary duty to do what’s in your best interest.  This is especially true if you have a portfolio of existing assets, since the fiduciary should be less likely to suggest that you sell everything to generate new commissions.

  2. Ask Questions – The confusing array of sales professionals makes it hard to tell whether a fiduciary standard of care is required or not.  Is a “financial planner” a fiduciary or not?  What about someone claiming to be an investment advisor?  What about insurance agents, annuity brokers, etc., etc., the list goes on and on. 

    The best way to settle the matter is to ask if the person giving you advice is required by their licensing to exercise a fiduciary standard of care in regard to the investment advice given to you.  Ask specifically what kind of registration or licensing they have, and check them out on the Internet at the appropriate regulatory website.

    Also ask about how the sales professional will be compensated, including any ancillary benefits such as credit for a contest or trip through the broker/dealer.  Yes, it is sometimes uncomfortable discussing compensation, but remember that it is from YOUR MONEY that any compensation will be paid.  This should make it somewhat easier to bring up.

    It also pays to ask if the person is dually licensed as both an Investment Advisor and registered rep.  If so, ask which hat he or she is wearing in the transaction you are contemplating.  If a financial professional acts indignant at your asking questions or minimizes the value of any disclosures, you may want to look elsewhere for an advisor.

  3. Read the Disclosures – As noted above, anyone in a fiduciary capacity must furnish certain disclosure materials that cover the way they do business, any potential conflicts of interest and the way the Advisor is compensated.  Absent these disclosures, it’s best to assume that you are dealing with someone who is only bound by the suitability rule, and does not owe you a fiduciary duty.  Yes, the disclosures are long and a sure cure for insomnia, but they contain important information you need to know before investing.

  4. Who Holds Your Money? – Even before the Bernie Madoff scandal broke, it was important to determine if the company actually holding your money was also affiliated with the Investment Advisor.  By employing an independent, third-party custodian or brokerage firm, you can have greater assurance that your money won’t disappear in the night or that you are receiving bogus periodic statements. 

    However, be sure to not execute any document that gives any advisor the authority to withdraw any money from your account other than fees, unless you are specifically interested in having a financial planner manage your cash flow and pay your bills.

  5. If it Sounds Too Good to be True… - This is the last but sometimes most important rule.  If an investment’s rate of return, level of risk or consistency of returns sound too good to be true, then they probably are.  High rates of return with minimal or no risk rarely, if ever, exist, nor do investment accounts with growth rates that are consistently the same from month to month.

There are other issues to consider when seeking an investment professional that space doesn’t permit me to cover in this week’s E-Letter.  To learn more, click on the following links to be taken to my July 11, 2006 and January 20, 2009 E-Letters that discuss ways to find reputable financial professionals.


The selection of a qualified financial professional is one of the most important decisions an investor will make.  However, the various licensing and registration requirements coupled with different duties and responsibilities often add confusion to the selection process.  Unfortunately, Congress quickly jettisoned the requirement for all financial professionals to be fiduciaries, so the current confusion will continue unless something changes.

I hope that the above discussion helps to clarify the fiduciary and non-fiduciary standard of care that affects you and your investments, and also who among the various types of sales professionals have the duty to put your interests first – and more importantly, those who don’t.

In the spirit of full disclosure, Halbert Wealth Management is a Registered Investment Advisor firm with the SEC.  As such, we have a fiduciary duty to those who seek our investment advice and counsel.  However, I also own a broker/dealer firm, ProFutures Financial Group, that exists only to facilitate the distribution of the various managed futures funds we have sponsored.

The important thing to know is that when you call or e-mail HWM about any of the programs I discuss in this E-Letter, you can know that you are dealing with an Investment Advisor employed by my firm who has a fiduciary duty to do what’s in your best interests.  I wouldn’t have it any other way!

With your best interests in mind,

Gary D. Halbert


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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