Congress Drops the "F-Word" (Fiduciary)
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
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:
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:
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:
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 ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, 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, ProFutures, 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.