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What Protects Investors More Than The Fiduciary Rule

The new government rule that kicks in today is very limited


Part of the Political Issues and Policies Special Report

You may have heard that the U.S. Department of Labor’s on-again/off-again Fiduciary Rule to protect retirement investors will finally begin taking effect today, June 9, 2017. The rule, finalized by the Obama administration in April 2016 and originally scheduled to take effect April 10, 2017 before the Trump Administration put a hold on it, is designed to put clients’ interests ahead of brokers.

But here’s the thing: It’s not the federal Fiduciary Rule for investors in IRAs and 401(k)s that matters. It’s the fiduciary standard for all investors.

Financial advisers who meet the fiduciary standard must put their clients’ loyalties first. All their clients. The irony is, this standard doesn’t apply to the vast majority of financial advisers. That’s because most financial advisers in America aren’t independent advisers. They work for brokerage firms and those firms aren’t required to meet the fiduciary standard.

The Suitability Standard

Let me explain: Advisers at brokerage firms are licensed representatives who are allowed to sell investments and receive commissions or kickbacks from those recommendations. By law, brokerage advisers only have to make sure the investments they recommend can be considered “suitable” for a client. This lower “suitability” standard has invited a multitude of conflicts of interest that have been tolerated for decades.

Financial advisers who meet the fiduciary standard must put their clients’ loyalties first. All their clients.

The federal Fiduciary Rule, by contrast, requires that any adviser who offers retirement advice be fully transparent with clients for all expenses, fees and conflicts of interest. It goes a long way to ensure that all advisers, brokers or insurance agents offering retirement investment advice would behave as fiduciaries, effectively replacing the lower bar provided by the suitability standard that brokerage firms have relied on.

The Public Favors The Fiduciary Rule

And it’s what the public wants: In a Financial Engines survey, 93 percent of Americans said they think it’s important that all financial advisers who provide retirement advice should be legally required to put their clients’ best interest first. (The survey also found that 53 percent of Americans mistakenly believe financial advisers have already been legally required to put their clients’ best interests first when giving retirement advice.)

The financial services industry doesn’t make it easy for investors to see how little is required of advisers when it comes to consumer protection. The FINRA suitability standard (FINRA is the financial services industry’s self-regulatory organization) that the brokerage world has operated under for years says in part, “A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.”

Nowhere in the suitability standard does it state that the broker must act in the client’s best interest.

The Fiduciary Standard

By contrast, the Securities and Exchange Commission (SEC) provides the following information for investment advisers who are newly registered with the government agency:

“As an investment adviser, you are a “fiduciary” to your advisory clients. This means that you have a fundamental obligation to act in the best interests of your clients and to provide investment advice in your clients’ best interests. You owe your clients a duty of undivided loyalty and utmost good faith. You should not engage in any activity in conflict with the interest of any client, and you should take steps reasonably necessary to fulfill your obligations.”

There is no ambiguity here. Advisers registered with the SEC must put clients’ interests first to stay in business; most state-registered advisers are covered by similar rules.

Although Wall Street brokerage firms are familiar to the investing public through their advertising and marketing, there are thousands of independent financial advisers and wealth managers who’ve held themselves to the higher fiduciary standard. These money pros don’t need a government rule telling them to do the right thing.

But adhering to the fiduciary standard doesn’t guarantee expertise. The challenge for consumers has always been how to find independent financial advisers who are both competent and live up to the fiduciary standard. Just as there are really good brokers, there are also really bad independent advisers who label themselves as fiduciaries.

To find a good one, you’ll first want to understand the difference between two types of independent advisers: fee-only advisers and fee-based advisers.

A fee-only adviser receives no commissions, adheres to the fiduciary standard and works directly, and only, for you. Expenses and transaction costs are kept to a minimum because these advisers don’t accept kickbacks from the investment products they recommend. Fee-only advisers are paid either through an hourly fee, a retainer fee or a fee based on a percentage of assets under management. Fee-only advisers typically belong to the National Association of Personal Financial Advisors or NAPFA.

Fee-based advisers can earn some of their money from commissions on financial products such as mutual funds, annuities and insurance, and some from fees. There is no exact definition for fee-based advisers and no guidelines for them, so you’re flying blind. If you’re interviewing a fee-based adviser and considering hiring him or her, you’ll need to require full transparency so the adviser openly discusses any potential conflicts of interest.

Many independent advisers take a planning-first approach instead of being focused only on investments. This approach allows a qualified adviser to fully develop strategies free of any conflicts of interest.

5 Questions to Ask Before Hiring an Independent Adviser

To throw some light on an independent adviser’s strengths and weaknesses, here are five questions to ask any you’re considering hiring:

1. Are you a fiduciary adviser? Can I have it in writing? This is a simple request and a big red flag if the adviser balks.

2. Are you fee-only or fee-based? How much do you earn from commissions? It is important to understand how the adviser’s fee structure works and to what extent he or she earns money from commissions. There are some instances where excellent advisers sell commissioned products to best serve the needs of their clients, and this is fine. What isn’t fine is anything less than full compensation disclosure. If the adviser hems and haws, the conversation should end with you leaving the person’s office or hanging up the phone.

3. What does your educational and professional experience look like? A good look at credentials and education provides a better understanding of how the adviser’s personal and professional experience aligns with your needs.

4. Who is the custodian for your clients’ accounts? This is important for several reasons. Is the custodian — a financial institution responsible for safeguarding your assets — someone who is reputable? One of the ways Bernie Madoff perpetrated his fraud was by using his own custodian. Ask the adviser why he or she chose this particular custodian. Does the adviser receive any compensation from the custodian? Will you have online access to your money?

5. May I see your background records? All financial advisers who are federally- or state-registered are required to provide you with their Form ADV when entering into a relationship with you. While this is a dry, legalese type document, it includes some good information about the adviser and how he or she and the firm do business. Read it.

Beyond this, you can check on any adviser or firm registered with the SEC or their state on the SEC’s Investment Advisor Public Disclosure site.  If the adviser was ever registered with a brokerage firm, or is now, you might also search the FINRA Broker Check database for information.

One last thing about The Fiduciary Rule: Even though it begins taking effect today, the U.S. Department of Labor is still considering revising or repealing it before the rule takes full effect January 1, 2018. The House of Representatives just passed The Financial Choice Act legislation that would kill the rule (although the Senate is unlikely to go along.) And SEC Chairman Jay Clayton recently said his agency is asking the public for comments about standards of conduct for investment advisers which could lead to further changes in the rule. Stay tuned.

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Pam Krueger
By Pam Krueger
Pam Krueger is the creator and co-host of MoneyTrack, the award-winning PBS TV series on personal finance investing. A former stockbroker, Pam has just launched Wealthramp.com,  an online tool helping consumers find and connect with vetted, qualified financial advisers.

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