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Why You Still Can’t Trust Your Financial Adviser

The giant loophole in the government's new fiduciary rule


(This article originally appeared on Nerdwallet.com.)

If you have a financial adviser, expect to hear from him or her soon about a great new investment opportunity for your IRA — if you haven’t already.

The reason: There’s a loophole in a strict new rule that requires advisers to act in their clients’ best interests when counseling them about retirement funds. That loophole allows advisers to continue lining their pockets at the expense of yours until the federal rule takes effect April 10, 2017, and even beyond.

People need to be watching out for advisers who are trying to earn last-minute excess profits before the rule goes into effect.

— Barbara Roper, Consumer Federation of America

“There’s a grandfather clause,” explains Barbara Roper, director of consumer protection for the Consumer Federation of America. “People need to be watching out for advisers who are trying to earn last-minute excess profits before the rule goes into effect.”

Not all advisers are out to get you, of course. But enough of them are taking advantage of small investors that the U.S. Department of Labor (DOL) finally has called foul.

The department’s so-called “fiduciary rule” holds advisers to a much higher standard when their advice pertains to a workplace retirement plan or an IRA. The rule doesn’t prohibit advisers from earning commissions on their investment recommendations, but it does require them to disclose their conflicts of interest and charge “only reasonable compensation” while forbidding financial incentives that encourage advisors to act contrary to their clients’ best interests.

Clients will have to sign this “best interests contract exemption” and can sue their advisers in court if they believe their interests haven’t been properly served.

The Fallout Will Be Huge

Among the many consequences, expect that:

Annuity sales will drop. It’s going to become a lot harder for an adviser to justify recommending high-cost, high-commission products such as variable annuities and indexed annuities for your retirement plan. The primary advantage of annuities is tax deferral, and you’ve already got that in your IRA and 401(k). It’s pretty clear who’s benefiting from these recommendations — and it’s not you.

Rollovers will be trickier. Advisers are often eager to get their hands on 401(k) money and they promote rollovers into IRAs as a way to get at it. Once the new rule is in effect, advisers will have to explain why you’re better off in a higher-cost retail IRA than you were in your lower-cost, institutional 401(k).

“Incentives” are on the endangered species list.  Annuity providers have long proffered bonuses, prizes and other inducements, including trips to luxury resorts on tropical islands, something known as “incentive travel,” to advisers who push their products. The effect of the Labor rule is expected to be so significant that two industry groups, the Financial & Insurance Conference Planners and the Society for Incentive Travel Excellence, issued a joint statement warning meeting planners to brace for its impact.

You’re Not Out of the Woods

Elimination of these obvious conflicts of interest is good, but there still are many substantial threats to your financial well-being. Among them:

The rule doesn’t apply to nonretirement accounts. Your adviser can continue to sell you expensive or poorly performing investments for your brokerage account or your kids’ college funds even though better, cheaper ones are available — just because the adviser gets paid more to push the inferior versions.

Advisers get away with this on nonretirement accounts because instead of being held to a fiduciary standard, they’re covered by the much lower “suitability standard,” which only requires the adviser to “have a reasonable basis for believing the recommendation is suitable for you,” according to the Securities and Exchange Commission.

Wall Street is still fighting the new rule. The U.S. House of Representatives voted in April to block the rule, but Republicans failed to gain enough support to override a sure presidential veto. Now, financial industry groups and the U.S. Chamber of Commerce have filed a lawsuit challenging the fiduciary standard. The Department of Labor says it’s confident the rule can withstand any legal challenges, but it’s possible the battle could delay implementation.

Financial firms still will try to justify the unjustifiable. Some companies will seek ways around the rule so they can continue to push “high-commission garbage” on their unsuspecting customers, says Bob Veres, publisher of the financial planning trade publication Inside Information. Investor lawsuits eventually will bring that behavior to a halt, since “the whole enforcement mechanism is the court system,” Veres says.

“One of the things that scares the brokerage firms and independent broker-dealers is the fact that they aren’t going to be dealing with regulators, who they can slyly promise a nice, lucrative post-DOL employment career if they ‘play ball,’” Veres says.

Even with the new rule in place, your adviser could be a skunk. The suitability standard isn’t that hard to meet, and yet many advisers couldn’t even manage that. More than 7 percent of advisers overall and up to 20 percent at some big firms have been disciplined for misconduct or fraud, according to a working paper by researchers at the University of Chicago and the University of Minnesota who studied 10 years of records from BrokerCheck, a financial adviser database.

The advisers were disciplined for unsuitable investments, unauthorized activity, omission of key facts, fraud, negligence, misrepresentations and excessive trading.

The researchers allege that some firms “specialize in misconduct” by tolerating bad behavior and hiring advisers with spotty records. Most of those disciplined either kept their jobs or promptly were hired by another firm.

How to Find a Good Adviser

You might conclude, as many others have, that you’re better off avoiding financial advisers entirely. You’re not.

The best advisers can save you time and money, protect you from threats to your wealth and get you to your goals a lot faster. A really good financial planner is especially important in the five years before and after retirement, when you’ll be making a lot of decisions that can’t be reversed. These choices can spell the difference between a comfortable retirement and running out of assets before you run out of breath.

So how do you make sure you have one of the good ones? These tests can help:

Your advisor has earned a CFP or a PFS credential. Certified Financial Planners and CPA-Personal Financial Specialists have to take comprehensive financial planning coursework, pass a rigorous test and agree to certain ethical standards, including acting as a fiduciary when advising you about financial planning.

Advisers without comprehensive financial planning credentials don’t know what they don’t know, which makes them a potential menace to your financial life. (You can check credentials with the CFP Board of Standards, the AICPA or CPAVerify.)

Your adviser will sign the fiduciary oath. This plain-English promise, created by a group of financial planners promoting the standard, spells out that your adviser is committed to putting your best interests ahead of his own. It’s simple, it’s straightforward and if he balks, you’ve learned all you need to know about whose side he’s on.

You’ve done a background check. You don’t get to skate on doing your due diligence. Not all bad actors have a checkered history — witness former investment adviser and fraudster Bernie Madoff — but there’s no excuse for hiring someone who’s already screwed over previous customers, however charming or highly recommended he or she may be.

There are too many other good, honest advisers out there to entrust your savings to someone with a history of misconduct.

Your adviser’s not human. The Department of Labor pointed to robo-advisers as a low-cost source of fiduciary advice for small investors — and for good reason. Robo-advisers such as Betterment and Wealthfront use computer algorithms and dirt-cheap exchange-traded funds to manage your investments for a fraction of what a human advisor would cost.

The services typically cost between 0.3 percent and 0.5 percent of the amount you invest, a charge that includes the expense ratios of the underlying funds. Contrast that with human advisers who may charge 1 percent, on top of the 1 percent or more cost of the underlying investments.

Some robo-advisers take a cyborg approach, combining computerized portfolios with phone and email access to a human adviser. Even when a human is involved, though, the services are committed to a fiduciary standard of care to put your best interests first.

Not all robo-advisers are conflict-free. Some, including Schwab Intelligent Portfolios and Blackrock’s FutureAdvisor, use proprietary products that could run afoul of the new Department of Labor rules, says financial planner Michael Kitces, who blogs at Nerd’s Eye View.

Still, we’re typically talking about fee differentials measured in tenths or even hundredths of a percent. That’s a far cry from the 5 percent commissions and 20 percent surrender charges that plague investments sold by nonfiduciary advisers.

And no one will ever offer a trip to a luxury resort to a computer as an incentive to tilt the portfolio their way.

By Liz Weston
Liz Weston is a columnist at NerdWallet, a personal finance website, and author of Your Credit Score. Email: [email protected] Twitter: @lizweston@lizweston

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