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New regulations require paid
financial advisers to adhere to a “fiduciary standard” instead of the much
weaker “suitability standard” when recommending retirement investments. What do
these regulations mean for consumers? And how can we ensure that our own
personal advisors are adhering to the new standard?
The fiduciary
standard in a nutshell
On April 6, 2016, the
Department of Labor announced a new fiduciary standard of care for brokers who
provide retirement advice. Prior to the announcement, commission-based brokers
were held to a less-stringent standard, requiring only that advice or product
offerings be “suitable” as opposed to “in the best interest” of the client.
“The new ruling is an important
first step toward greater transparency in the entire industry,” says Mathew
Dahlberg, who runs the wealth management firm Main Street
Investments in Kansas City, Missouri. “At its core, the
fiduciary standard means that an advisor must always act in their client’s best
interests as prescribed by law.”
So what, exactly, does that
mean? “As a practical matter, this means that the advisor must always disclose
conflicts of interests between themselves and their clients,” says Dahlberg.
“This distinction gets right to the heart of the advisor’s incentives.”
Dahlberg provides this
example: An advisor who doesn’t have to act in a fiduciary capacity, such as a
broker, could recommend an investment to their clients while at the same time
selling that same investment in their personal account. A fiduciary
advisor could never lawfully engage in such a practice.
Is your
financial expert obliged to comply?
Consumers can come right out
and ask if their advisor is a fiduciary, but it’s a bit of a loaded question.
“You should be aware that the law allows some financial advisors to act as
fiduciaries in some transactions while adhering to the suitability standard in other
transactions,” explains Dahlberg. “Therefore, it is important for the consumer
to get in writing that the advisor is always acting in a fiduciary capacity. An
easier way is to simply make sure that you engage an RIA [Registered Investment
Advisor] instead of a broker or dealer. While many of the latter are now often
pledging to act as fiduciaries in their client relationships, only the former
are legally required to do so at all times.”
The good news is that if an
advisor doesn’t adhere to the new standard, at least a consumer will have an avenue of recourse in the event of losses.
But is it all
it’s cracked up to be?
The rule will not go into
effect until the end of 2017, but it “paves the way for a greater standard of
care,” says Timothy Baker, founder and CEO of Wealthshape LLC, a Connecticut-based
financial advisor specializing in low-cost quantitative investment management and
fiduciary advice. “It demands more transparency from the brokers and shines a
light on the ‘suitability versus fiduciary’ delineation.”
But the new standard is not
perfect. “There are caveats to the rule that I’m not a fan of, the largest
being that it only applies to retirement accounts and not taxable investment
accounts along with the best interest contract exemptions,” says Baker.
“However, while I and others believe a fiduciary standard should apply to all
investment advice, this appears to be an important step in that direction.”
Others aren’t so sure. “I wish
the new rule were truly as significant as the headlines suggest, but intense
broker and insurance industry lobbying has prevented implementation of a true
fiduciary standard,” says certified financial planner Warren Ward of WWA Associates in Columbus, Indiana.
“Attorneys owe such a duty to their clients, but brokers and agents owe theirs
to their employer.”
Ward explains that the
Investment Advisors Act of the 1940s has created a relationship between the
brokerage industry and the Securities and Exchange Commission (SEC) that is so
intense that it has prevented enactment of such a standard for the entire
industry. “Instead, the Department of Labor has tried to do so by itself, at
least to extent that investments are part of its world—basically 401(k) plans
and rollovers.”
Between now and when the new
rule goes into effect, there are likely to be challenges to its full
implementation. “In addition,” says Ward, “some of the most unsuitable
investment options—proprietary funds, non-publicly traded REITs [Real Estate
Investment Trusts], and variable annuity contracts—will still be allowed under
what’s known as a Best Interest Contract Exemption (BICE).”
“Any financial advisor who
isn’t willing to state a fiduciary duty toward the client is in effect stating
that his or her duty remains with the agency or brokerage company and not with
the customer,” cautions Ward.
“At this point, the rule’s
greatest value is the increasing awareness,” observes Ward. “It’s time for
investors to begin asking themselves, ‘Wait a minute, why hasn’t my advisor
always been acting in my best interests?’”
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