How Brokers Can Spin New Fiduciary Rules

The brokerage industry fought against the new fiduciary rules of the Department of Labor every step of the way.

The battle seems to be over and ended in a kind of draw. The brokerage industry may not like the new rules for retirement accounts, but you are still free to do business as usual on taxable accounts. And many family investors remain as confused as ever about whether their broker has a conflict of interest.

These new rules address conflicts of interest for brokers and other financial professionals who offer retirement advice by requiring advisers to adhere to a fiduciary standard when managing assets in retirement accounts.

Many laypeople are confused about what this means and which professionals have fiduciary responsibility to their clients. In its simplest form, a fiduciary standard means that professionals subject to the standard must put the best interest of clients before their own gains when offering financial advice or making investment decisions. For example, a trustee is not only obligated to offer suitable investment options, but must take special care to avoid conflicts of interest whenever possible and to disclose potential conflicts when they arise. The Investment Advisers Act of 1940 specifically defines the role of a fiduciary, and the Securities and Exchange Commission is charged with enforcing the rule thoroughly.

Until the new rules went into effect, SEC-registered investment advisers were subject to this standard, but stock brokers, insurance agents, and some other professionals who provide investment advice were not. Instead, they were subject to the less strict suitability rule. This rule requires brokers to make recommendations consistent with the best interests of the client, which means that they cannot recommend totally inappropriate investments. But they are not required to put their own interests below those of the client, allowing them to favor more expensive investments or trade more frequently to generate more commissions. They are also not required to disclose conflicts of interest.

The new rules subject brokers to the fiduciary standard that applies to RIAs, but only in regards to retirement accounts. For taxable accounts, the eligibility rule still applies.

A highly publicized survey from a few years ago found that many people mistakenly believe that financial advisers to brokerage firms are fiduciaries; 76 percent of those surveyed thought so. (1) The same survey suggested that most investors were unaware that different rules apply to investment brokers and registered investment advisers.

Many brokers will take advantage of their clients’ confusion, apathy, or both to put these mandatory changes in the best possible light. For example, a couple I know works with a broker for a large wealth management company. The broker manages your portfolio, including retirement accounts, which means it is subject to the new rules. He told his clients that investments in his retirement accounts had underperformed, so he was moving assets toward better-performing, less expensive alternatives.

I asked if the broker had mentioned any other reason for the change, as it seemed obvious to me that the broker was acting in response to the new Department of Labor regulations. No, they told me, he did not mention other reasons.

It is not difficult to see why a broker would prefer to informally present such a change as his own good idea. We all want to present our professional services in the best possible light and of course he would rather be the hero saving a client money rather than the villain forced to put the client’s interests first because the government said what he had been doing was already it is not legal. Not talking about the new regulations is not completely misleading; many clients may not be interested in a detailed explanation. And changes are required to be mentioned in written disclosures, however voluminous. But this does not help investors to better control the situation.

The incident highlights a real and ongoing problem in the world of personal finance, one that the new rules don’t effectively address. For many consumers, it is unclear which financial professionals are sitting on their side of the table and which are the salespeople in the first place. Everyone wants to appear useful; many of the terms and titles say little to consumers unless they do more research. “Financial advisor” can mean many different things, depending on who the advisor works for and what exact services the company provides.

Department of Labor rules require counselors to commit to fiduciary standards, disclose any potential conflicts of interest, and institute policies to mitigate any conflicts that arise. But how many consultants will take the time to make sure clients read and understand the documentation, rather than simply marking the places where the client needs to sign what they assume is standard legal jargon?

For now, proactive clients will continue to be better served by asking their advisers, or potential advisers, directly if they are fiduciaries. In fact, it should be one of several questions, such as how often investments are monitored, what is the advisor’s underlying investment philosophy, and how their fee structure works. But the concern behind the new Labor Department rules is that many investors don’t know how to ask these questions in the first place.

While the new rules are helpful, they are not enough to ensure that consumers can make the best possible decisions. Consumers need a real education on what a fiduciary is, whether or not their advisor is, and why the distinction is important. We cannot reasonably expect non-fiduciary advisors to voluntarily provide such education if they are not required to do so.

Fountain:

1) Bloomberg, “‘Bewildered’ Investors Think Brokers Are Fiduciaries, Survey Finds”