Aug. 6, 2018
As a society, we embrace the idea that doctors and lawyers are required to act in their patients’ or clients’ best interests. Doctors violating the Hippocratic Oath face stiff penalties, including the potential to lose their license to practice medicine, and lawyers dealing in their own self-interests or who fail to disclose conflicts of interest can be disciplined or even disbarred. But what about the people you hire to advise you on your financial health? Shouldn’t they be legally required to act in your best interests as well? According to a recent Financial Engines survey, 93% of Americans think so.
From my perspective, acting in clients’ best interests has always been a no-brainer. But it’s also been the subject of hot debate for several years within the financial services industry—or at least until June of this year. That’s when the Department of Labor (DOL) Rule, which would require all financial advisors to act in their clients’ best interests regarding retirement accounts met its demise when the U.S. Fifth Circuit Court of Appeals confirmed its decision to vacate the rule. The decision came after the full implementation of the rule was stalled following efforts by the Trump administration to investigate its effects on business. Critics claimed the rule, which sought to redefine who is considered an investment advice fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA), would be costly for the advice industry to implement and could introduce liability that would essentially end access to financial advice by retirement savers of modest means who could not afford to pay directly for professional financial advice. However, proponents argued that the rule was necessary to provide valuable safeguards to those same investors. So, where does the demise of the DOL Rule leave investors?
While certain product features and compensation standards that were ushered in as the industry prepared to implement the DOL Rule may remain in place for the near future, it remains to be seen if the industry will revert to pre-DOL standards where the requirement for advisors to act in a fiduciary capacity when advising clients on retirement plan assets is concerned. To understand why, it’s important to first understand that not all financial advisors are fiduciaries. Many are simply brokers—essentially, financial sales representatives. As such, brokers are not obligated under the law to act in the best interests of their clients. Instead, they’re held to the suitability standard. That means a broker can sell investment products that are “suitable” for your goals and financial circumstances but are not required to ensure the products or advice they provide is in your best interests. In addition, while brokers must disclose conflicts of interest, they are not obligated to avoid conflicts. Fiduciaries, on the other hand, have a legal obligation to provide the highest standard of care by acting in the best interests of their clients at all times, which includes avoiding conflicts of interest.
While on the surface, these differences may appear subtle, in reality they’re anything but. That’s why it’s so important for investors to do their homework and understand if their financial advisor is a fiduciary. With few exceptions, the legal structure your advisor operates under will determine if she or he is required to serve you in a fiduciary capacity or is only subject to the suitability standard. For example, Under the Investment Advisers Act of 1940, registered investment advisor (RIA) firms have a fiduciary duty to all their investment clients. Yet, understanding the complex regulations and different legal structures that financial advisors and their broker dealers operate under can be highly confusing. In fact, according to Financial Engines, 38% of Americans are unsure if their advisor is a fiduciary and 60% would consider seeking help to determine whether their advisor is a fiduciary.
The easiest way to determine if your advisor is a fiduciary is to ask. Only Investment Adviser Representatives (IARs) are required to act as fiduciaries at all times with their clients. This means IARs must always place client interests above any personal interest. Advisors holding certain designations and certifications, while not required by law to act in a fiduciary capacity, are required to do so to maintain their designations. For example, CERTIFIED FINANCIAL PLANNERTM (CFP®) professionals are held to a fiduciary standard by the CFP Board of Standards. CFP® fiduciary standards apply to a broad scope of financial planning, including retirement, tax and insurance advice. Likewise, advisors holding the Accredited Investment Fiduciary® (AIF®) designation, issued by fi360’s Center for Fiduciary studies, are required not only to be fiduciaries, but also prove their knowledge of fiduciary rules and engage in ongoing education.
4 Questions to Ask Your Advisor Now
To determine if your advisor is required to avoid conflicts of interests and always placing your best interests first, begin by asking these questions.
1. What is your firm’s legal structure?
Advisors operating under their own or their broker dealer’s registered investment advisor (RIA) firm can serve clients in a fiduciary capacity. In some cases, an advisor may be a “dual-registered” or “hybrid” advisor who is both a registered representative associated with a broker dealer and an investment advisor representative of a RIA. If your advisor is dual-registered, ask the advisor to explain what that means for your relationship. In what circumstances will he or she act in a fiduciary capacity vs. a broker?
2. How are you registered and what professional designations do you hold?
As previously mentioned, registered investment advisor (RIA) firms and their investment adviser representatives (IARs) are required to serve as investment fiduciaries. Other advisors, such as AIF® and CFP® professionals are also bound to professional fiduciary standards of care. Registered representative of brokerage firms, or brokers, are only required to meet suitability rules when selling financial and investment products.
3. Are you compensated for selling financial products, or the services you provide?
If your financial advisor receives commissions for selling certain mutual funds, annuities, or other financial products, then they are almost certainly acting as a broker. IARs, on the other hand, generally charge an advisory services fee based on assets under management. This compensation structure helps to ensure advisors acting in a fiduciary capacity have a vested interest in the advice they provide.
As your advisor explains how they’re compensated, the way they disclose their fees can be very revealing. Clarify how much of the fee you’re paying is for your advisor’s services versus the fees that certain financial products have embedded in their cost structure. These undisclosed fees can sometimes mean you’re being charged up to twice as much as you have been told.
4. Have you or your firm ever been cited for disciplinary reasons?
Whether the advisor is a fiduciary investment advisor or a broker, you can look up the advisor’s record on BrokerCheck to find out if any complaints have been made against them. Disciplinary actions and complaints can be a red flag that current or past conflicts exist or that the advisor is not living up to fiduciary standards, assuming he or she is subject to them.