Only a fiduciary should be taking care of your money. But here’s something that might surprise you: All fiduciaries are not created equal, no matter what it says on paper. Some look after your interests more reliably than others.
Right now, we’re in the midst of a political brawl over whether advisers to retirement accounts should provide fiduciary care. The right answer is “yes,” but the brokerage and insurance industries are shouting “no.”
Out of sight of the public, an even more crucial fight is taking place. Should the fiduciary standard be watered down, to cover behavior that could render it essentially meaningless?
But before I dive into these risks and what they mean for investors, I need to provide some explanations.
First, what’s a “fiduciary?” It’s someone who owes you a duty of trust. When invited to manage your affairs, a fiduciary is required to act with loyalty and exemplary care. Those who give investment advice are currently held to what’s called a “best interests” standard – meaning that they’re supposed to put your financial interests ahead of theirs. Registered Investment Advisers (registered with your state or with the Securities and Exchange Commission) are always fiduciaries. They usually charge flat fees or a percentage of assets under management, as opposed to sales commissions. All fees and conflicts of interest have to be disclosed.
What’s a “financial adviser?” Undefined. In theory, anyone who gives investment advice for a living should register as an investment adviser and come under the fiduciary rule. But the SEC made an exception for brokerage firms. Brokers can give investment advice as long as its “solely incidental” to their basic business of selling financial products. Not surprisingly, a lot of advice (often, bad advice) gets classed as “incidental.”
With respect to clients, brokers are held only to a “suitability standard.” That allows them to sell high-commission products, rather than similar, lower-cost ones, as long as they’re suitable for someone of your age and circumstances. Put another way, they can – and do – put their clients’ financial interests last. You might not even know how much you’re paying for packaged products such as complex annuities. Hint: You’re paying plenty.
What’s the issue with retirement accounts? The U.S. Department of Labor hates to see workers’ savings eaten away by “suitable” but high-cost financial advice. So it created a new fiduciary rule, applicable to Individual Retirement Accounts and 401(k)s. The DOL rule is stiffer than the traditional fiduciary standard. It specifically discourages conflicts of interest, such as sales commissions, and is tougher on both cost disclosure and enforcement. Class action lawsuits are permitted if firms fail to discharge their fiduciary duties. Supposedly, this rule becomes effective April 10.
It sounds as if the fiduciary standard is spreading. What could go wrong? I have three main worries.
1) The DOL rule, or the heart of it, might bite the dust. Politically, its opponents in the financial industry have gained the upper hand. Last month, White House economic adviser Gary Cohn called the DOL rule “bad for consumers” and President Trump put it up for reconsideration. (In what passed for wit, Cohn said that customers deserve to see tasty, unhealthy foods on a restaurant menu, not just healthy ones.) Opponents of the rule especially want to quash any way of enforcing it.
2) The SEC, under assault by lobbyists for the financial industry, might weaken the classic fiduciary standard. As written, the standard focuses on disclosure. Fiduciaries should provide their clients with a complete list of costs and fees. They also have to disclose any conflicts of interest, to help you judge whether you’re being treated fairly. Conflicts include commissions as well as fees or referrals the adviser’s firm receives in return for recommending certain products or services. You’ll find the disclosures in the adviser’s ADV Form, Part 2, usually sent to you once a year.
Following the “best interests” standard, fiduciaries shouldn’t be influenced by commissions or fees. But highly-placed staff at the SEC have wondered, aloud, whether “best interests,” “suitability,” and “disclosure” are all pretty much the same thing. If the firm informs you of its conflicts of interest, these SEC staffers say, and you buy its costly proprietary products, you must have decided they’re in your best interest. Maybe the fiduciary standard merely means “informed consent.”
But by the traditional rule, conflicted advice is nowhere near a duty of loyalty and care. It’s what you expect from brokers, not fiduciaries. But the politics of regulation are leaning toward this self-interested version of “duty.” Already, some major investment firms are calling themselves fiduciaries even though their disclosures show that they favor their own high-cost mutual funds and accept payments from third parties to push hedge funds and similar products. Most likely, their clients don’t read the disclosures (heavy with legalese). Even if they do, academic research shows that disclosing conflicts of interest doesn’t deter investors from taking bad advice. All it does is secure investment firms against complaints.
3) Brokerage firms are already prepared to act as fiduciaries for retirement accounts, just in case the DOL rule, or part of it, takes effect. But instead of bringing clarity to their duty of care, many firms are muddying the waters. Your adviser might be a fiduciary for your IRA but a transactional broker for your non-IRA funds, freeing him or her to sell you high-cost products on the side. A rarely traded brokerage account might be switched into a fee-based managed account, at a much higher cost. You heard the word “fiduciary” when you signed up, so you assume that you’re in safe hands. That’s not necessarily true.
What does all this mean to investors? They have to be even more careful when searching for financial advice. Many more firms will be singing the fiduciary song and pledging to put your interests first. But as you have seen, “best interests” is fast becoming a slippery term. So read the fine print in any agreement, avoid advisers whose conflicts of interest loom large, demand low costs (they always beat high costs), and insist on fiduciary care for all your accounts. With the DOL probably neutered and the SEC wavering, it’s up to investors to be sure they’re getting the real thing.