You may not have noticed but, in our world of providing investment advice, there has been quite a discussion over the last nine years regarding how investment professionals conduct themselves on behalf of clients. It all began in 2010… when the U.S. Department of Labor (DOL) set forth a proposal to subject more of our industry to what is called a Fiduciary Duty (BCM has been a fiduciary since day one back in 1986). So, what’s all the fuss about?
There are two distinct standards of care in our business: On one side of the street there are the stock brokers and insurance agents who work under the Suitability Standard which allows them a wide latitude of what they recommend to clients. It does not have to be the best option, it can just come from among many options that could be reasonably expected to work for the client. Also, important issues such as conflicts of interest (contest trips, anyone?) and costs are either not required to be disclosed or considered, causing the broker to potentially be more loyal to their broker dealer/employer, and to their own pocketbooks, than they are to the client. In contrast, advisors who work under a Fiduciary Duty are required to always put the best interest of the client first. In doing so, they are required to fully disclose any conflicts of interest and costs do matter.
Let’s look at a quick example of how a client may be treated under both standards in the case of Sue who has $100,000 to invest.
Sue first goes to see Jim, a commissioned broker working under the Suitability Standard for Big Brokerage Firm. While there could be others, here are three typical options Jim might recommend to Sue:
Managed Account: This is a fee-based account where Sue will pay 1.5% annually. Jim splits that fee 50/50 with his brokerage firm. Since they bill Sue on a quarterly basis, Jim ends up getting paid about $187.50 per quarter.
Mutual Funds: Instead, Jim could choose from the firm’s list of approved mutual funds with upfront commissions between 3.00% and 5.75%. In this case, Jim’s 50/50 split with his firm pays him between $1,500 and $2,875 – now.
Annuity: A third option, one that has a lot of sizzle, is the variable annuity from the long-established insurance company. It has “guarantees” and tons of investment options, etc. (we call these bells and whistles) that make it appear almost too good to be true. The upfront commission is 8% netting Jim about $4,000 – now.
If all three of the above are suitable for Sue, which do you think Jim the Broker may be inclined to recommend? As always, follow the money.
Please do not misunderstand us. All brokers are not bad people, they just operate in an environment that incentivizes them to sell certain products over others. But there is a better way – the Fiduciary way.
Sue also considers working with Bob, an Investment Advisor Representative with the Fiduciary Advisory Group, an RIA working under a Fiduciary Duty. Bob’s firm has a clearly defined approach to investing that they apply to all their client relationships in a way that meets the needs and objectives of each client individually. In doing this, they also offer financial planning services to help Sue achieve her goals.
For these services, Sue will be charged according to the firm’s stated fee schedule: 1% annually. Bob, for his part, will be compensated only by his firm’s internal compensation structure which in no way incentivizes him to recommend one solution over another – only what is in Sue’s best interest.
In this arrangement, Bob and his firm have a natural incentive to maintain a good long-term relationship with Sue. On the other hand, Jim the Broker may be more interested in seeking new client relationships that generate upfront compensation.
Hopefully this helps explain why the DOL has been pushing so hard for so long to subject more in our industry to exercise a Fiduciary Duty in their client relationships.
But, as politics would have it, what was proposed some nine years ago has yet to be passed into law. It started under the Obama administration and is still being debated.
Even though the new Rule is not yet in place, the fact that such a discussion has been taking place over the last nine years has been beneficial. The Big Brokerage firms have been given notice and are starting to make small, albeit reluctant, changes. Even more important is how the public has become better educated. They are asking more questions and hopefully making better decisions.
While more government regulation is not something we typically applaud, we are pleased to know that, in the world of giving investment advice, there is a move towards the gold standard of care that we have always championed.
Q: How do I know if an advisor is a fiduciary?
A: Ask them. Our answer is: Yes, for 33 years and counting!