To Fiduciary or Not to Fiduciary

To Fiduciary or Not to Fiduciary:

Examzone asks the real questions

For years, agents and broker-dealers were guided by suitability, meaning any recommendation that matched the customer’s stated investment objectives was deemed suitable. If the agent received bonuses for pushing particular products, that was considered okay. On the other hand, investment advisers and their investment adviser representatives have long been held to a higher fiduciary standard. Unlike product salespersons at broker-dealers who sell mutual funds and annuities, investment advisers and their representatives are required to avoid, or at least disclose, any material conflict of interest that might make their advice less than objective.

For example, if the investment advisory firm places trades through their related broker-dealer when managing client accounts, the investment adviser is using client assets to benefit their related broker-dealer. That makes their advice less than disinterested and requires disclosure and client acknowledgment.

Fiduciary Fundamentals

At a time when most people had never heard the term “fiduciary,” back in 2010, the U.S. Department of Labor (DOL) started making the word part of the nation’s vocabulary with the introduction of the Fiduciary Rule.

In an April 2015 speech, President Obama proposed that the DOL resurrect the rule that all financial professionals—including securities and insurance agents—be held to a fiduciary standard if they provide any recommendations to retirement plans such as IRAs, 401(k) and 403b plans. From a speech to AARP, Obama said, 

“So, today, I’m calling on the Department of Labor to update the rules and requirements that retirement advisors put the best interests of their clients above their own financial interests.  It’s a very simple principle: You want to give financial advice, you’ve got to put your client’s interests first. You can’t have a conflict of interest.”

Any potential conflict of interest must be disclosed by investment advisers and IARs, and so the DOL fiduciary rule would have impacted securities and insurance agents much more than it would have the investment advisory side of the business. Insurance agents selling annuities would likely close fewer sales if they had to disclose the amount of their commissions, as would securities agents selling mutual funds with high loads or 12b-1 fees. Investment advisers, on the other hand, typically provide portfolio management services, billed as a percentage of the account value. Their compensation model aligns their interests with the client’s—the more the account grows, the higher the advisory fee goes. And, if the account value drops, so does the investment adviser’s fee. 

Best Interest

When President Trump took office in 2017 the rule’s implementation was delayed. Then, the Fifth Circuit Court of Appeals struck down the rule in a 2-1 decision, so we never saw the effects of the DOL rule on the Financial Industry.

With the death of the DOL rule, the Securities and Exchange Commission (SEC) passed a similar rule called Regulation BI, in which “BI” stands for “best interest.” Under the SEC rule, securities agents would be required to disclose conflicts of interest. For the first time, broker-dealers would be required to, “act in the retail customer’s best interest,” and would be prohibited from, “placing its own interests ahead of the customer’s interests.”

Regulation BI includes a requirement for both the brokerage and advisory side of the business to provide investors with a relationship summary explaining how they are compensated and what role(s) they perform in relation to the customer. While the advisory side has been doing this for years, it represents a dramatic change for the brokerage side, which has not had to disclose fees and compensation structures.

The implementation of Regulation BI is uncertain due to a lawsuit brought by seven states. The suit argues that requiring broker-dealers to, “not put their interests ahead of the customer’s” is a lower standard than required of the advisory side, which must put the client’s interests ahead of their own. The lawsuit, filed on September 9th, 2019, argues that the SEC rule does not provide sufficient protection to investors. As the Attorney General for the State of New York said, “Instead of adopting the investor protections of Dodd-Frank, this watered-down rule puts brokers first. The SEC is now promulgating a rule that fails to address the confusion felt by consumers and fails to remedy the conflicting advice that motivated Congress to act in the first place.”

Even if this lawsuit is worked out reasonably soon, there is already confusion between the fiduciary rules adopted independently by several State Securities Administrators and the SEC’s Regulation BI.

What should a financial services professional interested in being a fiduciary to investors do while all these competing rules and lawsuits are being sorted out? Examzone believes the best move is the tried-and-true approach to representing investors as a fiduciary—become a licensed Investment Adviser or Investment Adviser Representative. RIAs and IARs have long provided disclosure of potential conflicts of interest and have explained their relationship to clients both in their advisory brochures and client agreements. To become an IAR, or to start your own RIA, you typically need to take and pass only one exam, the Series 65. After that, you may register with the appropriate state securities department(s). 

The industry clearly seems to be moving in the fiduciary direction. You can either wait and see what happens with all the competing rules and lawsuits and, then, react accordingly. Or, you can take control and become either an Investment Adviser Representative or start your own Investment Advisory firm. Either way, you would be a fiduciary and will be covered no matter how things shake out. 

The choice seems clear to us. Let us help you pass your Series 65 and get started as a fiduciary.

This is not the GMAT

I used to think certain customers were being paranoid when they asked if the computer will adapt to their answers at the testing center. Now that I’ve examined the structure of the GMAT exam, it all makes perfect sense. On the GMAT your answer to the first multiple-choice question determines the difficulty of the next question presented to you. If you miss the question, you get an easier question. Get that one right, and the difficulty level will rise, allowing you to score more points. The Series 65, on the other hand, generates 140 questions randomly when you fire up your test–no adaptations to what you’re doing whatsoever on this exam. And, each question counts the same on the Series 65.

The GMAT also has a writing section scored by composition instructors and business professors, who use a “holistic” approach to score large batches of essays, as I did when teaching at Alabama State University back in the day. Good news, people–there are no essay questions on the Series 65 exam!

The GMAT teaches actual learning abilities/skills, while the Series 65 focuses on vocabulary, regulatory concerns, and basic features of securities investing. Therefore, the GMAT actually does put out “old test questions,” while the Series 65 never does.

One advantage you get on the Series 65 exam vs. the GMAT is that you can mark questions for review and then change your answers on the Series 65.

Purchasing Power

CPI measures the overall level of pricing for the goods and services that consumers buy over the month. Typically, the October number is compared both to September and the previous year’s October. CPI can be positive or negative. If the CPI is running at 2% annually, investors are losing that much purchasing power. If, however, the CPI is negative, investors are gaining purchasing power.
So, if you got a question like the following, how would you answer it?

Aunt Alice keeps her extra cash in a coffee can hidden in a secret compartment of her basement. Last year, the CPI was -1%. Therefore, which of the following is accurate?
A. Aunt Alice’s real rate of return was -1%
B. Aunt Alice’s real rate of return was 0
C. Aunt Alice’s real rate of return was +1%
D. Aunt Alice’s real rate of return was -2%

EXPLANATION: although putting money in a coffee can is not an investment, Aunt Alice got lucky last year when prices fell by 1% overall. Therefore, she is 1% above the level of pricing. The answer is . . . C.

Need extra help on your Series 65 Practice questions?  Go to

What the Series 65 or Series 66 Question Didn’t Say

Lately, some of my tutoring clients have been using our textbook, Pass the 65, or Pass the 66, to write their own practice questions. Some of the questions that are coming out are outstanding, too. Like this one:

An investor interested in purchasing 100 shares of stock in Amazon should place a

  1. Sell Stop
  2. Buy Stop
  3. Market Order
  4. Buy Stop Limit

EXPLANATION: obviously, you can eliminate any answer with the word “sell” in it, but notice how the question seems to be missing key details. That will really do a number on a test taker, trust me. Don’t panic. Whatever information was not provided is just as important as what was provided. What in the question justifies either a “buy stop” or a “buy stop limit” answer? I see nothing about wanting to buy only if the stock trades up at a certain price. All I see is that an investor wants to buy 100 shares of stock. So, if you want to get your order filled, you place a market order–Answer C. Right? At first, a question like this can seem too hard–just hang with it. Consider what the question said, and what it didn’t.

What’s Up with this Fiduciary Standard for Brokers Thing?

You have probably heard some of the uproar surrounding a proposed rule that would define fiduciary standards for both broker-dealers and advisers uniformly. Currently, advisers are held to a higher fiduciary standard under the Investment Advisers Act of 1940 than broker-dealers, who are held to a mere “suitability” standard under the Securities Exchange Act of 1934. While advisers have to put the client’s interests first, broker-dealers merely have to sell products that are suitable–and often the most lucrative to sell, as well.
The Department of Labor enforces ERISA, and four years ago they proposed a rule that would define anyone helping people save through a retirement account as a fiduciary. Although that rule was scrapped, they have just sent another one to the Office of Management and Budget, who has up to 90 days to review it before releasing it to the public. Dodd Frank required the SEC to do a study on a uniform definition of fiduciary standards, which they released back in 2011. Turns out, while the Department of Labor and the White House would love to force agents and broker-dealers to operate under the same standards that fiduciaries do under the Advisers Act, the SEC is not on the same page. The 5 commissioners still are not convinced there is any need for rulemaking here, and one of the Republican commissioners, Daniel Gallagher, fired back at the White House for leaking a memo recently designed to gain support for the DOL rule proposals making stockbrokers fiduciaries, just like their cousins in the advisory side of the business.
Some have stated that the brokerage industry’s lobbying group SIFMA opposes any changes to fiduciary standards. Actually, they support a standard–as long as it’s fair and does not hold brokers to the same fiduciary standards required of investment advisers.
How do I feel about the whole thing? That it’s totally unnecessary. That investors have to pay for advice somehow, and that I myself save untold thousands using a broker-dealer (whom I never talk to) as opposed to giving up, say, 1%, of my account value for someone to take over and start driving with discretion. In other words–investors need different options. Many individuals in a 401(k) account would benefit from talking to a financial planner. Others might need a portfolio manager. And still others–like myself–know what they want to buy and just enter their orders online through a broker-dealer who gives NO ADVICE whatsoever and simply executes trades with accuracy and competence while maintaining custody of assets. Why not give investors as much choice as possible? Because this White House and its Cabinet are often unable to trust the intelligence of the typical American, who if left to his or her own devices would be doomed. Of course, I have a conflict of interest here–if a rule goes out requiring all Series 6 and 7 reps to also get their Series 65 or 66, this would be a major financial benefit to Examzone. But, still, the whole thing seems like more effort than it’s worth to me.

Notes on Floating-Rate Notes – US Treasury also Issues FRNs

Even though buying a 2-year US Treasury Note was never a big risk, investors did face the risk of watching interest rates rise right after they buy. Buying new T-Bills every single week at auction is totally impractical for retail investors. Luckily, the Treasury now sells a floating-rate debt security whose interest rate re-sets each week based on the yield established through the weekly T-bill auction. Investors now don’t have to worry if interest rates go up each week if they own a Floating-Rate Note, or FRN, since investors will receive whatever rate is established each week for 13-week Treasury Bill yields. The key facts on Floating-Rate Notes or FRNs include:

  • Interest payments on FRNs rise and fall, based on discount rates for 13-week bills.
  • FRNs are sold in increments of $100. The minimum purchase is $100.
  • FRNs are issued in electronic form.
  • You can hold an FRN until it matures or sell it before it matures.
  • In a single auction, a bidder can buy up to $5 million in FRNs by non-competitive bidding or up to 35% of the initial offering amount by competitive bidding.
Floating-Rate Notes or FRNs provide liquidity and protection against capital risk/default risk, and interest-rate risk.

Insurance Agents giving Investment Advice in the State of Tennessee

Insurance agents selling fixed and indexed annuities have been operating in a gray area in many states for many years now. The definition of “investment adviser” under state securities law, remember, looks something like this:“Investment adviser” means any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as a part of a regular business, issues or promulgates analyses or reports concerning securities.” Right there, you can probably see how easy it would be for a state regulatory office to determine that an indexed annuity salesperson is in the business of advising others. . . as to the advisability of . . . selling securities. Therefore, he is not acting just as an insurance product salesman; he’s acting as an unregistered investment adviser if he tells people to liquidate mutual funds and put the proceeds into his safe-money product. While many states wait for someone to step out of line and then handle it on a case-by-case basis, the State of Tennessee has come right out and stipulated what an insurance agent can do versus what a securities representative can do. As we see from their bulletin “Licensing and/or Registration Requirements and Permitted Activities,” an “Insurance-Only Person” and a “Securities-Only Person” cannot engage in the same activities. The bulletin, at is something I encourage you to read regardless of your state. While you might be surprised to see what is prohibited for an “insurance-only person,” you might also be surprised to see the prohibitions for those who are considered “securities-only persons.” For example, a securities-only person may NOT “discuss the cost versus benefits of insurance in specific terms” and may NOT recommend specific allocations, in dollars or percentages, between insurance and securities investments. Probably more important, though, an insurance-only person may NOT discuss risks specific to the consumer’s individual securities portfolio and may NOT recommend the liquidation of specific investments/securities to fund the purchase of an annuity/insurance product.

Asset Allocation and Diversification for the Series 65 and Series 66 exams

A diversified portfolio of stocks would not contain all technology or pharmaceutical companies, for example. If there were a number of oil company stocks, they would be diversified between domestic and international companies, producers of oil and refiners of oil. They would not all be small cap or large cap. A bond portfolio would not be all triple-A-rated or all junk, but would instead be diversified throughout different maturities, credit quality, and issuers that don’t all come from the same industry. Asset allocation and diversification are somewhat related portfolio management techniques. Where they differ is that asset allocation puts set percentages of capital into various types of stocks, bonds, and cash to achieve strategic goals in regards to risk and reward. Within those allocations, we use diversification to balance the risk of one investment with the characteristics of another. So, 20% large-cap growth, 20% mid-cap growth, 30% small-cap growth, and 30% long-term bond is an asset allocation. Drill down into the “20% large-cap growth” category, and the various companies owned would come from different industries in order to maintain diversification.

Don’t Make Assumptions

Some exam candidates want quick black-and-white answers. If they read something about “10 years” in terms of the Administrator’s ability to deny/suspend/revoke a license, many want to memorize that number and apply it automatically. Unfortunately, it doesn’t work that way–sometimes people are let into the industry in spite of recent felonies, and sometimes people with certain misdemeanors are kept out indefinitely. The idea is that if you apply for a license and have felony convictions or specific misdemeanor convictions, the state can use those facts to deny your application, unless they decide otherwise. In the textbooks I mention that LLCs are associated with “limited life,” unlike corporations . Many exam candidates become uneasy at that statement. Wait–wait! My brother owns an LLC and it doesn’t expire on any particular date! That’s not quite what we’re saying. In an LLC the operating agreement has a section called “Dissolution and Termination.” In an LLC of which I am a member, this section states that the whole thing will be dissolved either on the date fixed for termination or by unanimous written agreement by the members. If the LLC were formed to produce a movie, we would dissolve it fairly quickly. On the other hand, if we were Five Guys Burgers and Fries, LLC, we would have no plans to shut down anytime soon, but their operating agreement surely lists certain events that would trigger dissolution of the LLC. Of course, as a private company, that is not information available to the general public, so I will not make the mistake of bothering them with an email. In any case, take in new information slowly and thoughtfully. Avoid jumping to conclusions. Did you just read that you can avoid a penalty, or did you think the text said you could take the money out tax-free? Big difference, right? The exam will exploit our tendency to rush through the questions. Your job is to slow everything down both as you study and as you take–and pass–your Series 65 or Series 66 exam.

Shark Tank and The Profit

To understand different investment approaches, one could watch two “reality TV” shows, both of which I caught last night: Shark Tank, and The Profit. In the Shark Tank, venture capitalists listen to start-up companies make pitches for capital in exchange for a percentage of equity in the business. Usually, the venture capitalists–the “sharks”–invest somewhere between $50,000 and $500,000 for a minority interest in the company. They are only interested in businesses that are already doing well, where the entrepreneur is kicking butt and seems able to adapt and solve problems without melting down. The companies have an interesting brand that either solves a problem or fills a niche, and their sales are growing. The best ways to turn off the spigot of capital from the sharks is to do any of the following individually or in any combination: fudge on your numbers, report either small or shrinking sales, reveal that after 10 years of hard struggle your business still makes no profit. The “sharks” are venture capitalists who invest in businesses long before any thought of an IPO to public investors, so whatever “growth investors” in public equities are looking for, so are the sharks–only more so. They are looking for a great idea, a great founder, and a business model that can easily be duplicated and scaled with a little bit of help from their rather large wallets. If they have to pay a little premium to get in, so be it. What’s a few thousand bucks when we’re clearly about to make millions here?

On the other hand, in The Profit, we see an investor named Marcus Lemonis who wants to take an equity stake in businesses that used to be great or could be great if only someone could come in and do some key fix-ups. See, growth investors like the sharks are out as soon as they hear even one problem, while turnaround specialists are investors interested only in companies with problems.

If Marcus, the turnaround specialist, sees, say, a pizza restaurant doing $2 million in sales yet still managing to lose $400,000 a year, he’s probably interested already. When he takes a closer look, maybe he finds a pretty decent staff of waitresses and pizza chefs, but sees immediately that the delivery personnel and the store manager are weak. There is no advertising, the restaurant looks tired and dated, and no one can even see the sign from the highway that passes by the place. While the sharks don’t have time to fix all these problems, the turnaround specialist now sees his opportunity. As he loves to remind the viewer, he only focuses on the three P’s–product, process, and people. The product must be great to do $2 million in revenue, so that’s probably not the issue. As far as the process, Marcus probably quickly invests in new pizza ovens that crank out more pies in less time, and then either re-trains the delivery drivers, equips them with GPS, or both. The first two p’s (product and process) are easy–he then has to deal with the scary part, the people.

He’s only in charge for one week, so he has to either turn a currently lousy employee into an asset or replace him quickly. Many currently lousy managers are just being human–they don’t communicate well; they don’t handle constructive criticism; they like to fudge the numbers and then get defensive about it, etc.. Unlike a therapist, who would use a gradual soft-sell approach, Marcus confronts the current problem  head-on, usually with as much rudeness as one can get by with without getting punched. After the tears (if female) or threats of violence (if male) the entrepreneur usually comes to recognize that he or she is actually part of the problem and is going to have to listen to the rich guy driving the flashy red sports car if they want to hang onto the business without dragging down the employees and the mom who foolishly took out the second mortgage to keep the thing afloat.

So, Marcus is taking on much more risk than what we call a “value investor,” like Warren Buffett. Warren Buffett would not invest money with any of the shifty, defensive people that Marcus routinely works with. For Mr. Buffett, the business is already doing well and is being run by people he trusts implicitly. How much hands-on management does he then do in the acquired companies?

None. If he had to go in and shape things up, he wouldn’t be investing in the first place. Warren Buffett doesn’t refer to himself as a “value investor,” actually–he just likes to buy great companies at currently marked-down prices. That tends to rule out growth stocks, as they simply can’t be purchased at an attractive price. But it doesn’t mean he sits there with a stock screener pouncing when price-to-book or price-to-cash-flow ratios drop to a certain pre-set multiple.
In any case, every investor mentioned above is doing about $3 billion better than I am, so let me get back to my little Simple IRA and see what I can do to boost my total return for the year. Sign Up for Online Classes That Make Sense