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.