Tuesday, May 01, 2012

A Fiduciary––Do You Have One?

Let’s get past the boring part first. Definitions rarely make a case for exciting reading, but they are, nevertheless, particularly important if you wish to discover whether the person providing you with investment advice is truly working solely on your behalf, or if his/her loyalties lie elsewhere. Here are two descriptions of rules defining what might be required of your financial advisor––which one do you believe applies to you?

Rule # 1) A stated or implied requirement by a regulatory body that financial advisers must reasonably believe that a certain investment decision will benefit a client before making a recommendation to him/her. That is, the broker or financial adviser must act in good faith, and may not knowingly recommend bad investments.

Rule #2) A required duty to serve the best interests of clients, including an obligation not to subordinate clients’ interests to its own. Included in the standard are the duties of loyalty and care. An adviser that has a material conflict of interest must either eliminate that conflict or fully disclose to its clients all material facts relating to the conflict.

The Rule Game

Rule #1 is known as the “Suitability Rule,” and is applied to stock brokers (often titled as “financial advisers, securities broker, investment analyst, financial adviser, investment banker,) as well as brokerage houses. Whatever decision the adviser makes must prove to be suitable to the client’s interests and goals. Rule #2 applies to “registered investor advisers,” imposing an additional component of “fiduciary” responsibility. It demands that this class of advisers who must register with the SEC (Securities and Exchange Commission) is bound to a fiduciary standard that was established as part of the Investment Advisers Act of 1940. They can be regulated by the SEC or state securities regulators, both of which hold advisers to a fiduciary standard that requires them to put their client's interests above their own.

Obviously, Rule # 2 sets a significantly higher standard, one that eliminates any inclination by the adviser to slant an investment decision he makes for you (suitable that it may be) that could provide morally inappropriate personal benefits. For example, a financial advisor may consider two different mutual funds as suitable for your portfolio. One has a better performance history and a better future, but he chooses the other one because it pays him a higher commission.

The Fiduciary Standard

There is a strong probability that you are using a financial adviser, not a registered investor adviser as defined by the SEC. The former is bound only by Rule #1, and thus has no responsibility to act as a fiduciary. Here are the odds: An investing tracking organization, Cerulli Associates estimates there are some 245,000 advisers in the industry. Of that number only about 13,000 are registered with the SEC, and have earned the official title of registered investor adviser.

The fiduciary standard is critically important for every investor to consider. As you will read below, my own investor adviser, who is extremely active in an organization attempting to educate investors of its importance, brought it to my attention. In addition however, the desirability for all advisors, regardless of title to be held to a fiduciary standard is now being considered by the SEC. Here is the opening portion of an actual report submitted to Congress, by the SEC, enunciating its opinion:

“The study, provided to Congress, which looked into obligations and standards of conduct of financial professionals, was required under the Dodd-Frank Wall Street Reform and Consumer Protection Act.”

The study declares, and I quote “…retail investors should not have to parse through legal distinctions to determine the type of advice they are entitled to receive. Instead, retail customers should be protected uniformly when receiving personalized investment advice about securities regardless of whether they choose to work with an investment adviser or a broker-dealer.”

Most significantly, the SEC report then asserts, “The Staff therefore recommends establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities to retail customers that is consistent with the standard that currently applies to investment advisers.” (My underline).

Before officially proposing a fiduciary standard to be legislated by Congress however, the SEC staff is delaying the proposal until a cost/benefit study is completed.

My Adviser Letter

Here is the letter from my investor adviser, and his (and my) suggestion as to action you should take until that legislation is passed to insure that your advisor’s loyalty extends only to you.

Dear Client/Investor,

Who can you trust to give you unbiased investment advice? If you are like most people, you assume that someone who provides investment advice to you must be required to act in your best interests. Unfortunately, that’s only true for some advisors – those who are fiduciaries.

Financial laws and regulations have two sets of rules. One set is for people who sell financial products, generally brokers and insurance company representatives. These salespeople are contractually obligated to place the interests of their employer ahead of the interests of their clients.

The other set of rules is for those who are registered as investment advisers with the federal Securities and Exchange Commission (SEC) or comparable state regulators. Registered investment advisers are legally obligated to place your interests first. They are fiduciaries. That means they must not only be loyal to serving your exclusive best interests, they also must adhere to a high standard of professional competence.

Unlike in other professions, such as law and medicine, anyone can call himself an investment or financial advisor––even if he is really a salesperson whose primary loyalty is to his employer rather than to the person he advises. This situation is confusing for investors, and it needs to change.

I am part of a grassroots organization of financial service professionals known as the Committee for the Fiduciary Standard. The Committee’s goal is to educate legislators, regulators, and the investing public about the importance of protecting investors by extending the fiduciary standard to cover everyone who provides personalized investment advice. Interestingly, the Committee includes a number of brokers and insurance representatives, in addition to registered investment advisers, who recognize how important it is to investors and society at large for advice to be truly trustworthy and based upon a uniform standard that requires advisors to be objective and competent.

The Committee has drafted the very straightforward oath you will find on the next page that commits an advisor to adhere to a fiduciary ethic and, in so doing, to be accountable for the advice the advisor renders to you, the client. I have signed this oath to you as an affirmation of my pledge to always act in your best interests.

I strongly recommend that you insist that any advisor you work with be willing to sign this oath. The commitment is as simple as “mom and pop and apple pie.” If the advisor won’t sign the oath, you owe it to yourself to ask why you would trust your financial future to that advisor’s care.

I encourage you to share this letter and the oath with your family and friends.


I will always put your best interests first.
I believe in placing your best interests first. Therefore, I am
Proud to commit to the following five fiduciary principles:
I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional.
I will not mislead you, and I will provide conspicuous, full, and fair disclosure of all-important facts.
I will avoid conflicts of interest.
I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.
Advisor ____________________________
Firm Affiliation ____________________________
Date ____________________________

Recognizing the dysfunctional status of our illustrious Congress these days, and its inability to concur on anything, I strongly urge you to have the oath signed now––otherwise it would be like waiting for Godot.