Financial Advisors and the Fiduciary Rule
Last year, the Department of Labor (DOL) issued a new ruling requiring that most financial professionals who provide advice on retirement investments must act as fiduciaries, meaning they are legally and ethically required to act in the best interest of their clients. Prior to this, most advisors acted under a “suitability standard” which gave advisors more wiggle room.
When a person accepts a fiduciary duty on behalf of another party, it creates an ethical relationship of trust with specific duties. Two such duties are to act in good faith and trust (the term fiduciary comes from “fiducia,” the Latin word for “trust”). Duties owed to another party are not always financial in nature – lawyers, for example, have fiduciary duties toward their clients – but in the context of investment, fiduciaries are expected to manage their clients’ assets for the investors’ benefit, not their own.
When the new ruling was first announced, many consumers were surprised to learn that all financial advisors didn’t already have a fiduciary duty, but in fact the existing industry standard was frequently merely one of “suitability.” Under the suitability standard advisors are required to recommend products and services that are suitable to meet investors’ needs and objectives, but those choices may or may not necessarily be the best or most cost-effective ones.
If a financial advisor receives a commission for selling certain products, that advisor may steer clients toward those products with higher commissions – again while suitable, not necessarily in the client’s best interests. In fact, consumers continue to be sold overpriced mutual funds and annuities that come at a real cost to their retirement security. Thanks to the magic of compounding, over decades even very small differences in costs can make a dramatic difference in the size of an investor’s nest egg when retirement time comes. In 2015, the White House Council of Economic Advisors estimated that biased advice costs investors $17 billion annually.
Under the new DOL ruling, investment advisors must put clients’ interests above their own, disclose any potential conflicts of interest (such as selling mutual funds managed by their employer or securities underwritten by their employer, or accepting 12b-1 distribution and marketing fees from mutual funds), and clearly communicate all commissions and fees (including fees embedded in the investments or mutual funds). Notably, the fiduciary rule does not apply to those engaged in retirement education, such as employers providing general advice when rolling out a new retirement plan, or to what is considered order taking, when customers ask brokers to buy or sell specific stocks.
The ruling was scheduled to take effect on April 10, 2017, but the DOL has announced a 60 day delay in implementing these policies while it reviews the regulations, with a view to modifying or overturning the ruling entirely. The review is based on concerns about onerous compliance costs and restricted choice.
For many financial advisors who already adhere to the higher fiduciary standard of care, nothing will change either way. Bank wealth managers and trust departments act under state or federally issued trust powers requiring them to act in a fiduciary capacity. Washington Trust Bank’s Wealth Management & Advisory Services operates on a noncommissioned, fee-for-service basis. Our portfolios are designed with no proprietary mutual funds and no securities “from inventory,” and we do not underwrite securities, so our advisors are unbiased in relation to the investments in a client’s portfolio. Transparency and communication regarding compensation are key.
Whether the DOL ruling is implemented, changed or struck down, investors should understand what fiduciaries are and how they must act. Of course if the ruling stands the new regulations won’t be a cure-all – there will always be a few individuals who act dishonestly regardless of the rules, and investors will still need to do their homework – but a broader application of the fiduciary standard would provide significant protection for investors, and the new regulations also make it easier for investors to sue advisers who do not act in their best interest. Even if the ruling is overturned, the discussion surrounding the legislation has already been beneficial in terms of raising both awareness and expectations, and an increasing number of investors will now demand greater transparency from their financial advisors.
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Dave is a Vice President and Senior Relationship Manager for Washington Trust Bank’s Wealth Management & Advisory Services in the Western Washington Region, and also serves as the region’s Fiduciary Team Leader.
Throughout his career as an attorney and in the financial services …