What is the most important story in the investment world right now? Greece? China? A Federal Reserve rate hike? The single most important story in the investment world right now is over the word ‘Fiduciary’. A Fiduciary (this word is so important that I’m capitalizing it) acts in the client’s best interest and owes clients a duty of undivided loyalty. Contrast this with the ‘suitability’ rule that says brokers need only find that an investment is suitable, not necessarily what’s best for the client. Maybe the best way to distinguish between the two codes is to view the SEC’s Fiduciary rule versus FINRA’s suitability rule. The SEC (Securities and Exchange Commission) is a US government regulatory agency. FINRA (Financial Industry Regulatory Authority) is a private corporation that acts as a regulatory agency that financial firms have put in place to monitor themselves. Fiduciary can be summed up in one paragraph (210 words) while suitability is, shall we say, more nuanced (1,133 words). Is your advisor a Fiduciary or do they just have to meet suitability? Are they more concerned with doing the right thing or selling you the product of the month as long as it’s legal (and they get paid)?
How did we get here? Financial services firms been allowed to regulate themselves. The thinking behind this was that financial firms could police themselves better than the government could while also providing a standard of service to clients that met society’s expectations both in terms of performance and ethics. Now it is clear that some firms have been operating in an unethical, yet legal manner to such an extent that the Federal government is stepping in. Loading client accounts with in-house products, selling unnecessary products, recommending products based on what gives the broker the highest payout, and trading against client positions are all actions that, while technically legal, are not in the best interest of the client. The financial crisis dragged some of the darker transgressions into the light and now the government is getting involved. It’s not that every advisor that is just subject to the suitability standard is giving bad, unethical advice. The vast majority of brokers serve clients well, but the current rules have allowed them to give “suitable” advice and not necessarily the “best” advice for the client.
The Department of Labor and the SEC are both putting forth plans to provide a uniform fiduciary code for investment professionals to act in the client’s best interest. This is a huge step in the right direction, but the efforts have been criticized by many financial services firms for being too strict. The arguments boil down to a Fiduciary rule adding too much paperwork and costing too much for the firms to implement. They say this will force financial firms to abandon smaller investors as their firms will have to pass the costs on to the clients and will make smaller clients unprofitable. It is interesting to note, however, that upstart “robo-advisor” Wealthfront doesn’t agree with this outlook at all. In their Comment Letter on the Department of Labor’s proposal they said, “We were built from the ground up to operate under the full fiduciary standard despite serving small accounts and charging incredibly low fees. Wealthfront is living proof that not only is it possible to provide fiduciary service at a low cost to small investors nationwide, but also that the market greatly rewards those efforts. Charles Schwab, a firm who has hundreds of branches across the U.S. now offers this type of service to small accounts as well, giving tens of thousands access to fiduciary investment advice.” Wealthfront’s history with Charles Schwab has been um… let’s say rocky… so it is interesting to see speak well of Schwab.
Financial institutions have brought regulation upon themselves. The financial crisis revealed unethical, yet technically legal behavior that has prompted government intervention. This should be a positive development, especially for investors who didn’t know their advisor wasn’t necessarily acting in their best interest.
Disclosure: I work for Fairway Wealth Management, an SEC-registered investment advisor. By law, Fairway has a Fiduciary duty to its clients. Our core values direct us to live up to that standard and act with honesty, independence, fairness, and sincerity in all of our client relationships. I would be delighted to see regulation that prevented cold calls to folks like my parents where they are hit with a high-pressure/high-commission product pitch and a large dose of unwarranted fear.