Financial advisors and the fiduciary rule

President Trump has issued a directive to the U.S. Department of Labor (DOL) that has the practical effect of delaying implementation of the fiduciary rule for retirement accounts. What does that mean to me?

Let’s start with a quick review of how we got here. President Obama’s administration determined that advice from financial advisors based on suitability standards was costing retirement investors up to $17 billion annually and considered this “excessive compensation” to be a conflict of interest. Obama then gave instructions to Thomas Perez, the then DOL Secretary, to write a new fiduciary rule to prevent this conflict of interest in retirement advice from continuing to occur. If implemented, retirement advisers would have been treated as “fiduciaries” under a broad DOL-created definition.

The new regulation was set for implementation on April 10 this spring. On Friday Feb. 3, President Trump signed an Executive Memorandum to delay this rule from being implemented. During this time the new DOL secretary will review this regulation and possibly make changes but, at this point no one knows exactly what or when a new standard might be put in place.

It is possible that the Securities and Exchange Commission (SEC), which is the government regulator, and the Financial Industry Regulatory Association (FINRA), which is the self-regulatory organization of the industry, will have more say going forward. Most in the industry feel this would be a more appropriate regulator than the DOL. It is also likely that any new standard adopted will eventually include all investment accounts and not just retirement accounts. As with any new regulation, there are additional costs and uncertainty. Therefore we have seen a lot of finger pointing and hyperbolic debate regarding this issue.

So while the politicians do their dance, let’s actually take a look at the difference between suitability and fiduciary standards of care in the financial services industry and how this may affect you, the investor.

The suitability standard is employed when you are paying for individual transactions. For example, if you buy or sell a stock or bond and you pay a commission for this transaction. The investment must be deemed suitable to meet your investment goals with regards to your specific financial means.

This suitability is measured by a number of metrics. One consideration is how long before you will be using the funds from this investment. This could be a short, intermediate or long-term time horizon. Another is your household income and whether you have enough liquid savings for emergencies. An advisor must consider your personal aversion to risk and what other investments you have to enable a holistic look at your investment strategy. Other considerations are investment experience and how long an investor has been investing, tax consequences, etc. This is the short list.

One key point to know is that under the suitability standard, an advisor does not typically have discretion to make trades in the account without first receiving explicit instructions from the investor. Prior to making the trades the advisor should be explaining costs, fees, commissions, etc. This transparency is important for an investor to be able to make an educated decision. These accounts are managed by the advisors of a Broker Dealer (B-D) Firm.

Under the general fiduciary standard an advisor must take all of the above into consideration and also take it to another level. This definition of fiduciary from the legal dictionary states: An individual in whom another has placed the utmost trust and confidence to manage and protect money or property. The relationship wherein one person has an obligation to act on another’s behalf. What that means as an advisor working under the fiduciary standard is that they must always act in the best interest of you, the client.

At this point you are thinking to yourself “that is how I thought advisors act.” Most likely your advisor has been acting in such a manner. An advisor working under the suitability standard is still capable of working in a fiduciary manner. The two standards are not necessarily exclusive of each other.

Under the current fiduciary standard, an investor will likely pay a fee based on the total assets under management, a retainer, an hourly fee, or possibly some variation thereof but, will not pay a commission every time a stock or bond is bought or sold. Prior authorization to make individual trades is typically not necessary due to the discretion given at the time the account was opened, a key difference from the suitability standard.

These accounts are managed by a Registered Investment Advisory (RIA) Firm. Again, accounts that are based on suitability are managed by a (B-D) Firm. Currently, the majority of firms in the industry have access to both business models. These firms might be considered a hybrid offering investors options from both business models. Our firm operates in this hybrid manner.

There are some things that all investors should know. You should understand what you are investing in. Not at the same level as your investment advisor but a level of understanding. You should know what the potential risks and rewards are. You absolutely should know what the costs are. You should be asking these questions and more until you are comfortable that you are making the right decision including, are you a fiduciary?

It is a huge responsibility managing other people’s investments and I believe the vast majority of financial advisors understand and willfully accept that responsibility. And I do believe they have their clients’ best interest in mind. Until we talk again, be well!