Defining a fiduciary

Despite the endearing advertisements in which the financial industry tries to make you think they are giving you advice that is in your best interest, in many cases, financial professionals simply want to sell you something.

Far too often, their profit motive is a higher priority than what is best for you. So, it is imperative that you protect yourself by: 1) understanding the term “fiduciary,” and 2) insisting on full disclosure of fees and terms.

Fiduciary is a legal term. A financial adviser who is a fiduciary is legally responsible for always giving advice that is in the customer’s best interest. A fiduciary cannot put their own interest above the customer’s.

In addition, a fiduciary is required to make full and fair disclosure of all material facts, especially when the adviser’s interests may conflict with their client’s interests. This means that profit motives (such as recommending a product that pays the adviser a high sales commission or one that is very profitable for the firm) cannot be placed before the customer’s best interests.

Many investors incorrectly assume that anyone giving financial advice is a fiduciary. Often, stockbrokers, insurance salespeople, and bank or credit union investment representatives are not fiduciaries. Sources estimate that 80 percent to 85 percent of financial professionals are not fiduciaries.

Financial advisers (and insurance agents) who are not fiduciaries are held to a lower legal standard called “suitability,” which means a product recommended to a customer is “suitable,” but it may not be in the customer’s best interest. Typically, suitability can be met if the investor can simply afford a product or if the investor has the risk tolerance to justify purchasing a product. This is a much lower standard than the fiduciary level of responsibility that requires that the product truly be in the investor’s best interest.

In case you think the distinction between a fiduciary standard and a suitability standard is a technicality, let’s use an annuity as an example. Annuities often pay the salesperson a commission that is 5 percent to 8 percent or higher. If the salesperson gets a higher commission by selling a customer an annuity (rather than a different product or investment), can you see why there could be a tendency for the salesperson to recommend the annuity?

The customer is at risk of being sold the product that pays the salesperson the highest commission. An annuity may pass the suitability standard if the customer can afford it, but it would not pass a fiduciary standard if other products would have been a better choice for that customer.

Annuities are also a good example for showing the “full and fair disclosure of all material facts” required of fiduciaries. When talking with a potential customer, an annuity salesperson may focus on the “guaranteed income for life” provision, which is an attractive feature.

However, they may fail to mention the high fees that are common in annuities, or the negative estate planning and tax consequences often caused by annuities. A full disclosure law does not exist in the U.S., but a fiduciary is required to disclose a product’s positive and negative features.

It should be noted that there are many different types of annuities, and not all annuities have high commissions. Certainly, annuities are not the only example of a potential conflict of interest. All financial advisers — even fiduciaries — have conflicts of interest. The key is to disclose them and then recommend the product or service that is truly in the client’s best interest.

So, who are fiduciaries? Registered Investment Advisers (RIAs) are required to be fiduciaries. They are independent financial advisers registered with the Securities and Exchange Commission or state securities regulators. At one point, Certified Financial Planner professionals were required to be fiduciaries, but this is no longer the case. Surprisingly, some stockbrokers may be fiduciaries when they are providing retirement advice but not be fiduciaries when they are selling investments (or annuities).

The only way to know if the financial person serving you is a fiduciary is to ask. A “Fiduciary Pledge” that originally appeared in The New York Times in 2010 in an article by Tara Siegel Bernard is provided. You can take this form to your adviser and ask them if they are a fiduciary. If they are, ask them to sign the pledge. If they are not, discuss why.

To be fair, some brokerage firms, insurance firms, and banks or credit unions do not allow their advisers to be fiduciaries. If your adviser is not a fiduciary, start a conversation, and let them know you expect to receive the same advice as if they were serving you as a fiduciary. Also, please note that this powerful pledge also requires full disclosure on fees and conflicts of interest.

Fortunately, investors are becoming more aware of the importance of working with a fiduciary, and more financial professionals are choosing to become fiduciaries for their customers. A Department of Labor ruling passed in 2016, which was scheduled to take effect April 10, 2017, would require

financial advisers giving advice on retirement accounts to serve the client as a fiduciary. On April 4, 2017, a 60-day delay was announced. The issue has been hotly debated.

Proponents believe the fiduciary rule will improve the quality of advice for consumers. Opponents believe it will lead to a mass exodus within the financial industry and middle-income investors will not be able to afford financial advice.

Other countries, such as the UK, Australia, India and the Netherlands have more stringent rules for financial advisers than the Labor fiduciary rule would require. The financial industry is waiting to see if the ruling will be approved, amended or repealed.

I encourage you to educate yourself on your finances. Consider your financial advisers as partners, and discuss the fiduciary pledge with them. You will be letting them know the type of service you expect and deserve.

Donna Skeels Cygan, CFP, MBA, is the author of “The Joy of Financial Security.” She has been the owner and financial planner for her own firm in Albuquerque for 19 years. Visit joyoffinancialsecurity.com.