From the August 2010 issue of Research Magazine • Subscribe!

Preparing for a Fiduciary Future

With a possibly wrenching change in business model up ahead, forward-thinking advisors may want to smooth the transition now.

The almost certain expansion of the fiduciary standard will have a dramatic impact on traditional brokers -- affecting everything from how much money they make to how they conduct business.

As Skip Schweiss, president of TD Ameritrade Trust Co., bluntly puts it: "Wall Street can see the train coming."

A preliminary analysis of a transformed fiduciary landscape by the non-profit Foundation for Fiduciary Studies offers some game-changing predictions including the elimination of the lucrative product-based compensation for people who give investment advice to retail clients and a rush by a "large number" of registered reps to the RIA channel.

Lou Harvey, the foundation's president, foresees a time as soon as two years from now when firms will have a product side and an advice side. In all likelihood, he says, the folks who sell products won't even be able to call themselves advisors. "The dividing line between the two is going to be fairly clear," he adds. "That's the fiduciary standard."

By press time in early July, the House of Representatives had passed a sweeping financial reform bill that includes language directing anyone who provides personalized investment advice to retail customers to act in the best interest of the customer -- in other words, a fiduciary standard. The Senate was expected to follow suit. Notably, the legislation also orders the SEC to conduct a six-month study analyzing the differences between fiduciary duty and the suitability standard that broker-dealers are bound by.

"The rules haven't been written yet. All this law really does is empower the SEC to create rules to apply to the principles of putting the client's interest first. My interpretation is that it requires them to level the playing field so all providers of advice are held to a similarly high standard," according to Chet Helck, chief operating officer of Raymond James Financial. "Now, the real work begins."

Some industry observers believe a fiduciary standard for all advisors will reshape Wall Street -- from the licensing and training of advisors to the client/advisor relationship. At the very least, it could quash the competitive advantage fiduciary-held RIAs fancy they now have over brokers.

At a meeting earlier this year with 35 of TD Ameritrade's top investment advisors, a couple of people told Schweiss they would prefer to see brokers continue to be held to the suitability standard.

"They basically said they like it the way it is," Schweiss said. "They said it's a major marketing advantage for us to tell our story to a prospective client about the difference between me and the broker down the street who also wants your business." When he asked the crowd how many wanted things to stay the same, all 35 hands shot up.

"If brokerage firms have to truly adopt a fiduciary standard, it's going to be a rather wrenching change in business model for them, which can't happen overnight. It represents a deep cultural as well as procedural change," Schweiss noted. "There's a very bright line between us and our competition. If it goes away, it's very possible our competitive edge goes away. If you fast forward to where [brokerages] get there, the differentiator has evaporated in that [RIA] world and advisors will have to sharpen their marketing pencils, if you will, to draw other distinctions."

The Road Ahead

Not surprisingly there's been a lot of misinformation about fiduciary requirements -- and no wonder. As Helck points out, there is no single fiduciary standard. Among others, ERISA, various states and the Investment Advisers Act of 1940 all have their own legal definitions and the Foundation for Fiduciary Studies just released its 2010 Fiduciary Standard, designed to comply with the financial reform package as well as the proposed language of the amended 2006 Pension Protection Act.

"There are so many different so-called fiduciary standards out there now," observes Helck. "What I hope to get out of the SEC is a fair and clear definition of what consumers can expect from a financial advisor and that all providers of financial advice will be held to those same high standards. What we need is clarity."

Still, experts say there's plenty advisors can do now to prepare for a fiduciary future.

"Most brokers in my experience are trying to operate to a fiduciary ethic all the time. But the fact is that those who are at the head of the large wirehouses and insurance companies are sitting on top of an organization that frankly was built on a sales model," says Blaine Aiken, president and CEO of fi360, a Bridgeville, Pa.-based fiduciary training firm. "They are facing the need to move to a professional advice model. For those who give advice -- and that's the vast majority of reps out there -- I think there is recognition and a desire [to adhere to a fiduciary standard], but there is also real trepidation about how to turn this giant ship."

Going forward, Aiken suggests advisors move more toward the avoidance of conflicts rather than just managing them. And, for their own protection, he advises brokers to act as fiduciaries even though it is not now a requirement.

"The No. 1 complaint in arbitration panels is the breach of fiduciary responsibility. Most people don't understand that," he adds. "If you are in a relationship of trust there is a presumption of fiduciary duty. For pure self-interest on the part of a broker, act as a fiduciary would. You are in effect a functional fiduciary."

Finally, he says, forward-thinking advisors need to comply with the five core principles practiced by investment fiduciaries: 1) a singular duty to the client; 2) due care; 3) utmost good faith, demonstrated by full disclosure; 4) the avoidance of conflicts of interest; and 5) managing in the client's best interest.

One of the biggest pieces of misinformation about fiduciary duty is that if the client loses money, the advisor has to make it good. "I've heard people you'd not expect that from make those kinds of statements," says Harvey. What a fiduciary standard does do is define an advisor's liability and range of exposure and declares what an advisor must do to mitigate that liability. "In acting as an investment advisor, you have the responsibility to act in the interest of your client," he explains. "If you fail to do that, then you are liable for whatever that client loses."

As for the advisor who doesn't adhere to fiduciary requirements, Harvey says: "You'd have to be nuts to go out there and not do this, knowing you are on the hook. It's the equivalent of a doctor going off to play golf while the patient is on the table."

A Fiduciary Checklist

Any conversation about fiduciary duty naturally includes its most critical component: putting the best interest of the client first. What is often overlooked is the requirement to demonstrate procedural prudence, the second-most critical element.

"Simply stated, it's documenting the details of the decision-making process," says Donald Trone, founder of the Foundation for Fiduciary Studies and the lead developer of the 2010 Fiduciary Standard. "The wirehouses have been moving toward a process standard. Even using the term financial advisor is conveying process. But it's often a fa?ade. When you listen to the dialogue of many leading financial advisors you still hear product-centric conversations taking place. Something all advisors can start doing today is become more conscious of the fact it's about process, not product."

Moreover, he adds, advisors who engage in a consistently applied decision-making process will also realize greater efficiencies in the back office as well as attract a broader array of clients. As an example, what might start out as a typical wealth management engagement might develop -- as a result of the fiduciary piece -- into extended relationships with a client's charitable foundation or small business with an attached 401 (k) plan.

It's important to note, too, says Trone, that many brokers already use some fiduciary tools. One fiduciary requirement, for instance, involves identifying a client's goals and objectives. "Brokers do that in spades with questionnaires and client discovery," he adds. Another is to diversify assets to a specific risk-return profile. "Same thing," he says. "Virtually every wirehouse has a risk questionnaire."

Potentially more challenging: formalizing an investment strategy with a written policy statement. "The preparation and maintenance of an investment policy statement program represents the most significant additional requirement most brokers are not prepared for -- but they're close," according to Trone. A services agreement, routine for brokers, outlines many of the same elements contained in an investment policy statement. Among those elements: recapturing the data on a client's goals and objectives; establishing why a certain asset allocation was selected; explaining how the strategy is to be implemented, whether it's with mutual funds, wrap fees or something else; and determining how often performance will be monitored.

Another requirement on Trone's checklist -- implementing a strategy with "prudent experts" -- will be a "fairly radical" change for advisors picking individual stocks and bonds. "In essence, those advisors will now be compared to a professional money manager," he adds. "It's going to raise the bar as to how many advisors will be able to demonstrate that level of expertise."

One last requirement involving the monitoring of performance is something brokers now do "in a fashion," Trone says, but as a fiduciary the advisor will have to drill down further. For example, while a typical brokerage custodial statement today compares performance to an index, it would now have to include peer group reviews as well.

"Those who have never had exposure to fiduciary training are flipping out, there's no question about that," he adds. "But those who have taken even a modest amount of time to study fiduciary standards have come to realize there are very little changes they will have to make to their investment process."

A recent study from Dalbar, the financial services consulting firm that Harvey heads, shows that while all advisors are aware of the fiduciary debate, few have taken action to prepare for it.

Notably, 81 percent of advisors expressed some level of concern and 67 percent had done nothing about it.

"The point is the vast majority of people are in fact aware of it and they think it's going to be material and affect their life severely, but they don't have a plan. There's a huge gap between fear and concern and having resolution," Harvey says. "Anybody who doesn't react to this is asleep at the switch."

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What They're Saying

"There's nothing in this I've seen that worries me or keeps me up at night. The key theme is disclosure. That means being very clear about what you do and don't do -- disclosing the conflicts of interest that are inevitable."

Chet Helck, Chief Operating Officer, Raymond James Financial

"The truth is advisors wake up every day with a sense of purpose -- doing what's right for the client. From a perspective of how they think and how they approach relationships, I view nothing changing. This is simply about trying to define a legal definition."

Jim Tracy, Director, Consulting Group, Morgan Stanley Smith Barney

"I don't think there's an advisor out there that doesn't think they put their clients' interests first, whether it's a commission broker or a fee-only advisor. They honestly believe that's what they do. I generally believe that's the case too."

Paul Tolley, Chief Compliance Officer, Commonwealth Financial Network

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