The Case of the Mysterious Best-Interest Standard

I recently received the following email from an advisor who is clearly upset about the Department of Labor’s fiduciary rule and came up with some creative ways to express it. They are interesting arguments that, at least to my mind, cry out for further exploration.

Him: Just know no one knows what [a client’s] best interest is or can know. ... it’s not a Vanguard Index Fund either ... and ... the [fiduciary] rule was sold in part by saying that doctors operate under a standard. But they sure as heck do not receive reasonable compensation with salaries in the $300,000s. How a hospital figures out a way to charge $3,000 for a broken arm is a real mystery to me. That's as non-fiduciary as it gets. Remember equity abhors a windfall. ... the real fact is that very few of us will be able to conform to an unworkable rule.

Me: Thanks for the email. You make some interesting, and often novel, points, but I have to respectfully disagree on virtually every one of them. Is it really your argument that a top-producing broker can make $1 million a year (and often much more) selling securities, but a doctor who saves peoples' lives or fixes their broken bodies so they can once again lead normal lives is overpaid at $300,000? (And by the way, a good chunk of that $3,000 for a broken arm is going toward malpractice insurance).

More importantly, neither an "advisor's total comp" nor a doctor’s total comp are fiduciary issues, anyway. They key question is: What did they, or other types of advisors, do to make their incomes? And the issue is providing financial/investment advice to retail clients about the products and strategies most likely to help them achieve their financial goals at the lowest price. Because the cost of financial "products" has a major impact on portfolio outcomes many years into the future, lower costs are often in a client's best interest.

And certainly I agree with you that the "lowest cost" product isn't always in a client’s best interest. In those cases, the advisor needs to be able to rationally defend their higher-cost recommendation — and if the advisor and/or their firm (or any affiliate) is receiving compensation in any form, for recommending the higher cost product, rather than a lower cost product, additional scrutiny is clearly warranted.

To my mind, these financial conflicts of interest represent the greatest threat to fiduciary, client-centered advice. They can create huge incentives to recommend one product over another, regardless of the client's best interest. Conversely, if a broker and their firm receive the same level of compensation whether the client buys an ETF or a 150-basis-point mutual fund, then more leeway should be given for the advisor's rational (but it still has to be a good reason).

My point is, there's really no mystery about "acting in the clients' best interest." With that said, I also don't have any problem with securities or investment "sales" as long as customers understand that they are being "sold" products, not getting "investment advice." Which means that they understand that the salesperson works for their BD, not the investor, and consequently may be making recommendations that are in the firm’s, rather than the client’s, best interest. Conversely, a "fiduciary adviser" works only for the client, and in the case of AUM fee compensation, stands to make “more” money only when the client’s portfolio increases in value.

As for the business angle, as it turns out, fiduciary advisors who manage retail client assets can and do make millions of dollars a year, acting in their clients' best interests at all times. For clients with more modest portfolios, there are fiduciary advisors who charge by the hour, or on a low monthly or quarterly retainer. For folks who want to give investment advice, these are all good business models.

For people who want to "sell" investment products, that's a good business model, too, as long as their investors understand these salespeople are not required to give them "advice that is their best interest." The problem, in my view, is that many within the brokerage community actively blur that line, for obvious reasons. This is the problem that the Labor Department is attempting to correct for retirement investors, and I believe these corrective measures should be extended to all of retail financial services: clearly separating financial advice from investment sales.

Today, many large financial services institutions are recognizing the wisdom in this thinking and are actively taking steps to create a separation of these two services for all retail clients. I believe within the next 10 years, this will be the norm in the industry. I also believe that this restructuring will be a tremendous relief to a majority of retail brokers, who truly want to act in the best interests of their clients, but are currently in a system that incentivizes other behavior.

Many of today’s RIAs started their careers as brokers, but eventually went independent to better serve their clients. Seems to me it would be a better business model for brokerage firms, too, to create a culture that supports advisors who want to act in the best interest of their clients, rather than forcing them to leave to do so.   

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