The battle for the fiduciary standard in financial reform legislation took an unexpected turn a couple weeks ago. The National Association of Insurance and Financial Advisors (NAIFA), directly acknowledged a key challenge many insurance brokers face in adopting the fiduciary standard: existing contractual obligations to put the interests of their insurance companies first.

In a Webinar discussion hosted by the American College on March 2, between NAIFA president-elect, Terry Headley, and myself, Headley suggested that brokers with access to a limited number of products through selected companies could not meet the standard. Then, in a March 7 story in The Washington Post, “Financial reform bill likely to lose measure to protect Main Street investors,” NAIFA president Thomas Currey stated that most insurance brokers are contractually obligated to “look after the interests of the company” and that the “original” fiduciary proposal (in Sen. Christopher Dodd’s (D-Connecticut) Discussion Draft legislation) puts a broker in an “untenable situation.” Why? It’s simple: Currey suggested it is not possible to put the client’s best interests first and meet these contractual obligations.

Currey is partially correct. He is correct in noting the obvious conflict. This is part of the ‘facts and circumstances,’ but it is not an analysis. The conflict represented when a broker has access to limited products from selected companies does not automatically preclude a broker from meeting the fiduciary standard. Conformity can only be determined by completing a due diligence process, based on a number of factors, to evaluate how well or how poorly the product(s) meet the investor’s objectives, given the scope of engagement. The process results either will or will not show that the product is fairly and reasonably deemed competitive with other products in the market, and thus in the client’s best interest. Absent such due diligence, it’s not possible to conclude if the product recommendation in this situation–or any situation–meets the standard.

Still, Currey’s observation is important. It may be a first. His candid statement regarding the inherent conflict posed by either proprietary products or by special relationships with product manufacturers is refreshing. He spoke honestly about a real challenge to meeting the standard. While critics have suggested for years that these arrangements are inherently conflicted, the industry has seemed to ignore such criticism.

Yet, there are other concerns expressed by NAIFA about the fiduciary standard that are unwarranted. For example, the basis on which a “look back” at a product recommendation, to determine fiduciary compliance, may be made. The expressed concerns are that if the lowest cost product is not selected or the subsequent investment performance is deemed inadequate, there may be a fiduciary breach.

These concerns are without merit. It is well settled that a fiduciary is not required to recommend the lowest cost product, and that the fiduciary requirement is to incur only fair and reasonable costs based on the services provided. Further, as a process-driven standard, investment performance is not a consideration in assessing fiduciary compliance, after the fact. Hindsight is 20-20 on performance; fiduciaries are not. The process-driven standard only requires exercising good professional judgment, not using a crystal ball.

The number and quality of serious misunderstandings besieging the fiduciary standard discussion is significant and unfortunate. It reminds one of the quips by former New York Senator Daniel Patrick Moynihan, “Everyone is entitled to his own opinion but not his own facts.” NAIFA deserves credit for expressing its opinion regarding the challenge of dealing with contractual obligations. Let the discussion continue.

Knut A. Rostad (kar@rpjadvisors.com) is the regulatory and compliance officer at Rembert Pendleton Jackson (RPJ), a registered investment advisor in Falls Church, Virginia, and chairman of The Committee for the Fiduciary Standard. The views expressed here are his own and do not necessarily reflect views of the Committee.

Read more of Knut Rostad’s Regulatory Reason blog posts:

What’s Truth Got to do With It? January 18, 2010 As Wall Street banks announce their 2009 bonus plans, estimated by WSJ to be $145 billion, what better time is there to discuss whether Wall Street firms can win back the trust of investors?…
The Return of Investor Confidence? In 2010? December 29, 2009 A snapshot of consumer attitudes right now is not a pretty picture and suggests there is a long road to travel before investor confidence returns. …
Partisanship on Steroids December 14, 2009 Passage of the financial reform legislation in the House is historic and important. It may also be, unfortunately, short-lived in the current, toxic partisan environment. …
Peter Drucker for Wall Street Czar November 24, 2009 Drucker would advise Wall Street to ask what retail brokers think. About being a fiduciary, brokers might “surprise” execs. Many would say “Bring it on!”…
Too Rich or Too Thin? November 03, 2009 You can never be too rich or too thin: Can we disclose ourselves out of obesity? Can disclosures replace fiduciary duty?…
A Tail is Not a Leg October 16, 2009 As the rhetoric heats up over regulatory reform one is reminded how much political life has not changed all that much since Abraham Lincoln was quoted noting the following: “How many legs does a dog have if you call the tail a leg? Four…” …
SEC Chairman Speaking the Fiduciary Language September 28, 2009 SEC Chairman Mary L. Schapiro’s September 24th speech, before the Financial Services Roundtable, included her most recent public remarks on the fiduciary standard. The Chairman’s remarks are important. …
Rakoff’s Bank of America Opinion: “The Tipping Point” September 16, 2009 In September 2013 when we look back on Lehman Bothers’ demise, will we also see a “reformed” financial system and regulatory structure? One that may be hard to recognize compared to today’s structure? If “yes,” look to Judge Jed S. Rakoff’s opinion. …
Listen to Chuck August 31, 2009 When Chuck Schwab talks do people listen? They ought to–even when he is off base, as he was in an August 19 opinion piece, “Brokers Aren’t Responsible for Bad Bets,” in The Wall Street Journal….
Disclosures and Evoking the Lewis Liman Defense August 14, 2009 Why did the SEC accept a $33 million settlement in light of its allegations that Bank of America failed to disclose that bonus payments were authorized for up to $5.8 billion? Judge Jed Rakoff wants to know. …
The Authentic Fiduciary Standard–What’s the Fuss About? August 11, 2009 Recent discussion in some quarters has focused on the “similarities” between the fiduciary and “arm’s length” standards. The clear implication appears to be: What’s all the fuss about whether investors retain fiduciary advisors or not? …
Blog: Talking the “Fiduciary Talk” in Washington July 07, 2009 The Obama Administration proposes that brokers giving investment advice should meet a fiduciary standard. SEC Chairman Mary Schapiro states strong support for a fiduciary standard. How will this translate into legislation?…