Editor’s Note: This article is an expanded version of a blog the author published on LifeHealthPro in February 2013, titled A uniform fiduciary standard won’t change anything

A uniform fiduciary standard won’t change anything if we don’t fix some of the underlying problems plaguing the industry.

Let me start by saying that you can’t impose morality and ethical behavior through legislation. An industry centered on money will always attract criminal activity. However, change is coming in the financial services industry, and it’s coming in the form of a fiduciary standard. Unfortunately, those who wish to take advantage of others for personal gain, by nature, do not follow the rules. Therefore, any additional legislation or rules attempting to enforce moral character, in my opinion, will not work. Don’t get me wrong; I think change is necessary in the financial services industry, but there must be a better way.

I believe it is every financial professional’s moral responsibility to put the clients’ interests ahead of their own, with no exceptions. With that said, I understand that does not always happen.

To fix the problem as an industry, I feel we need to focus on three key areas:

  • Better enforcement of existing regulations,
  • Improved communication to investors, and
  • Financial literacy and education.

Better enforcement of existing regulations

Taking into consideration my statement above, the debate for a uniform fiduciary standard is flawed. Given the current model, registered investment advisors (RIAs) are regulated by the SEC (primarily under the Investment Advisers Act of 1940). They’re the only type of advisor held to a fiduciary standard and are legally required to work in their clients’ best interest. Essentially this means all other advisors have a moral (but not legal) responsibility to work in the clients’ best interest.

I personally feel that the SEC and FINRA are ill-equipped to provide the necessary level of enforcement required if all financial advisors are fiduciaries. Given the rampant cases of investor fraud across the country, I see no end in sight, with nominal punishments for bad behavior.

For example, I recently read an article that mentioned an advisor receiving a $5,000 fine and one-month suspension for cheating on his continuing education (CE) courses. Will that punishment curb the behavior in the future? I doubt it. Cheating is the result of someone’s conscious decision to break the rules. It’s a mindset. Once the line is crossed, what’s to stop that person from doing it again, this time on a larger scale? In this instance, after one month, the advisor can begin to solicit business and work with clients to manage their money again. Would you want someone who has cheated in the past to manage your money? I know I wouldn’t.

In addition, NBC News published an article last year titled “Too Big to Fail Means Too Big for Jail,” which discussed a money-laundering case involving one of the world’s largest banks. The bank was forced to pay $1.9 billion dollars (accounting for only six weeks of the bank’s profits), and not one member of the bank received jail time for his or her part in the string of illegal activities.

The inability to regulate the large banking institutions only perpetuates the trickle-down behaviors that permit fraud and misconduct at the advisor level, which ultimately impacts the average investor. Now, this case had nothing to do with the average investor. However, it paints a gloomy picture of the level of enforcement on existing regulations. As the media clearly points out via the regular flow of articles on advisor misconduct, the current punishments are not curbing the behaviors. I’m an advocate for more substantial and strict punishments for misconduct and illegal activity. But that’s not going to solve the problem, and neither is a legal responsibility.

Improving communication to investors

Next, there is the argument of compensation. Regardless of how an advisor is compensated, I feel it is their “moral responsibility” to put the clients’ interest first. There isn’t a compensation model available today that eliminates biased advice.

Commissioned advisors may be biased by offering insurance products and/or investments that pay them a higher commission. However, fee-only advisors provide recommendations that may be biased as well. For example, advisors have certain insurance products and investment vehicles that they prefer to offer their clients based on past performance, familiarity with the product and their own personal preferences. The manner in which they are compensated does not deter them from favoring certain insurance and investment vehicles in their financial plans for clients. Therefore, their advice lends itself to bias because of their own personal preferences.

In March, SEC Chairman Elisse Walter was quoted in an OnWallStreet article as saying,“Studies have shown that few investors realize that the standard of care they receive depends on the type of investment professional they use. And often, investors do not know which type of financial professionals they are relying on.”

It is the responsibility of every industry organization to provide more clear and concise explanation regarding the types of advisors available for investors. In the past year, the Certified Financial Planner Board of Standards has made significant strides in promoting not only their CFP designation, but also the type of financial professional that holds their designation. In my opinion, their online marketing efforts and TV ads for the “Let’s Make a Plan” campaign have helped provide clarity to an area of financial planning that was lacking. More initiatives such as this from other organizations will only help improve the level of understanding investors have before choosing their next advisor.

Financial literacy and education

How do we protect ourselves and minimize the risk of being the victim of fraudulent activity? Become more aware! In most cases, when we think of crime, we protect ourselves with things like neighborhood watches and self-defense classes. We watch shows and read articles on crime prevention. Why? We are afraid of physical harm.

However, when it comes to our money, Americans are often less than prepared to protect themselves. With skyrocketing debt-per-household numbers and bankruptcy filings in America, it is clear we are not holding ourselves accountable. The SEC’s August 2012 “Study Regarding Financial Literacy Among Investors,” found that “studies reviewed by the Library of Congress indicated that U.S. retail investors lack basic financial literacy. The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.”

Dare I say that we have a financial literacy epidemic on our hands? A uniform fiduciary standard doesn’t change the fact that investors may not even know whether an advisor is working in their best interest (even if they were) because he or she may lack elementary knowledge of financial concepts and critical knowledge on how to avoid investment fraud.

Perhaps if we better educate the average investor by providing sound and unbiased financial education, we can better equip investors to be able to identify potential investment fraud and empower them to select the type of advisor that is appropriate for their specific needs.

There needs to be a cultural shift in the country rather than a legislative movement to clean up the industry. While I understand the impact of a comprehensive financial literacy campaign may not be seen for years to come, we have to start pushing the industry and investors to better themselves and take strides in the right direction in order to change our economic status.

There is no easy answer to the problems plaguing the financial industry and America, but as an industry, all sides must come together to make any substantial progress and stop casting blame.

 

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