Scene: The lobby lounge of a hotel. Five people, three men and two women, are seated around a cocktail table. They have just attended a meeting sponsored by a professional association for financial advisors and are discussing the day’s presentations. They are:
Andy: A life insurance agent
Barbara: A fee-based financial planner
Charlie: an attorney, working in the compliance department of a large insurance company
Don: a freelance writer, specializing in “consumerist” articles involving the financial services industry
Ellie: An investigator for the State Department of Insurance
Andy: I don’t know about you folks, but I found today’s sessions to be very helpful, especially that lawyer’s presentation on “standards of care.” I was always under the impression that we life insurance agents are obliged to make recommendations that are suitable, but that we are not subject to the fiduciary duty that applies to portfolio managers and investment advisors. Frankly, what I heard is a bit scary.
Barbara: I can relate to that. As a registered investment advisor, I am held to that fiduciary standard when I am acting in that capacity, but, like you, I always thought that insurance agents don’t have that burden. Charlie, is that your impression?
Charlie: That’s a very interesting question, Barbara. It’s an issue that we have been kicking around for some time at my shop. Some of our people are insurance agents without securities registrations, some are both agents and registered representatives, and a few are registered investment advisory associates with the advisory arm of our firm.
We have always taken the position that when our people are acting solely as insurance agents, the “suitability standard” that applies to such agents is the only applicable standard of care, and even when the agent is selling a security and acting as a registered rep, the same is true. But, of course, our advisory folks are held to a higher standard, which is spelled out in the ADV form that they must supply to the client. But we are re-examining this issue, in the light of this whole fiduciary duty debate.
Barbara: Are you thinking about applying the fiduciary standard to everyone?
Charlie: We’re giving a lot of thought to that. Frankly, we’re just not sure that the rules are clear.
Don: Wait a minute. I’m confused. Aren’t all of your people obliged to put the client’s interest first? Doesn’t everyone who sells financial products to consumers have to do that?
Andy: Sure. All good insurance agents do that. When we sell something, whether it’s life insurance, an annuity, or some other product, it has to be suitable. The client has to be better off by buying that product.
Barbara: Yeah, but that’s not the same thing as “putting the client’s interest first,” is it?
Charlie: Not exactly. Our understanding is that for a sale to be “suitable,” it must meet the client’s needs. But, if it’s an insurance or securities sale made by an insurance agent or registered rep who is not acting as an “investment advisor,” that rep doesn’t have to disregard his own commission interest. By contrast, the investment advisor must put the client’s interest ahead of his own.Don: Hold on a minute. How is that even possible? Are you suggesting that an insurance agent or registered rep — stockbroker or whatever — can take into account how much money he will make on a sale, but an investment advisor can’t do that? Aren’t all advisors, no matter how they are designated, in business to make a profit?
Barbara: Sure. I certainly am. But I don’t get commissions. I charge a fee for my advice.
Don: So, are commissions different from fees? Are fees treated differently, for purposes of determining the client’s best interest, from commissions?
Andy: Uh oh. I saw this coming.
Barbara: It’s not that one is better than the other, but they are different. The real distinction is, I think, not in the nature of compensation, but in what a financial professional does to earn that compensation. Andy is selling products. I sell advice. And, as I understand it, those of us who sell financial advice, who are “investment advisors,” for purposes of the 1940 Investment Advisors Act, are held to a higher standard than those who sell financial products for a commission.
Charlie: That’s right.
Ellie: If I can jump in, I think the Barbara is right that there are two standards of care involved here. Our department regulates the sale of insurance products. We do not regulate investment advisors. That’s handled by our friends at the State Department of Securities. They regulate both the sale of securities by registered reps, who are compensated by commissions, and the sale of advice by investment advisers, who are compensated by fees. The so-called “suitability standard” applies to registered representatives — and to insurance agents, whom we regulate — and the “fiduciary standard” applies to investment advisors. The suitability standard is not as high. It does not require disclosure of compensation, nor does it require the insurance agent or registered rep to put the client’ s interest ahead of his or her own. That said, I’m told that there are elements of the fiduciary standard that do apply to stockbrokers or registered reps in our state, such as the duty to execute trades faithfully and promptly and to maintain proper custody of client’s assets.
Don: This is really confusing. How can a consumer know what to expect and which duty applies to the person offering him financial products or advice?
Barbara: That is a question that the SEC has been wrestling with and that Congress specifically addressed in the Dodd-Frank financial reform law. Sections of that law direct the SEC to develop a fiduciary standard that will apply to everyone who gives financial advice.
Andy: Are you saying that the SEC is going to hold me, an insurance agent, to the same standard that applies to you, Barbara, or to a trust officer or portfolio manager? Will those sections of the Dodd-Frank law that you mentioned say that I cannot earn commissions?
Charlie: No, Andy, they don’t. One section of that law specifically states that the standard that Dodd-Frank requires the SEC to develop must acknowledge that the receipt of commissions, in and of itself, will not violate that standard, and also that recommending financial products that are proprietary, or that come from only a limited portfolio of products, will, in and of itself, not violate that standard.