Last week, at the TD Ameritrade annual conference in San Diego, the Institute for the Fiduciary Standard announced its “Best Practices for Advisers and Brokers Seeking to Meet a True Fiduciary Standard.” (See Jamie Green’s article from that announcement, Side-Stepping SEC and DOL, 11 Fiduciary Best Practices for Advisors are Proposed).
It’s a proposal for “eleven Best Practices fiduciaries should meet to serve the best interests of their clients,” which is open for industry comments until March 9, at www.thefiduciaryinstitute.org (or email at [email protected]).
It’s a comprehensive and thoughtful list, and I thought I’d get the discussion going by making a few comments and observations of my own. But before we get to my thoughts, I think it’s important to set the stage by exploring why these best practices are necessary, and what the Institute’s goal is for proposing them.
As for why, here’s what the IFFS’s president, Knut Rostad, had to say: “Fiduciary duties have defined relationships of trust and confidence in investment advice for generations. Yet in recent years the meaning of fiduciary has been transformed, so many investors today are confused or skeptical or downright distrustful of financial professionals–even fiduciaries. Investor misconceptions about who’s selling products and who’s offering advice, and what they pay, are pervasive… …Best Practices are designed to help investors identify true fiduciaries…”
So, the reason for these “best practices” is the confusion created in financial industry and in Washington, D.C., about the different kinds of “financial advisors” and their respective legal responsibilities to their clients. And the IFFS’s goal is to restore investor confidence in financial advice, by creating a standard set of behaviors that will identify those advisors who actually act in their clients’ best interests, and which will be disclosed to advisors’ clients in an engagement agreement.
Now, let’s take a look at the best practices themselves, and see how they stack up:
The first two fall under the heading “General Practices.”
1. “Affirm that the fiduciary standard under the Advisers Act of 1940 governs the professional Relationship at all times.” While it’s not clear to me that this requires fiduciary advisors to be fiduciaries for all their clients (“fiduciary-only,” if you will), it does close the loophole for what is in my view one of the most deceptive practices in financial services: the ability of “advisors” to be “part-time” fiduciaries for each client.
2. “Provide a ‘reasonable basis’ for advice in the best interest of the client.” This is about being able to support advice given and actions taken on a client’s behalf; not, as I first read it, about creating an environment in which one can be reasonably sure that client-centered advice can and will be delivered. There’s more on that later on.
The next six practices fall under the heading of “Duty: Act in Utmost Good Faith;”
3. “Communicate clearly and truthfully, both orally and in writing. Make all disclosures and agreements in writing.” While this may seem obvious, I suspect it needs to be stated to avoid any ambiguity about whether certain disclosures are, in fact, being made to clients.
4. “Provide, at least annually, a written statement of total fees and underlying expenses paid by the client. Include an accounting or good faith estimate of any payments to the advisor or the firm or related parties from any third party resulting from the advisor’ s recommendations.” This “practice” includes all financial fees and expenses that each client pays to any party, as well as to their advisor, and includes any non-client income paid to the advisor and/or his/her firm. It is followed by lengthy and detailed guidance for compliance, and is explained this way:
“The purpose of this practice is to increase transparency and understanding of investment expenses… …While improvements have been made, the industry remains too opaque about underlying investments’ fees and expenses.”
5. “Avoid all conflicts and potential conflicts. Disclose all unavoidable potential and actual conflicts. Manage or mitigate material conflicts. Acknowledge that conflicts of interest can corrode objective advice.” All conflicts are required to be disclosed in a document attached to the engagement agreement. This “practice” goes on in great detail about how material conflicts should be managed, including crediting back “duplicate compensation.”
6. “Abstain from principal trading unless a client initiates an order to purchase the security on an unsolicited basis.” This is perhaps the most curious of the “practices,” in that principal trading typically occurs in brokerage firm operations, not with individual brokers or advisors. I can only infer the intent is that advisors are restricted from advising their clients to buy securities out of their own firms’ portfolios, as these are not arm’s-length or “market” transactions.
7. “Avoid significant gifts, third party payments, sales commissions, or compensation in association with client transactions that cannot be directly credited back to the client or managed as a fee offset.” This “practice” includes some detail about the specifics of the types of remuneration to be “offset” back to the clients, such as commissions. But at least for me, it is the most problematic of all the “practices.” In a conversation, Rostad told me that this practice is “intended to enable client-centered brokers to meet a genuine fiduciary standard.” More on this below.
The next two best practices fall under the heading, “Duty: Act Prudently—With the Care, Skill and Judgment of a Professional”
8. Ensure baseline knowledge, competence, experience and ongoing education appropriate for the engagement.
Baseline knowledge and experience can be demonstrated by holding accepted industry designations, which include: “AICPA/PFS, CFA, CFP, ChFC, Masters in Financial Planning.”
9. “Institute an investment policy statement (IPS) or an investment policy process (IPP) that is appropriate to the engagement and describes the investment strategy. Consistently follow and document a prudent process of due diligence to research and analyze investment vehicles; on request, document the prudent process applicable to any recommendation.” TheseIPSs or IPPs “should express, at minimum, assumptions regarding objectives, risk and expectations regarding performance.”
10. Have access to a broad universe of investment vehicles that provide ample options to meet the desired asset allocation and in consideration of widely accepted criteria. No further explanation is offered for this “practice,” but I suspect it’s mostly covered under the “reasonable basis for investments” in practice #2.