As the recent Department of Labor proposal illustrates, the trickiest part of creating a fiduciary standard for brokers (and other registered reps) is how to fit commission compensation into fiduciary duty. As reported by Melanie Waddell in her May 4 ThinkAdvisor article, Experts Take Aim at DOL Fiduciary Redraft, to get commissions under a fiduciary umbrella, the DOL created what it calls “The Best Interest Contract Exemption,” or BICE. Waddell quotes Fred Reish, partner and chairman of the financial services ERISA team at Drinker Biddle & Reath in Los Angeles, describing how the BICE would work:
“The exemption “would permit receipt by advisors and financial institutions of otherwise prohibited compensation commonly received in the retail market, such as commissions, 12b-1 fees and revenue sharing payments, subject to conditions designed specifically to protect the interests of the investors.”
To qualify for this “exemption,” brokers would have to enter into a contract with their clients, promising to act in their “best interest.” And while that sounds like a workable solution, in reality, its client protection would rest solely on the definition of “best interest.” As Knut Rostad, president of the Institute for the Fiduciary Standard documented in his recent white paper, Conflicts of Interests and the Duty of Loyalty at the Securities and Exchange Commission, the SEC has been quietly redefining clients’ “best interest” to mean “disclosure of conflicts.” Consequently, should the DOL adopt the SEC’s view of “best interests,” which seems much more likely than not, its new regulations would amount to little more than business as usual, leaving the question of whether fiduciaries can take commissions still up in the air.
I’ve recently received insightful comments to two of my blogs which address just this issue. The first was by III Financial, commenting on my May 10 blog Deconstructing One Broker’s take on a Fiduciary Standard.
“Having been on both sides of the commission vs. fee-only fences, I strongly feel [that problems arise from a] structural issue with the system rather than unscrupulous brokers in a large majority of the cases. When I sold products on commission, in my mind I was always trying to do the best thing for the client, but since I was acting as an agent of an insurance company I was legally representing the company and not the client. Same with brokerage products—I could have the best intentions in the world but legally the structure told me that I was acting on the BD’s behalf, not the client. In part, this conflict led me to leave that side of the system. Give advisors the chance to legally act as a fiduciary, while still giving them the ability to provide insurance and brokerage products, and I think you’d see a huge number do just that.”
This is exactly the problem with commission compensation: How can an advisor be expected to act in the clients’ best interests when he/she is legally required to act in the best interest of their employer? The other side to that coin is whether commission-paid advisors can actually make a living under a fiduciary standard.
This issue was addressed by Elliott Weir, commenting on my May 6 blog, Toward a Workable Fiduciary Standard for Brokers, in which I proposed seven questions that could reveal a clients’ best interest:
“Many of these points are great, though the compensation structures in today’s environment prevent some advisers (even those who want to work in their client’s best interest) from following these guidelines. A commission-based advisor, recommending ETFs and no-load index funds means $0 compensation. My experience in the BD world showed me that people with $25,000 to invest did not want to pay for one hour of my time via a planning fee, but would buy an A-share that netted me $600 one time. For annuities, Jefferson National has a very good VA that charges $20/month flat, and it can be used for additional tax-deferred savings, 1035 exchanges from other WL and VA policies, etc. Great for flat-fee people like me, but $0 for a commission-based adviser. The single most important question is: how can all advisers work within a fiduciary standard, where both parties (advisor and client) feel that the compensation is acceptable for the time, effort, and value delivered. Solve that, and the answers get a lot easier.”
To my mind, the solution is relatively simple. Both of these issues—the legal requirements and earning a living—boil down to the difference between sales and advice.