Self-described as a consultant who’s also insurance and securities licensed, David F. Sterling made some interesting observations in a lengthy comment to my September 10 blog: Fiduciary September: A Time for Client-Centered Advisors to Come Together, which warrant further discussion. 

First, he rightly points out that there isn’t just one fiduciary standard: “By the fiduciary standard and its relevance, I am inclined to presume [your article focuses on] protocols established under the 1940 Act. But, here’s the problem: Though the Act has a bearing on the rules and procedures proposed by the DOL, the Act and the DOL Fiduciary Rule proposal are not one and the same.” 

Fair enough, as far as it goes: and the SEC and FINRA also have their own interpretations of the Fiduciary Standard as well. Yet with that said, all “fiduciary standards” are “principle based.” That is, while different bodies may have their own interpretations, the underlying principle for all “fiduciary standards” is that the advisor act in the “best interest of their client” at all times. Generally, that means recommending products and strategies that best help clients attain their financial goals, mitigating conflicts, and obtaining the best pricing for appropriate products—which is certainly detailed enough for our general discussion. 

Mr. Sterling then goes on to point out that that what’s best for a client isn’t always obvious: “Second, because what may be in the client’s best interest requires considerable examination and evaluation, no assumption can be made that one service or product solution or compensation arrangement is superior to another.” 

While it’s true that there are cases where, say, a higher loaded actively managed mutual fund (as opposed to an ETF) would be in a client’s best interest, such situations can be easily documented. In the absence of a requirement to put a client’s interests first, however, the conflicts of interest of a commission-charging broker and his/her BD appear to invite abuse. 

Sterling takes this argument to the next level by addressing the issue of advisor compensation: “I submit that commission-based products often offer considerably more value than fee-based product line as circumstances might dictate. Very simply, commission compensated solutions [often] represent an ideal solution for a client’s needs and interests.” 

Again, there’s certainly some truth here. As brokerage industry advocates have pointed out many times in recent years, it’s much cheaper for a client to pay a 3% upfront sales load than to pay 1% (or 2% to 3%, in the case of broker managed assets) in AUM for each of the next ten years. And for clients who aren’t looking for “advice” about which product to buy, or ongoing portfolio management, the commission is probably the way to go. 

Yet as far as I can tell, we’re talking about a very small client group here. In my experience, most financial clients today want advice about what investments to buy, and how to manage them in their portfolios year after year. What they don’t understand is that what they are getting from their broker is “sold,” rather than “advised.”

The problem with commissions is that, by law, they remove the fiduciary duty of the broker/advisor (through the “broker exemption” to the ’40 Act). Consequently, while I’m sure some brokers do make recommendations in their clients’ best interests, given the large financial conflicts involved, they cannot be reasonably relied upon to do so.

The Financial Services Institute’s latest study admits as much when it concludes that it would “cost independent financial services firms $3.9 billion,” if brokers were required to act in the best interests of their clients (see my previous posting, “How Not to Conduct a Legitimate Study on DOL Fiduciary Costs”) by, among other things, using lower-load investments.

A billion here and a billion there adds up pretty quickly to some serious conflict, no?