Rethinking Best Practices for Fiduciaries

Investor confusion seems to be exacerbated by some of the advisory industry’s own accrediting organizations. For instance, the CFP Board appears to take it on faith that CFPs act as fiduciaries at all times for their clients, as its canons of ethics require. So does fi360, for advisors who have earned its Accredited Investment Fiduciary (AIF) designation. While both organizations may yank their accreditation from advisors who are sanctioned by the courts or regulators, by their own admissions, neither actively monitors their designees for compliance with a fiduciary standard, despite the fact that both organizations accredit brokers, who do not legally have an obligation to act as fiduciaries at all times. Consequently, brokers (and other advisors) can show clients their CFP or AIF standard to act as fiduciaries at all times, without any outside confirmation that they are actually doing so.

‘Concrete and Verifiable’

That brings us to IFFS’s “Fiduciary Best Practices.” In his Oct. 21 blog for ThinkAdvisor, Rostad wrote that the “Best Practices were developed because federal regulators and industry groups have fallen short in establishing, much less enforcing, a true ’40 Act fiduciary standard. […] Advisors must act to protect investors. They must raise the bar on standard practices, demonstrate they do so and speak out to investors of the great work of good advisors.”

Of the Institute’s best practices, five are fairly straightforward:

• Communicate clearly and truthfully.

• Ensure baseline knowledge, competence and ongoing education appropriate for the engagement.

• Institute an investment policy statement or an investment policy process that is appropriate to the engagement and describes the investment strategy.

• Abstain from principal trading unless a client initiates an order to purchase the security on an unsolicited basis.

• The advisor affirms in writing adherence to Best Practices, and attains written affirmation from the firm that these practices may be met by the advisor.

The other practices warrant some discussion:

“Avoid conflicts and potential conflicts. Disclose all unavoidable potential and actual conflicts. Manage or mitigate material conflicts. Acknowledge that material conflicts of interest are incompatible with objective advice.” This last sentence is intended to undo the SEC’s erosion of the ’40 Act standard by acknowledging that major conflicts cannot be merely disclosed away. This practice also requires that after receiving a client’s acknowledgement of a conflict, advisors must “be able to demonstrate that the transaction remains reasonable and fair and consistent with the client’s best interest.”

“Provide, or instruct clients how to obtain, a written statement of total fees and underlying investment expenses paid by the client. Include any payments to the advisor or the firm or related parties from any third party resulting from the advisor’s recommendations.” Disclosing third-party payments to advisors’ firms is currently not required under any standard that I know of, yet is essential for clients to assess the magnitude of the financial incentives to make specific recommendations. I suspect that it is unlikely any BD will allow such a disclosure.

“Avoid compensation in association with client transactions. If such compensation is unavoidable, demonstrate how the conflict is managed and overcome, and [how] the product recommendation and compensation serves the client’s best interest.” This, of course, is about commissions, and seems to be a reasonable attempt by the Institute to enable brokers to comply with its Best Practices.

“Avoid gifts or entertainment that are not minimal and not occasional. Avoid third-party payments, ‘benefits’ and indirect payments that do not generally benefit the firm’s clients and may reasonably be perceived to impair objectivity.” This is another attempt to reveal hidden conflicts.

“Consider peer group rankings in ensuring underlying investment expenses are reasonable.” Although this practice sounds as if it applies to advisory fees, the discussion suggests it addresses the relative costs of actively versus passively managed funds. It would seem that the usefulness of this practice would boil down to who decides which alternatives are included in a given “peer group.”

According to Rostad, “the Best Practices are crafted to be concrete and verifiable and understandable.” To my mind, “verifiable” is the operative consideration. While these standards represent a marked improvement over any existing fiduciary standard that I know of, without active verification by an independent body, they run the risk of becoming just a marketing tool.

— Read “Are Brokers Really as Anti-DOL Fiduciary as Their BDs?” on ThinkAdvisor.