Adhering to DOL Fiduciary Rule: Heal Thyself

Consequently, these ‘Assessments’ raise the question: “Is it reasonable to believe that an investor can work with the same advisor on both a fiduciary basis and a non-fiduciary basis at various times, and fully understand the duty of care they are getting each time?” 

Of the Institute’s 12 areas of self-assessment, six are fairly basic:

1. Ensure baseline knowledge, competence, and ongoing education appropriate for the engagement
2. Communicate clearly and truthfully, both orally and in writing. Do not mislead. Make all disclosures and important agreements in writing
3. Provide a written Investment Policy Statement
4. Use peer group ranking to determine reasonable investment expenses
5. Abstain from principal trading unless initiated by the client
6. Avoid gifts or entertainment that are not minimal and not occasional. Avoid third party payment, “benefits,” and indirect payments that do not generally benefit the firm’s clients and may reasonable be perceived to impair objectivity.

The other six, however, raise some interesting questions:

• Provide a written statement of total fees and underlying investment expenses paid by the client. Include any payment to the advisory or the firm or related parties from any third party resulting from the advisor’s recommendations.

  What’s interesting here is the reference to any “third-party payments” to the firm. Brokerage firms get paid in various ways by product manufacturers ,including underwriting, marketing, and due diligence fees. While these payments can create large financial incentives to ‘sell’ these products, to my knowledge they aren’t disclosed anywhere, and certainly not to brokers or their clients. While these conflicts certainly seem material, it’s not clear to me how the veracity—or lack of it—in disclosures could be ascertained.

• Avoid compensation in associate with client transactions. If such compensation is unavoidable, demonstrate how the conflict is managed and overcome and the product recommendation and compensation serves the client’s best interest. 

These last four areas all seem to raise the issues of a broker’s legal status as “registered representative” and an “employee” of their BD, so I’ll address them collectively

• 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.

• Affirm that the fiduciary standard under the Advisors Act of 1940 and common law principles govern all professional advisory client relationships at all times.

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

• Establish and document a ‘reasonable basis’ for advice in the best interest of the client. 

Considering that the income, future income (payout percentage), “loans and their repayment,” career advancement, access to new and transferred clients for an employee broker (and even some independent brokers) are all dependent upon the largesse of their firms, it’s hard for me to understand how these conflicts might be “avoided” or even “managed.” To my mind, these are “material conflicts” that are indeed “incompatible with objective advice.”

What’s more, as securities law requires “registered representatives” to “represent” the interests of their BDs, and business law requires employees to represent the interests of their employers, it’s hard to understand how the ’40 Act fiduciary standard could “govern all professional advisory client relationships at all times.”

Consequently, it’s hard to see how these standards could be truthfully met, by employee brokers, or attested to, by their brokerage firms.

Yet my fear is that they will be: through clever definitions and wording. Such as that these practice “may be” met (as opposed to actually meeting them); that the fiduciary standard applies to an advisory relationship at all time (but not if the advisor is acting as a “broker”) and, of course, whether material conflicts are really so “material” after all.

The net result of this “worst case” scenario could be to create even more client confusion, and to further blur the lines between product sales and fiduciary advice. It will be incumbent on the IFFS to see that their self-assessment does not get watered down—as have so many other professional movements—into yet another “powerful marketing tool.”