Are You Conflict-Free?

The most appealing position statements in financial services businesses profess a freedom from conflicts of interest. At the same time, this position may be the most difficult to prove. The Department of Labor’s newly released Conflict of Interest rule is poised to raise the bar on the fiduciary standard even higher.

The DOL finally released its long-awaited rule redefining who is a fiduciary under ERISA on April 6, giving advisors until Jan. 1, 2018, to come into compliance. 

The DOL’s regulation of retirement business will clamp down on advisors who seem to serve their own interests before the interests of their clients. News of these additional requirements has stirred a hornet’s nest throughout the financial services industry. The DOL’s emphasis on a fiduciary standard of care likely will apply to the general delivery of advice in all of its manifestations, not just retirement accounts.

Acting in a client’s best interests is always the proper stance. Can you imagine a doctor proclaiming disdain for the Hippocratic Oath, which requires physicians to swear by certain ethical standards? Yet how are these standards defined in the financial services arena? The DOL’s regulations identify an ethical tipping point in the payment of commissions to brokers who sell financial products.

The DOL seems to view the payment of commissions as self-dealing and conflicted, as advisors may be incented to trade to generate income. They believe that conflicts may be mitigated by contractual obligations that will create a higher standard of client care. Pressure on the industry is causing many to shift to an advisory or, as some broker-dealers term it, fee-based model to diminish the threat of self-dealing.

RIAs ‘Validated’ by Rule

Registered investment advisors (RIAs) who are fiduciaries under the Investment Advisers Act, and probably already act as fiduciaries under ERISA, are thrilled to point out how their fee-only approach positions them as client advocates rather than product advocates. Consequently, they feel validated by the government’s efforts to control conflicts of interest in the professional management of retirement savings. Now RIAs must surrender one of their best differentiators to a competing business model.

Many contend that “what’s good for the client is good for the profession” and assume that there is enough business to go around. However, before RIAs become too self-righteous about their business models, this community must examine its own conflicts.

If you accept dinner with a fund company or tickets to an event from a technology provider, does this create a conflict? If you accept a referral from your custodian in return for keeping the assets on their platform forever, are you acting in your client’s best interests — or your own? If you charge fees based on the amount of assets a client brings, are your interests truly aligned? If you talk your client out of paying down their mortgage, thus keeping more assets under your management, do you disclose how this benefits you?

One of the greatest conflicts I see in financial services occurs when the client pays a fee based on the value they bring instead of the value the professional offers. How does a person’s net worth dictate the amount they should pay? That is like a doctor charging by the pound. In this comparison, both professions would be equating size to complexity, and the amount accumulated (in dollars or pounds) to the effort needed to serve the client.

The financial services industry is in dire need of a reputational facelift, but the new regulations raise some important questions about how the business of financial advice will be conducted post implementation. It would be a mistake for RIAs to think that a new fiduciary standard for the management of retirement accounts will not influence their business, including the vehicles they use such as options and derivatives; differentiated fee-based pricing for equities, fixed income and cash; or even actively managed mutual funds. If there is a massive shift to passive investment vehicles, will active managers provide enough thrust to lift the indexes that the passive vehicles depend on?