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Industry Spotlight > RIAs

Why a Fiduciary Duty Matters

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Does a fiduciary duty really make a difference in the quality of the advice that retail investors get? According to the brokerage industry, the answer is a resounding “No!”

To hear SIFMA tell it, it’s just a matter of differing business models. Worse, over the six years since the signing of the Dodd-Frank Act, industry representatives have claimed that if their brokers were required to act in the best interest of their clients, the costs of advice would go up, access to financial advice would be denied to smaller investors, and (my personal favorite), having to act in their clients’ best interests would, in fact, not be in their clients’ best interest.

Over those years, many proponents of a broker fiduciary standard, including the Obama administration and the Consumer Federation of America, have offered studies of the striking costs of non-fiduciary advice to retail investors. The industry responded with complicated, academic-sounding dismissals of this “evidence,” causing most investors’ eyes to glaze over, and driving them back to watching “Better Call Saul.”

All of this begs the question of whether there isn’t some clear, easily understandable, and hard-to-argue-with data that graphically demonstrates the differences between fiduciary advisors and nonfiduciary or part-time fiduciary advisors. If such data does exist, could it be used as a way for full-time fiduciary advisors to demonstrate their differences to clients, prospective clients and the media? As it turns out, the answers are yes, and yes.

As part of this year’s Fiduciary September, the Institute for the Fiduciary Standard (IFFS) released a study of what various types of RIAs (ranging from small, independent RIAs to large institutions) disclosed in their Form ADVs. The results are, to say the least, surprising. More importantly, they graphically capture the differences between fiduciary and non-fiduciary advice in financial services firms’ own words.

“These data reveal the differences and similarities among RIA firms in how they conduct their businesses,” wrote the study’s authors, Knut Rostad and Darren Fogarty. “Chief among the questions is the degree to which firms minimize conflicts of interest and render financial and investment advice for a fee solely paid by clients.”

Rostad is president and founder of the Institute for the Fiduciary Standard, where Fogarty is a research associate.

To make these comparisons, Rostad and Fogarty collected the Form ADVs (which all registered investment advisory firms file each year with the Securities and Exchange Commission) of 135 RIAs and nine very large financial services firms. The RIAs were chosen from Financial Advisor magazine’s July 2016 RIA Survey & Ranking list of the top 610 RIAs by total assets under management. Only RIAs with $250 million in assets under management or more were considered for the IFFS survey, and then every third RIA on the list was selected.

Some 18% of the RIAs (25) have AUM of $3 billion or more. All 135 of these firms offer portfolio management, and 94% of them offer financial planning services. For compensation, 99% of all the RIAs charge a fee calculated by percentage of AUM, while 61% of them also charge hourly fees.

The nine large firms included in the survey are: Ameriprise, Edward Jones, JPMorgan Securities, LPL Financial, Merrill Lynch, Morgan Stanley, PNC Investments, UBS Financial Services and Wells Fargo Financial Advisors. They collectively manage some $2.54 trillion in aggregated assets, ranging from PNC Investments’ $11.2 billion in AUM, to Morgan Stanley with $575 billion. Not surprisingly, in addition to being RIA reps, 88% of the employees of these nine large firms were also identified on their firm’s ADVs as registered reps of a broker-dealer.

The authors found the most telling information for these RIAs under two sections of their ADVs. The first is under Part 1A: Material conflicts of interest.

  • Thirty-five percent of the RIAs and 100% of the large financial services firms reported employees who are registered representatives of a broker-dealer, the report found. Additionally, 39% of the RIAs and 100% of the large financial services firms reported employees who are licensed agents of an insurance company or agency. These numbers are significant as both brokers and agents owe a duty to their respective employers when they are “selling,” rather than to their clients.

  • Two percent of the RIAs and 89% of the large banks report that “the entity or a related person buy or sell securities from advisory clients or to advisory clients. This is a clear indicator that ‘principal trading’ plays a minimal role in these RIA firms.” Principal trading — selling stocks and bonds owned by the firm — represents a major conflict of interest as the selling price is not arrived at through an arms-length transaction.

  • Seventeen percent of RIAs and 78% of large financial services firms “recommend securities to advisory clients in which the advisor or related person has some proprietary interests.” An even greater conflict than principal trading (due to costs and fees that investors often don’t understand), proprietary products clearly play a larger role in RIA firms than does “principal trading.”

  • Thirty-four percent of RIAs and 0% of the large financial services firms analyzed by IFFS exclusively receive fees from clients. “Of the 66% of the RIAs that receive other forms of compensation, 52% receive brokerage compensation, and 34% receive insurance compensation.”

  • Seventy-six percent of RIAs and 100% of the large financial services firms have “a relationship material to their business that creates a material conflict of interest with their clients.” This generally means receiving outside compensation from the sale of securities or insurance. In contrast, the authors found that the 25 RIA firms (18%) with “no material conflicts” also had “no registered representatives and insurance agents and reported only receiving compensation from client fees.”

Top Five RIA, BD Infractions

Even more interesting than these material conflicts of interest is the information the authors found in Part 1A, Item 11: Disclosure Information. “Each of the large financial services firms answered affirmatively to between five and 22 of the 24 questions in Item 11, for a total of 115 infractions.” Did you get that? “Each” of the large firms had at least five wrongdoings, compared to three RIA firms with one infraction each. The graph above shows a tally of five major infractions.

Collectively, the large firms reported paying fines or restitution totaling over $4 billion for their 115 infractions, compared to fines of $5,700 and $62,500 for two of the RIA infractions. A third RIA reported paying a fine to Florida “exceeding five figures” in addition to credits to clients also exceeding “five figures.”

What are investors and advisors who would educate them to make of this information? First, the difference between both the number and the magnitude of the reported securities violations of large financial institutions and RIA firms should be tattooed on the forehead of every registered rep in the country. We’re not talking about a few “bad apples” here. Every large firm on the list committed at least five of these major infractions. Call me crazy, but this doesn’t spell “trusted advisor” to me.

Second, the IFFS findings provide a very clear and easy way for even the most financially illiterate investor to differentiate between full-time fiduciary and part-time fiduciary RIA firms, as the RIA firms with no material conflicts also had no registered representatives and insurance agents, and only received compensation from client fees. It doesn’t get much clearer than that — and the best part is that those statistics come right out of firms’ own ADV filings.

— Read Why the Wirehouses Hate the AUM Business Model on ThinkAdvisor.


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