The word fiduciary has caused heartburn for most advisors. It is not the promise to act in clients’ best interest that scares most advisors; it is the task of proving that this was actually done that causes the pain. How is it possible to show that the motivation behind a recommendation is the client’s interest and not the compensation the advisor earns?

Thank You, DOL!

While many are celebrating the striking down of the Labor Department’s fiduciary rule and the introduction of the SEC’s less intrusive best-interest proposal, it should be noted that these events have had an irreversible effect on the public awareness of a fiduciary relationship. The appeal of having an assurance that the advisor acts in the client’s best interest is irresistible to consumers. Make no mistake: The public is aware, and if given the choice, clients will always go with the fiduciary advisor.

Prior to the demise of the fiduciary rule, many institutions and advisors had established fiduciary practices that they can now use as a powerful strategic advantage to grow their business. The superior standard of care provided by a fiduciary relationship is a winning differentiator in the investment and insurance business.

Making ‘Fiduciary’ Into a Must-Have Feature

Advisors who see only the threat of a fiduciary relationship are headed to the dustbin of history, while those who recognize the opportunity will use its appeal to bring in assets at an awe-inspiring pace.

Advisors can now differentiate themselves with an achievable promise. In the existing structure, advisors who convince clients of their expertise by offering superior results, better protection or a financial plan cannot guarantee success with any of these. In fact, these are aspirations at best, and required disclosures reveal that recommendations based on past patterns may or may not repeat.

A Better Way

Promising a superior standard of care through a fiduciary relationship is achievable. It creates an asset gathering powerhouse, capable of capturing assets from advisors who fail to meet the standard of fiduciary comfort.

However, success with a fiduciary relationship requires that exposure to fiduciary risks are mitigated and that the benefits are aggressively promoted.

Fiduciary Risk Mitigation: The Wrong Way

Traditional fiduciary risk mitigation strategies cancel out the benefits!

First on the traditional mitigation list is, “Nothing in writing should have the word fiduciary.” This obviously cripples the usefulness of a fiduciary relationship. You must be able to boldly and repeatedly say at every available opportunity, “I am your fiduciary.”

The second traditional fiduciary risk mitigation is to limit the areas where fiduciary responsibility applies, often limiting applicability to only what regulations require. This approach may actually be less effective for asset gathering than the first (omitting the term), because limiting the scope raises suspicions of mischief in the areas declared to be non-fiduciary. Once disclosed, non-fiduciary activities become highly visible. Clients will want to know why these areas are omitted. An answer of “so you can’t sue me” is unlikely to win business.

Regulations

State and federal regulations permit fiduciary relationships even when they don’t require it.

It is important to understand that having a fiduciary relationship can be entirely voluntary and does not require any specific regulation. It does, however, require compliance with state and regulatory requirements. For example, if a fiduciary relationship includes rendering investment advice, state and federal regulations require registration. This distinction is important because the mitigation of fiduciary threats are independent of and in addition to state and federal requirements.

Existing registrations permit an advisor to use a fiduciary relationship as a registered representative, an IAR, RIA, insurance agent, or any applicable state or federal registration.

Fiduciary Risk Mitigation: The Right Way

Far and away the best mitigation that retains the benefits of the fiduciary relationship is the use of a generally accepted process that the client understands and agrees to in writing. That understanding and agreement and strict adherence protects the advisor from any claims by the client. The advisor needs to prove three things: The communication is understandable, the process is generally accepted and it is used consistently.

Proof of understandability, general acceptance and consistency requires credible evidence. Understandability is proven in two ways. The first is by formal testing of written and verbal communication against established standards. The second is by independent reviews or client surveys.

General acceptance of the process used is proven by evidence of wide usage or an independent expert opinion. Wide usage is the easiest method but it provides little differentiation for the advisor. It is not helpful to claim that “I do what everyone else does!” Using an expert opinion can establish the quality of the process as well as its general acceptability.

Consistency is proven by creating and maintaining records of the steps in the process. It is not necessary to maintain a record of every event, only those that are essential to the process. For example, a process may involve five steps such as 1) Determining client needs, 2) Explaining process used to create recommendations, 3) Using a computer model to identify possible options, 4) Selecting best options and preparing recommendations, 5) Obtaining client acceptance/rejection of recommendations. It is only necessary to record the fact that these five steps were performed and the outcome of each. These records should be retrievable for any and every client.

The mitigation is complete when the advisor also complies with applicable regulations.

Now to Gather Assets…

Effective use of the fiduciary relationship begins with a message that is highly appealing but not so broad as to be misleading. The language of the message is adapted for the specific advisor and target clients but the essence should include three key points:

  • Recommendations are always in clients’ best interest.
  • Clients have access to our knowledge and experience for a modest cost, which is aligned with a superior standard of care.
  • A reliable process is used to determine what clients’ best interests are.

Such fiduciary messages tend to be most effective with middle market clients. While still appealing to clients with large holdings, these clients are more likely to already have fiduciary relationships. However, many of these relationships are weak because the fiduciary role is limited to certain activities (usually those that regulations require). Small clients have less fear of being disadvantaged and are not as likely to be swayed by a fiduciary relationship.

The Appointment

An effective fiduciary message will lead to the next step, an appointment.

With the opportunity to make a presentation, the advisor must deliver a compelling case for why the client should trust the recommendations made. Using the fiduciary relationship (acting in the client’s best interest) as a backdrop, the presentation or proposal should make the following points:

  • Value the advisor brings: How the advisor adds recognizable value for the client. The value proposition should be clear, simple and repeatable. It should enable the client to answer why he/she chose that advisor.
  • Services being offered: The process used by the advisor and the results produced.
  • Risks and Regulations: The acknowledgement that the future is uncertain is made here and the method(s) used to limit or prevent harm is explained. The advisor should also inform the client about which state or federal regulations apply.
  • Prerequisites: Expectations of what will be necessary for the client to do/have.
  • History/Experience: Advisor’s background and highlights that are of interest to the client.
  • Alternatives: Pros and cons of the client acting without an advisor and using another advisor. This should include an explanation of any negative disclosures.
  • Costs: The net one-time or annual cost. A reasonable estimate is what is important, not an exact figure because of the unpredictable future. Explaining the basis for the estimate is not necessary at this time.
  • Timetable: When to act and when to expect follow-up. This should take the client’s individual situation into consideration.
  • Next Steps: What to do right now. This typically includes an agreement for the engagement to begin followed by some form of fact finding.
  • Deliverables: What client can expect to receive and when. The first deliverable is generally a recommendation or an investment policy statement that reflects the client’s situation.

Conclusion

Advisors have a unique opportunity to become leaders by taking advantage of the unquenched public thirst for a fiduciary relationship.


Lou Harvey, founder, DalbarLouis S. Harvey is the president and founder of Dalbar, which is recognized as the leading provider of advisor audit and evaluation services to the financial services community.

Most recently, Harvey has been at the forefront of major changes facing the retirement plan business, including Social Security reform, disclosure reform, participant advice, qualified default investment alternatives and the transition from plans that require “elections by participants” to ones that make “elections for participants.”

Lou Harvey has served on several boards and committees including the Federal Reserve of Boston, NASD, Bentley College and several nonprofit organizations.