Value and meaning of Fiduciary

Barry Ritholtz owns a financial advisory business, and has a very successful blog, as does his coworker Josh Brown.  They are both excellent writers and I agree with most of what they post.  In addition, they are both highly critical of the default position of the financial industry, which is to steal as much as possible from everyone with whom it interacts.

Here are some select portions of an excellent essay by Mr. Ritholtz on finding a financial advisor.  The entire essay is worth reading:

Find a financial adviser who will put your interests first
Barry Ritholtz
October 25, 2014

If you want financial advice, there are two things you should be aware of: First, the quality of advice you receive varies widely. You probably knew this already. The quality of everything you buy varies widely. It is as true for financial advice as it is for any product or service you may buy or otherwise consume. You can buy a Yugo or a Mercedes-Benz. They may both be automobiles, but they vary dramatically.

Regardless, everywhere these cars are sold, they each must meet the same government rules. Safety regulations, crash worthiness standards, fuel economy, consumer warranties, etc., apply equally to both vehicles.

This is decidedly not true of the people who provide you with financial advice. So we come to the second point: There are two completely different standards for these people — they are governed by two wholly different sets of regulations. The two standards are “suitability” and “fiduciary.”

People who operate under the suitability standard typically are called “brokers,” but they also go by the name registered representative — or, on their business cards, vice president. (On Wall Street, no one ever has a title below VP.). People who adhere to the fiduciary standard are called registered investment advisers, or RIAs.

Fiduciaries have a much stricter duty and legal obligation than do those who operate under suitability rules.

…The fiduciary legally obligates the registered investment adviser to act at all times for the sole benefit and interest of the client. That straightforward, cut-and-dried standard has enormous ramifications.

The standard is simple. There is zero wiggle room. Any advice, product or service offered to a client must meet the test of “Is this in the client’s best interest?” If the answer is “No,” then it cannot be performed by a fiduciary. It is against the law.

In contrast, the suitability standard is far more complicated — and offers much less protection to investors.

The simplest way to describe this standard is “Don’t sell AliBaba IPO to Grandma.” In other words, all that matters is the investor is “suitable” for a particular product. This is true regardless of how expensive that product might be or how much of a dog the investment is. There are lots of wrinkles and permutations, but the bottom line is that the client’s best interest is not part of the equation.

How they charge

The RIAs operating under the fiduciary standard charge fees — typically, a percentage of assets under management. These range from 25 basis points up to 2 percent per year.

The brokers governed by suitability rules typically charge commissions. This is a transactional rate, and ranges from the online broker who gets $8 a trade to the full- service operation that charges thousands of dollars per trade.

…My personal observations and experiences indicate that over the course of a year, brokers charge from five to 10 times (or more) what an investment adviser will charge per account. So long as it is for “suitable” investments, it is all perfectly legal.

So the ordinary individual investor has three problems with the suitability standard:

1. It favors the brokerage firm and its employees over the investor.

Note:  Not only is someone working for a brokerage firm compensated and in all ways motivated to look out for the best interest of the firm ahead of the client, in fact, they are legally bound by the employer-employee relationship to do so.

2. It costs much more than services provided under other standards.

3. And it creates an inherent conflict of interest between the adviser and the investor.

The last one is perhaps the most important. Any conflict of interest between an investor and their adviser is extremely problematic.

Any time the client’s best interest is not the focus, what occurs instead is the opportunity to “max out” the revenue each client generates. Brokers under the suitability standard are allowed to do this, yet remain within their rules. Since “maxing out fees” is not in the client’s best interest, fiduciaries cannot.

… fiduciary rules protect investors from adviser malfeasance, while suitability rules protect brokers from investor lawsuits.When seeking out advice, do yourself this favor: Find an adviser who is legally obligated to put your interests first.

Our President Obama recently came out in favor of requiring anyone advising individual or group retirement plans to be required to act as a fiduciary.  The reasons stated above are why.  Having been repeatedly hoped-up and disappointed over the last 6 years, I do not think we will hear any more about this.  However, I am glad that at least it got a little press.  Every little bit helps, for people to understand this.

I would add to what Barry wrote, that not only are there brokers and RIAs, (and, confusingly, brokers that are also RIAs), but there are also people out there working for lots of other financial related companies who call themselves financial advisors.  People working for insurance companies, banks (usually these are also brokers), accountants, and now robo-advisors (not even people).

When you go see someone, ask them these questions:

  1. How are you compensated?  The answer to this must include ALL the ways that the advisor is compensated.  If it is something other than “fee-only,” then there is an immediate, built in conflict of interest.
  2. What other businesses do you have an interest in?  If they also are connected to an insurance business, or any other financial services related business, then there is a conflict of interest.
  3. Are you acting as my fiduciary?  If so, is that ALL the time, or only part of the time?  Some advisors may act as your fiduciary when they come up with the plan itself, that is, save X dollars and invest them in allocation scheme A, but then when it is time to select the specific products making up A, they are brokers working for a company selling you only a certain set of products.  The WSJ has an excellent article on this issue:

In one common arrangement, an adviser might own his or her own advisory business but distribute securities as a representative of a securities firm that specializes in working with such independent contractors.

Financial firms can similarly wear two hats: They can operate and be supervised as both registered investment advisers and securities broker/dealers.

But it can get even more confusing, because both advisers who act as fiduciaries and those who fall under the suitability rule can charge commissions and fees. The difference: A fiduciary adviser should disclose what commissions he earns and why a particular investment is chose over another.

Please be aware, there are legitimate reasons to do business with these non-fiduciaries, or other advisors with conflicts of interest, that may make them worth your while.

  • If you need a large line of credit for your business, and you can get a good deal on that in combination with financial advisory services from a bank, that might be better for you in the short run, and maybe even in the long run.
  • If you are young and just starting to save, and you are looking for a cheap and easy way to start out, a robo-advisor may suit your needs for a few years.

 

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