Fiduciary Standard: Why the Objections?

Friday, January 20, 2017

By: Christopher P. Cline

There is a lot written lately about the "fiduciary standard" in investing, largely because the Department of Labor is set to impose that standard on advisors who manage retirement accounts. The concept is taken from the duty owed by a trustee to beneficiaries, or by an agent under a power of attorney to its principal. Essentially, it means putting the interests of another ahead of your own. This seems like it should be the undisputed goal of every investment advisor: we should always be putting our clients' interests ahead of our own. So why is the brokerage industry fighting it?

At first glance, it looks like the industry might be moving in the right direction. In an article from January 7, the Wall Street Journal described how Merrill Lynch was ending the broker practice of charging commissions on stock sales in retirement accounts. Instead, its brokers will charge a fee based on assets under management. This change has been made to comply with a new rule set to go into effect from the Department of Labor, requiring all investment advisors to act as fiduciaries with respect to their clients' retirement accounts.

The article interviews a Merrill Lynch broker who started with the firm in the 1980's. When he first joined, he "spent his time cold-calling would-be investors and pitching stocks to nab sales commissions. But in the three decades since, Merrill and many other big brokerages have pushed their brokers instead to serve as overall financial advisers, providing long-term financial planning and pitching checking accounts, credit cards and other banking products, rather than single stocks." So, a huge brokerage firm is belatedly changing its ways, which is a good thing (even if it's only doing it in response to federal regulation).

But another article in the same issue, entitled "Brokers Once Disdained Independent Advisers. Now They Copy Them" points out that other big firms, like Morgan Stanley and Wells Fargo Advisors, will still allow their brokers to sell on a commission basis to clients with retirement accounts. Even Merrill is only making this change with respect to broker-managed retirement accounts, not to all of its accounts, nor to its clients’ full relationships. This makes an otherwise reasonable change seem like mere window dressing. Or, as a Merrill broker-turned-independent advisor puts it in that article, “there are still major differences between someone who is a true fiduciary over the entire relationship of the client versus someone who takes that step [only] on retirement accounts.”

Why is an entire industry, with big budgets and armies of lobbyists, resisting the apparently obvious move to put its clients' interests first? I've heard brokers argue that they would not be able to adequately serve smaller clients under a fiduciary standard. Such clients, they say, need high-commission products like annuities, and the higher standard would limit their ability to serve those clients. But if a given product is actually the best choice for a client's needs, and the broker has selected the lowest-price (and lowest commission) product in its class, the standard is met. So why is the brokerage industry not cooperating?

To be sure, many brokers adhere to the fiduciary standard, adopting a fee-based approach and using the lowest-cost options for their clients. In fact, I have personal experience with an outstanding brokerage advisor who used to manage my accounts. He did an excellent job not only with his investment choices but also helping me with my real-world financial goals. Perhaps the industry isn't following the lead of advisors like him simply because a significant part of its sales force doesn't know how to do anything other than sell product.

Maybe the industry is only trying to protect its lowest common denominator: brokers whose only skills lie in selling, who don't know how to truly advise clients about things like estate planning, asset protection and business succession. Skills like these are what justify paying fees of any sort, whether a percentage of assets under management or commissions.

If this is true, then the real issue raised by this discussion of fiduciary standards is "what are you paying for?" Investment management is now being provided by robo-advisors that, whether we like it or not, are almost as good at building portfolios as we are. The real value that investment advisors provide, which justifies their fees, lies in the highly technical levels of planning and real-world skills of providing comfort and reassurance to their clients. An advisor who is truly a fiduciary should be able to provide these benefits to their clients.

When hiring a new advisor, or reviewing the performance of an existing one, investors should pay less attention to "past performance" of investments (an easily manipulated number than can be used to tell any story in hindsight the advisor wants), and more attention to what the advisor provides IN ADDITION TO investment services. A truly sophisticated advisor will have extensive experience advising on your estate plan, business succession, asset titling, income tax situation and cash flow needs, as well as providing fee-only investment advice using the lowest cost investment options available. This, in the end, defines the fiduciary standard.

And perhaps that's what the brokerage industry is really objecting to, the fact that it's hard to make huge profits when you have to devote a lot of time to finding, training and retaining team members of that caliber, who can achieve the fiduciary standard.