This post is going to be a bit of a rant. I apologize in advance if you are offended. It might also be a little more “inside information” about the financial industry than you want to know. But it’s something that you should know. It’s not overly dramatic to say that your financial future could depend on it. I strongly believe that if you are paying for financial advice, you deserve to know whether the advisor you are paying is looking out for your best interest.
I am referring to the “fiduciary rule,” the on-again, off-again attempt by the government to protect investors from conflicted advice. But first, some background. A fiduciary is a person in a relationship who is expected, and obligated, to act in the other party’s best interest. A fiduciary has the power and responsibility to act for another in situations regarding total trust, good faith, and honesty. Common examples of professionals who are held to a fiduciary standard are lawyers, who have a fiduciary duty to their clients; doctors, who have a fiduciary duty to their patients; and teachers, who have a fiduciary duty to their students. Accountants, real estate agents, priests, trustees, and many other professionals are required act as fiduciaries.
But it’s different in the financial services world. That’s because the financial services industry has been, and largely remains, a business built upon the sale of financial products. In the early days, stockbrokers sold stocks and bonds. Over the years, they came up with more and more creative products. The commissions earned on the sale of mutual funds, unit investment trusts, annuities, exotic derivatives and structured products built many a Wall Street firm into household names.
Their commercials and other marketing material make it look like their role is to make sure that the goals and dreams of all their customers are achieved. In reality, their focus is on sales. I understand that all sales are not bad and that selling is the grease that keep the wheels of capitalism turning. But a sales relationship is different from a fiduciary relationship. There’s an inherent conflict of interest when one party is “selling” to the other. Commissions on products that are opaque and confusing to most people can lead to a variety of dishonest sales practices.
The government, in its infinite wisdom, has tried to put rules in place that protect the individual investor. The Investment Advisers Act of 1940 provided some framework for the regulation of financial advisors. Under the law, advisors are required to provide their services under a fiduciary standard. However, there’s a huge hole in the law. It depends on how you define advisors.
Advisors whose advice is merely “incidental” to their business are not considered to be advisors. Wall Street firms have always maintained that any advice from their brokers or agents is incidental to the sale of their financial products. Therefore, they are not subject to the fiduciary rules that apply to advisors … even though they often call those brokers and agents by a different name … advisors. There have been many challenges to their view over the years, but their lobbying efforts and campaign contributions have kept our legislators from eliminating the loophole. And yes, you can color me cynical!
Because of the inability, or refusal, of Congress to act, in 2016, the Department of Labor released its version of a new fiduciary rule. It required anyone providing any financial advice on retirement accounts to act as a fiduciary. Despite the protests from Wall Street, the rule began to be phased in, with “full compliance” required in 2018.
We started to see positive changes. Even as the Wall Street firms appealed through the courts, they started moving toward compliance. Several firms stopped allowing their brokers to charge commissions in retirement accounts. We saw sales of annuity products drop dramatically. Maybe the small investor would finally be protected against sales abuses.
Unfortunately, that is not the case. In the appeal process, Wall Street found a friend in the Fifth Court of Appeals, which ruled that the Department of Labor overreached its authority in establishing the rule. I can’t say that I disagree with the fact that the DOL overreached—it would seem more appropriate for the Securities and Exchange Commission (the SEC) to develop and enforce a financial services rule. The SEC did release a “proposed” rule in April of this year, but it falls short of calling for all financial advisors to act in a fiduciary manner.
It didn’t take long for the large Wall Street firms—which had suspended commissions in retirement accounts two years ago when it looked like the fiduciary standard would become law—to reverse course. Now they are allowing commissions again. And not surprisingly, sales of variable annuities have surged since the fiduciary rule died.
It’s important to know that fee-only advisors are, and always have been, held to a fiduciary standard. We get paid for the advice and guidance that we provide, not for selling a product. Isn’t that the way it should be?