Fiduciary Requirements and Why It Matters

Much is being made of legislation discussions in Washington about the requirement for advisors of retirement accounts to have a fiduciary responsibility to their clients. What does it mean? Why does it matter?

Fiduciary Responsibility

A fiduciary duty is a legal duty to act solely in another party's interests. Fiduciaries may not profit from their relationship with their clients unless they have the clients' express informed consent. They also have a duty to avoid any conflicts of interest. A fiduciary duty is the strictest duty of care recognized by the US legal system.

Financial Advisors working for brokerage firms are not fiduciaries. Financial Advisors working with Registered Investment Advisors are. This is an important distinction.

Why It Matters

In the absence of the fiduciary duty, if a broker is advising a plan sponsor and plan participants of a 401k plan, current requirements only state that the investments are suitable. If Fund A is suitable, but pays the broker 5 times the commissions compared to Fund B. There would be no problem recommending Fund A over Fund B, even if Fund B has significantly performed better. As long as its suitable, the suitability standard has been served, but fiduciary duty has not.

Fiduciary requirements would mean the broker is required to act solely in the best interest of the client. They would be required to advise the plan sponsor and participants to buy Fund B, due to better performance and lower expenses.

To put it bluntly, a broker is a salesman, who can sell you anything, as long as it’s risk profile and objectives fit your risk tolerance, time horizon, liquidity needs, and investment need. It does not matter if that investment is the most expensive, worst performing investment among suitable choices, as long as its suitable the broker is not violating suitability rules. There is a very distinct difference in an investment being suitable and an investment being in your best interest against all alternatives.

Impact?

I represent a Registered Investment Advisor (or RIA). As an RIA, we currently are held to the fiduciary standard. In other words, there would be no change to how we operate. However, a vast majority of the investment public is served by brokerage firms, which are only held to the suitability standard. A law change would mean that the brokerage firms would have to change the way they do business with regard to retirement acc

ounts, or exit the retirement account business.

In other words, all of the companies you see advertising while watching CNBC or any sporting event would likely need to start telling you how much they are making off of you. Or exit the retirement business.

Conclusion

It sure is nice to operate under a model that already conforms to a fiduciary standard. Further, why would anyone want to be doing business any other way?