Lost in the shuffle of President Obama’s recently proposed regulatory overhaul is the proposal to hold all brokers to the same fiduciary standard as registered investment advisors.
First, a little background. A quick check of Wikipedia finds this definition of fiduciary duty as ‘… the highest standard of care at either equity or law. A fiduciary (abbreviation fid) is expected to be extremely loyal to the person to whom he owes the duty (the ‘principal’): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents. The word itself comes originally from the Latin fides, meaning faith, and fiducia, trust’.
Under current regulations, registered investment advisors, like our firm, are required to accept fiduciary responsibility in all our actions. Brokers, like those found in most of the large brokerage firms aren’t held to the same high standard. The only requirement they have is to recommend investments that are ‘suitable’ for the client.
Sounds like the same thing, right? While the difference in responsibility between the Investment Advisor and Broker might seem like semantics, it can mean a real difference in practice.
For example, your advisor at XYZ Brokerage has determined, correctly, that a mutual fund that invests in Large Cap companies is a suitable investment given your risk tolerance, age and circumstances. Among her many fund choices, your advisor at XYZ has available to her Fund A and Fund B. Fund A is a proprietary fund run by the firm and Fund B is a fund run by an independent mutual fund company and both have similar performance results. Fund A, though successful and clearly suitable, carries a higher expense ratio and higher turnover than Fund B but also pays the advisor more. Both of the funds are ‘suitable’ for your portfolio and the advisor would be well within the rules to recommend Fund A over Fund B.
If your advisor worked for a Registered Investment Advisor (RIA), they would have a fiduciary responsibility to recommend a fund that is not only suitable, but that is in your overall best interest. That means that despite the fact that they would make more money recommending Fund A, they are obligated to recommend Fund B since it carries lower overall expenses.
If adopted, this proposal could fundamentally change the way the brokerage business operates. Firms would be required to change their compensation structure to de-emphasize proprietary products and would most likely cause them to reduce expenses and improve the performance of those same proprietary products in order to make them more compatible with the fiduciary standard. The result would be better protection for the consumer, something the Obama administration is pushing aggressively for as part of this overhaul.
This article was written to illustrate one aspect of President Obama’s regulatory overhaul proposal and to highlight some of the differences between advisors that work for Investment Advisors and those that work for brokerage firms. It is in no way intended to imply that advisors at the brokerage firms are anything but ethical. I truly believe that the vast majority of people in the financial services industry, whether they are technically subject to fiduciary responsibility or not, act in the best interest of their clients on a day in and day out basis.
If you’d like more information on fiduciary responsibility or if you’d like to schedule a portfolio review to ensure that your current advisor is adhering to the standard, drop us an email at info@rtjfinancial.com or call our office at (310) 587-3370.
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