The question – although simple – has no answer because the CFP Board of Standards, the department of labour and the Securities and Exchange Commission do not have a shared definition for the term ‘fiduciary’. The SEC is expected to provide clarification in late 2013 or early 2014.
A New York adviser observed: “People get into the business to make money. The vast majority choose to earn their income by being paid for helping clients make progress towards their goals. It is ethical behaviour. It makes sense. Satisfied clients bring in more assets. They refer their friends.”
Now consider the famous quote attributed to IBM’s Tom Watson: “If you have a one-in-a-million failure rate, what do you tell the millionth customer?” Clients who feel victimised vote with their feet. Some write letters of complaint. Some sue.
Professionals
If a broker places orders and an adviser offers advice, most industry professionals want to be advisers. The problem develops when you ask: who does the adviser work for? Does the adviser work for the person who writes the cheque? If so, the adviser works for the client. Does the adviser work for their firm, because the firm issues their paycheque? If so, they are an agent of the firm. If that is defined up front, fine. The public does not know if titles are similar. Sometimes the client only learns who bears what degree of responsibility after something goes wrong.
Registered investment advisers are keen to institutionalise a fiduciary standard. The adviser works for the client acting in the client’s best interests. All fees are transparent. They offer a range of options, including those not available from their firm. Consider the lawyer/client relationship – the lawyer takes instruction from the client.
The benefits to the client are obvious. How far is the standard applied? If the adviser collects a fee for providing advice, offers a range of options and the client chooses ones purchased away from the adviser, does the adviser have a fiduciary responsibility?
Where does performance fit in? Will Rogers quipped: “Buy some good stock and hold it till it goes up, then sell it. If it doesn’t go up, don’t buy it.” Does fiduciary responsibility extend to not making as much money because another alternative ended up performing better? Some people can be smart on hindsight – “So many factors were obvious, you should have anticipated...”, etc.
The wirehouse world has traditionally held itself to the suitability standard. Recommendations should be appropriate for the client’s stated risk factors and objectives. This allows advisers to limit recommendations to products available at their firm. This makes sense if the ongoing relationship will be in-house.
The word “fiduciary” implies liability. Most would agree if a client followed instructions and the investments went drastically awry, someone should be accountable, and it is not the client – at least in their minds. They took advice – the adviser should be held accountable.
The flaw in this argument centres on discretion. Consider two extremes:
- A client completes a financial plan. They invest a lump sum. The funds are asset allocated. Professional money managers are hired for different segments. The portfolio automatically reallocates as needed. The adviser has run a Monte Carlo analysis showing a range of probable outcomes and the likelihood of each. It is a discretionary relationship. It sounds like fiduciary responsibility means accepting liability for the outcome.
- A client completes a financial plan. They invest a lump sum. The adviser chooses investments. The client never speaks to the adviser again. No letters or calls are returned. No discretion is involved. No changes are ever made to the portfolio. Maybe the client did answer the phone but always refused to follow advice. The client is upset with the result. How does fiduciary responsibility apply? It is difficult to hold the adviser liable if the client never agreed to any changes.
Courts and disciplinary hearings address this question often. In the absence of a definition (or assumption) of a fiduciary standard, the issue could be decided on intent. Firms and advisers keep excellent records, contacts and attempts are tracked. If an adviser shows he intended to provide the best advice possible, and proactively reached out, yet the client did not respond or refused advice, it makes the case that the adviser put the client’s interests first.
Outcomes
Until a standard definition of “fiduciary” is issued, business continues as usual. Once a standard is in place many outcomes are possible. With a strict standard, the investor would have recourse if they do business with a planner or adviser bound by the standard. A less strict standard would also have its merits as legal definitions are rarely one-size-fits-all: consider that the Honours List recognises achievements at different levels; at the other extreme, serious crimes are graduated by degree.
Possible outcomes of a strict fiduciary standard
- Wirehouse firms move to a fee-only system for advice. Clients might or might not invest with the firm providing advice. This requires changes in compensation plans.
- Firms ask clients to opt out of the fiduciary relationship. In the US clients agree to arbitration when they complete the new account paperwork.
- Today firms use disclaimers to specify they do not offer legal or accounting advice. Financial planning in a fiduciary context is added.
- Firms exit the financial planning business. They provide guidance held to a different definition while working outside this framework.
- Financial planning is outsourced. Planners may choose to bring their plan to an adviser who helps with implementation.
Possible outcomes of a non-strict fiduciary standard
- Definition includes more than one level of fiduciary advice. Registered investment advisers advertise how they adhere to the highest level. Wirehouse firms use the word but qualify it.
- Wirehouse advisers use financial planning tools to guide the client but do not offer planning advice in a fiduciary capacity.
- The standard is determined by how much discretion the client has authorised the adviser and firm. Wirehouses using entirely discretionary platforms would have a higher degree of liability. Advisers might still offer advice in non-discretionary situations but clients would need to acknowledge it is not a fiduciary relationship.
- Advisers choose whether to be brokers or advisers and clients agree to a relationship based on qualifications and accountability for advice offered. Pricing is commoditised on the lower tier.
Good behaviour cannot be legislated. Investors should ask: “Do I trust my adviser? Is he working in my best interests? Has he told me what I am paying in direct and indirect costs? Is he accountable, delivering bad news even if I might choose to leave the relationship? Do I understand that even well-intentioned people make honest mistakes?”
Bryce Sanders is president of Perceptive Business Solutions
Key points
- How will wirehouses address fiduciary standards that are part of the CFP ethics code?
- Most would agree that if a client followed instructions and the investments went drastically awry, someone should be accountable, and it is not the client – at least in their minds.
- Good behaviour cannot be legislated, so it is up to investors to decide on the suitability of their advisers.
