Why Shouldn’t Investors’ Best Interests Come First? 

• By KATHLEEN M. McBRIDE

In fact, there are plenty of instances in which you could say the playing field is not level between some professional investors—such as some of those charged with investing local municipal or even county funds (remember Orange County California?)—and their financial intermediaries, as a look at Massachusetts Secretary of State William Galvin’s Web site would show. But that’s a column for a different day.  

So what hope of a level playing field does the average retail investor have? First, investing is necessary for most Americans who want to retire—it is a relative few who enjoy a defined benefit pension plan anymore. And, it’s not just stocks, bonds and cash anymore (in whatever format you choose—individual securities, mutual or hedge funds, ETFs). Now add to the mix structured securities, options, futures, commodities and more, and investing today becomes a place where advice that is in a retail investor’s best interest is not a luxury, but a necessity. Add to that the reality that investment advisors and registered reps. both provide investment advice; but investment advisors are required, as fiduciaries, to put client’s interests first; and registered reps. operate under a fiduciary duty to their firm, not their client, in most cases. Mix in the ubiquitous ‘financial advisor’ title for nearly everyone, or use of other consultant or counselor titles by those who are not required to put client’s best interests ahead of their own—and can you blame retail investors for being confused? Of course not.

One of the issues has been, as indicated by the Rand Report, investor confusion over the differences between brokers and investment advisors and their relationships and roles. The proposed fiduciary standard had not made it into mainstream media—for the most part—until very recently. Now that it has, though, big media has begun to make up for that deficit.

Bloomberg, The New York Times and The Wall Street Journal have, of late, reported on the fiduciary discussion that has heated up in recent days after Sen. Tim Johnson (D-South Dakota) circulated an amendment that could effectively kill the requirement that brokers and insurers who provide investment advice put their client’s interests first.

Johnson proposes replacing the current Senate fiduciary requirement with a “Study and Rulemaking Regarding Obligations of Brokers, Dealers, and Investment Advisers.” It’s a study that sounds very much like what the SEC thoroughly covered in 2008 in, “Investor Perspectives on Investment Advisers and Broker-Dealers,” performed for the SEC by the Rand Institute for Civil Justice.

Bloomberg reported on the Johnson amendment in, “Lobbying May Kill Fiduciary-Rules Plan for Brokers” on Feb 12. Tara Siegel Bernard wrote “Struggling for a Rule Over Brokers,” in The New York Times on February 15. The New York Times continued its coverage in a special “Wealth and Personal Finance,” section on February 18 with “Broker? Advisor? What’s the Difference?” and “Homework for Hiring a Broker,” and Ms. Bernard blogged about it in “Will You be my Fiduciary?”

Not to be outdone, The Wall Street Journal carried a Financial Advisor blog by Zach Anchors, “Voices: Knut Rostad on showing support for a fiduciary standard.” Rostad is chairman of The Committee for the Fiduciary Standard. 

Why should bank, broker or insurance company interests be put before investor’s interests? This is a part of proposed financial services reforms that would not cost taxpayers any money, could help mitigate the growing risk of a retirement crisis, and would be materially meaningful to nearly every American who wants to save and invest to retire, put children through college, or for any other reason.  

A number of Senators are reported to be working on different versions of the financial services reform package. The real question is: Are Senators strong enough—and do they have enough integrity—to stand up on behalf of retail investors and insist on extending the fiduciary standard to cover those who provide investment advice to retail investors? There's a real chance for someone to ride in on the white horse and be a hero or heroine here. Or will Congress, as so often happens, bow down to the bank, insurance and broker lobbyists and throw investors under the train?

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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• • 2/22/2010 1:32:54 PM
  • Morris Armstrong
  • Fiduciary
  • Kate Will every vendor, journalist, politician, public employee promise to put my best interest first? People who have a fiduciray responsibility such as Trutees, Conservators, Attorneys, RIAs more often than not are actually acting on behalf or the client, acting in their place. Calling up a broker and saying,, hey whats a good stock for me is not quite the same. Neither is asking someone for advice when it is noted that I do not have to accept it or not. The RAND Report showed confusion on the publics part. Should new legislation or education be implemented that might provide a useful solution to end the confusion? Congress has a full plate of really important issues to deal with and I am not sure that rushing through a bad or ill thought piece of legislation, imposing the fiducairy standard on all, is not in the best interest of the public. Senator Johnson has taken a reasonable approach in my opinion.
• • 2/23/2010 10:26:24 AM
  • Morris Armstrong
  • Fiduciary
  • Yesterday I received a few calls asking me if my position had changed from when Wealth Manager published my article in 2007 under Fiduciary Facts. http://www.wealthmanagerweb.com/Issues/2007/3/Pages/Fiduciary-Facts.aspx?k=%22morris+armstrong%22 I do not think that my position has changed one iota. In 2007 I advocated that "incidental" be addressed and that attorneys and accountants not be exempt from regulation. The current legislation seems to be driven by compensation issues and not really on the giving of advice. People who do place, legitimately, their trust in others should have the protection of the laws dealing with fiduciary issues.
• • 2/24/2010 8:20:25 AM
  • Ron A. Rhoades
  • Exceptional Article
  • Kate, an exceptional opinion piece on this ongoing debate. So many groups, including the Committee for the Fiduciary Standard, the Friends of Fiduciary (CFP Board, FPA, NAPFA, NASAA, Consumer Federation of America, IAA, Fund Democracy), and many others, have lobbied long and hard to preserve the existing fiduciary standard found in the Advisers Act. They have also sought to reverse recent SEC rule-making efforts which effectively negate any common sense interpretation of the "solely incidental" language of the broker-dealer exemption from the Advisers Act. Their efforts, and yours, are to be applauded. What's the likely outcome? Next week Senator Dodd unveils a new draft. This will be followed by Senate Banking Committee consideration (and amendments), followed (hopefully) by consideration by the full Senate, followed by reconciliation with the House's flawed bill, followed by votes on the reconciliation bill. At each point, as this process continues, huge amounts of money will be spent by commercial interests lobbying Wall Street. In essence, those seeking to preserve fiduciary standards for investment adviser, and seek common sense application of the standard to all those in relationships of trust and confidence with their clients, are outgunned by about 1,000 to 1. What is even more amazing is that the "self-regulatory organization" whose charge is to enhance high standards of conduct on Wall Street - FINRA - is doing everything it can to weaken standards. The drafters of the Securities and Exchange Act of 1934, and the Maloney Act of 1938 (which gave rise to the NASD in 1939) possessed a vision of a “professional” in the business of providing advice on “other people’s money” which FINRA (previously NASD) has long frustrated. In the first year of his Administration, Franklin D. Roosevelt opined to the press regarding securities law reform: [T]he big objective is to restore the old idea that a person who uses other people’s money is doing so in a fiduciary capacity. That applies whether he is a dealer in new securities or whether he is a dealer in old securities. . . . In other words, a person who works in an exchange … is acting as the agent for other people so that he is acting in a fiduciary capacity.[vi] The 1938 Maloney Act adopted amendments to the Securities Exchange of 1934 which led to the creation of NASD (the forerunner to today’s FINRA): "The Senate Committee Report on the 1938 bill stated that the legislation was intended 'to protect the investor and the honest dealer … from dishonest and unfair practices by the submarginal element in the industry.' It was also intended to 'cope with those methods of doing business which, while technically outside the area of definite illegality, are nevertheless unfair both to customer and to decent competitor, and are seriously damaging to the mechanism of the free and open market.' A securities association was expected to accomplish these goals through cooperative regulation subject to the SEC’s supervision and supplementary powers of direct regulation. Similarly, an SEC official said that the legislation was intended to raise 'the standards of those on the edge to the level of the standards of the best…' Officials of the early SEC urged the securities industry to think of itself as an honorable, great and progressive profession … an SEC official said that the [Maloney Act] was intended to raise ‘the standards of those on the edge to the level of the standards of the best’ … the year after it was enacted, Senator Maloney said that it had been ‘the purpose of Congress to provide the broadest practicable opportunity for the knowledge and experience of the members of this highly technical calling to be employed in the elimination of undesirable practices and in the promotion of truly professional standards of character and competence’ …." Yet, as seen by FINRA’s long-standing adoption of the suitability standard of conduct (a very low level of protection for individual investors), and despite decades of developments in the academic world as to the understanding of risks and returns with respect to investment decisions, “truly professional standards of character” have yet to be adopted by FINRA for the broker-dealer firms and registered representatives it regulates. Indeed, I can find no evidence that FINRA (nor its predecessor, the NASD), has ever even seriously considered the adoption of “truly professional” fiduciary standards of conduct for its members, nor anything that approaches "the standards of the best." More recently, FINRA has “embraced” the fiduciary duty in concept, but its unfounded criticisms of the current fiduciary standard under the Investment Advisers Act suggest that its goal is to promote a “new federal fiduciary standard” that will allow firms to continue conducting business as usual. FINRA advocacy for a “universal standard” or “new federal fiduciary standard” is – in reality – an attempt to lower existing protections for investors who receive investment advice. As made clear by the testimony and comments of numerous observers and consumer groups, the “new federal fiduciary standard” FINRA promotes is not even close to a true fiduciary standard. Self-regulation of Wall Street by an organization whose members are the very firms sought to be regulated is a failed experiment. FINRA and its predecessor, NASD, rather than embracing reforms over time and seeking to raise the standard of conduct of registered representatives, have long fought tooth and nail against substantive reform of market conduct regulation. The leaders of corporations – including broker-dealer firms – are driven substantially by profit motivations, in deference to their own fiduciary duties to their shareholders. A fiduciary cannot wear two hats. FINRA, governed by corporations with strong economic interests in seeking lower standards of conduct, in order to permit greater profit-taking, would be a poor and conflicted choice to assume responsibility for enforcement of the fiduciary standard of conduct. Despite Senator Maloney’s belief, when the Maloney Act was adopted in 1938 (which lead to NASD’s, now FINRA’s, creation), a “profession” was not created in the securities industry; instead, FINRA f/k/a NASD have steadfastly refused to raise standards for their members over time, even when broker-dealers and registered representatives increasingly entered the realm of investment and financial advisory services. As seen by seven decades of a failed experiment in “self-regulation” by securities firms of their own conduct, the commercial interests of corporations should possess no role in the regulation of professional services. I suggest that it will be very difficult to break up large financial institutions. But it would be far easier to dismantle FINRA. Transfer some of its authority back to true governmental oversight bodies - the SEC and state securities administrators. Provide for a professional board of standards to implement the bona fide fiduciary standard for all those who provide financial and investment advice, through appropriate formulation and promulgation of professional rules of conduct. History has shown, time and again, that when INDIVIDUALS - i.e., PROFESSIONALS (not firms and commercial interests) are in charge of establishing standards, they will act courageously to preserve and enhance those standards, as a means of fostering the profession. To have any real shot of true financial services reform, FINRA should be dismantled. And, of course, your "white horse" (and perhaps a whole herd of them) will be needed in Congress, to ensure that the shared interests of professionals and consumers in preserving the bona fide fiduciary standard of conduct are not subsumed by the tens of millions of dollars Wall Street and insurance lobbies are expending on this issue. Where's the "statesman" (or "stateswoman") when you need them?
• • 2/24/2010 8:50:00 AM
  • Dan Danford
  • Fiduciary standard
  • The crux of this discussion is simple. The people who oppose a genuine fiduciary standard are the same people who thrive in an "anything goes" environment. Senators who oppose a genuine fiduciary standard are ones who collect large contributions from the Anything Goes crowd. This is like letting auto manufacturers set safety standards, or pharmaceutical companies vet new drugs. Congress has an opportunity to do the right thing for consumers, but we'll see how this unfolds. Sad truth is that their crowd is so much bigger than ours.
• • 2/24/2010 10:53:17 AM
  • Stephen Winks
  • Fiduciary Standing Can Not Be Legislated, It Is Up To The Free Market To Find A Solution
  • Kate, I believe we have placed false hope in legislators and regulators who are not familiar with the issues, do not have an indepth understanding of advisory services and are easily confused by the massive brokerage lobby. We know what fiduciary standing is based on objective criteria of statute, case law and regulatory opinion letters, but we are divided. We have learned objective expert criteria used in defining advice is divisive for the FPA and the advice lobby because it means many planners are not in fact acting in a fiduciary capacity. So rather than advancing our strongest case in support of fiduciary standing on behalf of the consumer, we have lost all our most salient points in support of advice and have been terribly ineffective in countering a very well organized and effective brokerage lobby that out numbers us 500 to one. The only definitive solution is a free enterprise solution that creates large scale institutionalized support for fiduciary standfing based on objective criteria of statute case law and regulatory opinion letters with an audit path to prove it. Legislators, regulators and the brokerage industry will do none of this. It is up to the free markets. We know what to do and how to do it--the question is who will seize the industry's leadership mantle and execute. SCW
• • 2/24/2010 11:15:12 AM
  • 25 year broker
  • Holier than Thou Attitude (HTTA)... "throw investors under the train?"
  • If the RIA's have to put client's interest first.. shouldn't they only charge enough to keep the lights on. If they are saving for the kids college .. aren't their interest put before the clients? Your HTTA changes how you invest for clients. My RIA friends tell me, "If I see it, I have to charge it.. 1.5%" Doesn't that preclude them from having an conservative investment model. My conservative model is 25% cash and 50% short term bonds. My HTTA RIA friends cannot do that.. their 1.5% fee eats up any returns. They tell me they have to put the money at risk to justify the fee. I charge nothing on cash and .6% on the balance. So it changes how they invest. Last year I charge my clients $600,000 on $189 million in assets. If I went the HTTA route.. "if I saw it".. I would have to/get to charge $2.83 million... Maybe I should join your Committee for the Fiduciary Standard... I would be saving for college for everyone in my neighborhood. I admit, fiduciary standard sounds great.. but there are real world implications that regulators and writers do not fully understand.
• • 2/24/2010 6:24:02 PM
  • Ron A. Rhoades, JD, CFP(r)
  • HTTA ... I'm Guilty!!!
  • Holier Than Thou Attitude (HTTA)? I plead guilty. 1. I set my compensation with the client, in advance. Sometimes its a percentage of the assets upon which advice is provided. Sometimes a flat fee. On rare occassions, an hourly fee. I have concluded that there is no "perfect" way to charge fees. But agreed-in-advance level compensation arrangements avoid many conflicts of interest. I don't accept material compensation from any brokerage firm or product provider. Period. 2. I ensure that the "total fees and costs" my clients pay relating to their investments AND the receipt of my comprehensive advice are extremely reasonable. For the investments I recommend, I discern (or at least estimate) transaction costs (bid-ask spreads, market impact, brokerage commissions paid within pooled investment vehicles), scrutinize securities lending revenue (and who receives what portion of it), and opportunity costs relating to cash holdings. I don't just disclose the "annual expense ratio" of a pooled investment vehicle - I ensure the client knows ALL of the fees and costs of the products I recommend, and is aware of how these fees and costs impact them. I formed an independent RIA firm, in order that no one would impose restrictions on the products I can access. (If, for example, I wanted to access a brokerage firm's captive product, I could easily advise my client to establish an account there, and work to negotiate the brokerage fee for the acquisition of that product. Of course, very few proprietary products, or limited access products, meet my criteria for recommending them to my clients, following my extensive due diligence.) I have nothing against commissions, per se. If level compensation could be achieved, commission-based compensation could, in some instances, make sense. But since commissions vary depending upon the product sold, such varying compensation creates a strong conflict of interest - one which I would rather just avoid. 3. The portfolios I design and manage are ALWAYS tax-efficient. I don't hide behind that ever-popular statement "Our firm does not provide tax advice; consult your tax advisor." I AM my client's advisor - and taxes are so crucial to the client's after-tax returns that I would not think but to plan out each individual trade of a client so that it is undertaken to minimize the client's long-term tax drag. 4. The portfolio strategies I employ are not based on speculation, or guess-work. I minimize risks in investing which do not adequately reward my client. I have my clients assume risks with full knowledge of the range of likely outcomes. I tell clients I don't profess to have a crystal ball. I do tell them that I can apply a large body of academic research which will, with a very high degree of probability, result in higher returns, or lower risk, as to their overall portfolio, or some combination of the two as dictated by the client's needs. 5. Yes, I reduce my fees for my clients who have conservative portfolios. Not because I have to. But because at all times I seek to add value to the client. 6. I'm there for my clients, as their trusted advisor. They are free to call me with any question relating to their financial lives. And they do. I encourage them, and provide them with the confidence, to pursue their lifetime goals. I keep them focused. And, when necessary, I'm brutally honest with them. 7. Every client has an investment policy. Each client knows what we will do if the stock market goes up, or down. And I'm there to make certain they follow the plan. My client's success rate over the last 2 years - 97% - in following their plan. 8. I strive to ever improve, personally and professionally. I am a student of all of the subject areas found in financial planning, and constantly read and look for new ideas and insights. Even then, I know I will never "know it all," and I choose to surround myself - both in my firm in in the associations I join and participate in - with knowledgeable associates and friends. 9. I understand that being a "fiduciary" is not just about undertaking disclosures (even though the SEC seems wholly focused on same). That, even when a conflict of interest cannot be avoided, and even after disclosure, I must still manage that conflict to keep my clients' best interests paramount. I adopt the client's ends as my own. I represent the client only. Having agreed to in advance what my reasonable compensation, and eschewing third-party-paid fees, permits me to act truly as a representative of the client. I realize that a true fiduciary can never wear two hats. 10. Ninety-nine percent of the new clients to our firm possess highly costly, tax-inefficient, overly risky portfolios, with no plan for what happens "if" (and "when") the worst case occurs, and often an investment policy and and financial plan (or lack thereof) which has no meaningful relationship to the client's short-term and/or long-term goals and needs. Through hard work, and some serious counseling time spent with clients, I can, and do, add significant value to my clients. I am proud to be able to provide a high degree of expertise to my clients, for their benefit, and in their best interests at all times. I'm proud to be a fiduciary, and a true professional. If that means that, in the eyes of some, I possess a HTTA - so be it! For the sake of our fellow Americans, I hope that we have many more capable RIAs, who acquire and maintain a high degree of knowledge and experience, who are diligent, and who embrace their fiduciary status. I hope we have many more persons with HTTA. Want to change your ways, and join us? (Hint ... you'll feel really good after turning over a new leaf. It has nothing to do with FINRA, or regulation, or compliance. It has everything to do with the knowledge that, each and every day as you enter the office, you will make a difference in someone's life, and your clients will become your best friends. Your life will be filled with passion and fulfillment.) Again, if the cost of that is being accused of being HTTA ... I'll gladly plead guilty!
• • 2/25/2010 10:51:50 AM
  • Sanford
  • Confusing
  • I am an average investor who happenned upon this article. Quite frankly I am surprised at some of the responses. Mr Danford seems belligent... all or none.. without any compromise on definitions. The 25 Year Stock Broker makes no sense although I am sure his math is good. Mr Rhodes lost me completely with his never ending remarks that were obviously taken from somewhere else and even I can see that the groups that have lobbied long and hard all seem to be composed of the same people. I am sure that the late Senator Mahoney is pleased that his empty rhetoric still echoes today. How many people, after having a bill passed talk about it in anything less than glowing terms? What does surprise me is that your some of yoru respondents are saying that because investors don't understand the law, then the law should be changed to suit them. That is the crux of the RAND report.
• • 2/26/2010 3:54:06 PM
  • Bob Garey
  • Fiduciary
  • Good article, Kate. If brokers / agents of the banks, brokerages, and insurance companies are required to practice under a true fiduciary standard, those financial companies will find ingenious ways to water down the standard so that they can still sell their profitable products. It's just the way it is. They (the companies) have too much at stake, and they need a distribution system for their products. Certainly some brokers / agents care enough about their customers that they live up to the spirit of fiduciary standards, which requires ignoring or fending off the internal marketing to them from their companies to sell profitable products. But investors are left to a hit or miss chance of whether their broker will be one of them. Those big financial companies exist to sell things to people, and they won't easily give up their profitable system. And expecting Congress to make them is actually kind of funny. But that's just because we've seen Congress in action recently.
• • 3/15/2010 2:37:57 PM
  • Brian Ashe
  • Fiduciary Standard
  • Placing all advisors under a fiduciary standard will not automatically bring about positive results. Bernie Madoff was a fiduciary and he perpetrated the biggest financial fraud in U.S. history. Additionally, the imposition of this standard assumes that anyone is capable of determining what is "best" for a client--best when, best compared to what, best as determined by what standard or standards and who determines what those standards are. We will create a hotbed of potential litigation. Additionally, it is very possible the SEC would outlaw commission based sales. Experience in the UK in this type of environment would indicate that tens of thousands of advisors may leave the business, leaving consumers with few choices to go for advice. This is bad legislation. That's why it needs to be studied further for its impact.
• • 3/15/2010 5:19:24 PM
  • David F. Sterling, Esq., Consultant
  • Investor's BEST Interests?
  • I was so pleased to see your reference to the insurance industry at the end of the article. My question is simple. When are regulators, fiduciary gurus, investor advocates going to broaden their "vision" just a bit to include fixed insurance products under the "best interests" of the client umbrella? I have refrained from any reference to "investors" for to do so would likely disqualify consideration of fixed insurance product promotions and solicitations. For example, we all know that purchasers of fixed index annuities completely understand that they are buying insurance and not making an investment. When do advocates begin to turn their attention to what is taking place on that side of the ledger? David F. Sterling, Esq., Consultant
• • 3/15/2010 5:57:04 PM
  • Kate McBride
  • Fiduciary Standard
  • Editor's Note to Brian Ashe comment: First, delighted that this is bringing out many thoughtful comments. 1) I must point out that Bernie Madoff was a broker/dealer until 2006, and that most of his crimes were conducted onder that regulatory authority. 2) No regulation or legislation will deter a criminal. Madoff's acts were criminal. When we talk about fiduciary duty here we are talking about law abiding advisors doing the right thing by their clients. 2) Being a fiduciary does not mean that you cannot have commission income. It is about disclosing all material facts--including compensation, put investors’ best interests first; a fiduciary has to act in a prudent manner; disclose conflicts and all important facts; avoid or manage in the investor’s interest all material conflicts; disclose fees and control expenses; follow and document a due diligence process in making decisions; and diversify investments. There is a lot of mis-information circulating about the application of the fiduciary standard to everyday brokerage situations. I can say from the many meetings I have attended in Washington over the last nine months, that these issues are being thoughtfully discussed by all sides. As far as who determines what is best for a client you are giving advice to, you are going to need to have a process in place for determining that according to the needs and goals of your clients. There are firms that can help you put that knowledge and structure into place for your own clients, should you so desire. The investment advisory model has been around--quite successfully--for 70 years, so there is plenty of precedent for advisors being fully capable of putting clients' interests ahead of their own and still being able to run a profitable firm.--Kate McBride, editor.
• • 3/29/2010 2:29:30 PM
  • J Gunther
  • retail banks and IRA investing
  • Why aren't retail banks required to tell customers that there are alternatives to CDs for their IRA investments?