Let’s start with a few simple questions. Do you want the person managing your money to be required to do what is in your best interest? Need more time or was that an easy answer? I’m guessing you assumed your advisor was already required to do that?
There’s a battle taking place in the money management business and it’s contentious enough that the typical quiet policy changes that occur behind the scenes are sneaking "above the fold." At issue is the question of fiduciary financial services. The word fiduciary, while simple in definition, is tremendously complicated when put into action in the asset management space. (For more, see: Choosing a Financial Advisor: Suitability vs. Fiduciary Standards.)
You may know "your guy" well and feel like he’s looking out for you and will always do what’s in your best interest - though by definition, they are not required to behave that way. The majority of financial services professionals are only obligated to do what is "suitable" for you, a vague and often stretched version of a code of conduct. Here’s a hint: the guys that work at Merrill Lynch, Wells Fargo, Morgan Stanley, etc? They are most likely not fiduciaries and instead are operating under the suitability standard.
Suitability Versus Fiduciary
Want a simple example of what is suitable versus fiduciary? If I’m your financial advisor and you want to invest in a growth mutual fund, I can look at a list of growth mutual funds and choose the one that pays me the most (the advisor’s paycheck is removed directly from your investment in the fund). I could have chosen a growth fund that charged you less, but I don’t have to do so. I did what was suitable for you. I bought you a growth mutual fund according to your wishes. As long as I have disclosed (that’s the 100 page document you get in the mail and immediately toss in the recycle bin) the fees involved, I’ve fulfilled my duty.
That same move would be considered unacceptable under a fiduciary standard because I did not technically do what is in your complete best interest. The original fiduciary standard comes from the Employee Retirement Income Security Act of 1974, commonly known in the industry as ERISA. ERISA is the reason we all have a 401(k). ERISA says that an advisor must "act prudently and solely in the interest of his or her client." Additionally, an advisor providing tailored advice to you must avoid certain transactions and situations where he or she might benefit from an investment or action.
Without diving into the weeds of legal jargon, the spirit of a fiduciary standard is that the person you hire is obligated to do what is in your best interest. Always. And that includes not offering a “product that causes me to earn an additional fee, even with disclosure,” as Steven W. Rabitz, an ERISA attorney, told the Wall Street Journal earlier this year. (For more, see: Paying Your Investment Advisor - Fees Or Commissions?)
Prefer a more humorous explanation? Let’s say you’re shopping for a suit and talking to your local, friendly, suit salesperson: a suitable suit has to fit you, a fiduciary suit actually has to look good on you too.
If you’ve ever come across a salesperson from a large insurance firm (you know the ones) then you’ll know how difficult this rule can be in practice. They have proprietary insurance products that put food on their table, and that means you are going to get a proprietary, high-fee insurance product. I often say if you walk into a barber shop and ask if you need a haircut, you’re probably getting a haircut. These are good people, even honest people, but they are forced to sell you something that is probably not in your best interest because their paycheck is on the line. Much like the suit salesperson, there are only so many proprietary products on the rack, and you’re going home with a suit. The rules have been set for them. They are simply playing the game as they were trained. Inevitably, that guy gets paid, the company makes money and only you, the consumer, suffer.
The Fiduciary Rule
Over the last several years, the Department of Labor (DOL) has stepped into this murky legal soup and offered to beef up the regulation as it applies to retirement accounts. Immediately, all of the big Wall Street banks and insurance companies (you know the ones) hired attorneys and expensive lobbyists to fight the language of the rule. They succeeded in tweaking and watering it down such that clients could still be sold high commission and proprietary products as long as clients signed a "best-interests contract exemption." Basically, another disclosure that will be written by lawyers, with many pages, that you won’t read.
That’s not all. There are currently active lawsuits filed by - you guessed it - the big Wall Street banks and insurance companies. Their goal is to stop the rule entirely. The first, filed by the National Association of Fixed Annuities, is already in the courts. In addition, groups such as the Securities Industry and Financial Markets Association, the Financial Services Institute, the American Council of Life Insurers, the National Association of Insurance and Financial Advisors and the Indexed Annuity Leadership Council have all filed suit together or on their own. Check out this hilarious ad they’ve created to scare you. Who’s funding that ad? Metlife, Aflac, Mutual of Omaha and other brands in the Insurance industry. (For more, see: DOL Fiduciary Rule Explained as of August 31, 2017.)
Here’s another video gem just released from Merrill Lynch. They’ve decided to outlaw commissions in retirement accounts and crafted this heartwarming message to let you know they’re looking out for you. Note if you will, right around the1:00 mark, where they make sure to differentiate that "when it comes to their retirement savings" clients will receive a fiduciary standard of care. That clarification wasn’t a mistake. It’s because with all your other accounts they’re completely comfortable operating as they always have - with hidden commissions, proprietary products and high fees.
Ask yourself: Why would all of the big players fight a rule that so clearly has your best interest at heart?
The worst kept secret on Wall Street is there are rampant conflicts of interest in the business, but those conflicts create an enormous sum of dollars. In a White House memo that made it to the press, citing numerous academic studies, Jason Furman and Betsy Stevenson of the Council of Economic Advisers write that investors lose between $8 billion and $17 billion a year to high-fee, commission products inside retirement plans.
You’re not dumb. Wall Street and large insurance companies are fighting this rule because it creates massive piles of revenue for them, usually at your expense.
Who’s not against this rule? The Certified Financial Planner Board and the Financial Planning Association. They have come out in support of the changes. It is a trench war, with the product creators and their salespeople on one side and the no-commission planning people on another. In the middle is you and your wallet.
As the fiduciary headlines have gotten more frequent, so have the headlines on behalf of consumers. On August 19th, Morgan Stanley was sued in a class action by its own employees, claiming “the company mismanaged its own employees’ retirement plans by offering poorly performing funds and charging excessive fees.” And who could have missed the backlash against Wells Fargo? Their bank employees had such an incentive to open accounts that they allegedly did so without consent, repeatedly, for years. Do you need more examples to know that the sales culture of these large banks is not in your best interest?
Generally, I don’t believe you can legislate bad behavior. People with bad intentions will always find a way to circumvent whatever rules are put in place, as evidenced by the countless Ponzi schemes that are prosecuted every year, 100 years after Charles himself first tried it. To think that the government will regulate the problem away is naïve, but the status quo is officially dead. Change had to happen and arguing against a best interest rule just makes no sense. Consumers are becoming more aware and will continue to demand better and financial services companies are scrambling to patch up their business models.
The DOL’s new fiduciary rule, as it’s come to be known, took effect in April of 2017. While these changes are going to be slow, and the traditional brokerage and insurance businesses will do their best to slow them down, changes are most certainly coming.
Let’s end with another set of questions. On which side of this fight do you want to be? Does your advisor receive commissions you don’t know about? You sure? Is your advisor a sworn fiduciary? Why not? (For more, see: Lawsuits Aim to Overturn DOL's Fiduciary Rule.)