For the past several months, the financial advisory community has been bracing itself for the dreaded new fiduciary rule from the Department of Labor that will soon appear in its final form. Many advisors, particularly those who work on commission as brokers, have been fearful of the potential impact that this legislation may have on their businesses.
The fiduciary standard that the DOL intends to use will differ somewhat from the standard currently used by the SEC, and many advisors are worried that this dual standard may be difficult to uphold. But advisors need to stop and take stock of what’s already happening across the board in the industry now. The new fiduciary rule may ultimately be merely an extension of a general movement towards a fiduciary standard in the industry.
On March 14, the SEC handed down a ruling that fined three broker-dealers in the AIG Advisory Group $7.5 million for using mutual funds in advisory accounts that charged 12b-1 fees when there were equivalent funds available that did not carry this charge. The three broker-dealers (Royal Alliance, SagePoint Financial and FSC Securities) had earned about $2 million from these fees from 2012 to 2014, and the SEC ruled that they did not clearly inform their clients about the conflict of interest that came with using these funds. This failure amounted to a breach of fiduciary duty and repeated failures by their compliance departments to use the lowest-cost fund alternatives that were available. (For more, see: What the DoL's Fiduciary Policy Means for Advisors.)
FINRA has likewise issued a report to advisors regarding their employment of robo-advisors to manage their clients’ assets. The report indicates that advisors need to begin maintaining a fiduciary standard when they use these automated programs and analyze their underlying algorithms to ensure that they will always act unconditionally in the clients’ best interests. This will require an ongoing process of evaluating the program in several different respects, including accuracy of data that is input, any possible conflicts of interest that may be generated and the overall relationship between the clients, the firm and the program. (For more, see: Can Robo-Advisors Meet the Fiduciary Standard?)
One section of the report states that advisors are responsible for “governance and supervision of algorithms, including initially assessing the methodology of digital tools and the quality and the reliability of data inputs, as well as ongoing evaluation such as testing the tools to ensure they are performing as expected, and determining whether models used by a tool remain appropriate as market conditions change.” This essentially means that compliance officers are going to have to become literate enough with computers to properly supervise the codes that are used in robotic programs so that they uphold a fiduciary standard. Key issues here will include how much clients are able to rely on these programs to carry out their functions in a fiduciary manner and how well the programs get to “know” the clients and understand their investment objectives, risk tolerance and time horizons. These programs will therefore ultimately be subject to the same scrutiny as human advisors, so planners need to make sure that their automated platforms toe the mark.
(For more, see: How Advisors Can Plan for Fiduciary Rule Changes.)
The Bottom Line
The new fiduciary rule will likely have a substantial impact on the business models of many financial planners, but the industry clearly seems to be heading in this direction in any case. Advisors who use robo-platforms in their practices need to make sure that their programs will meet the new fiduciary standard when it is published, and that the actions of these programs accurately mirror the actions that their human sponsors would take for their clients. For more information on the new fiduciary rule, visit the Department of Labor’s website at www.dol.gov. (For more, see: How the Fiduciary Rule Creates IRA Rollover Conflicts.)