This week’s showdown over whether your adviser can put his or her
interests above yours hinges on the difference between legal and ethical
standards
Mom, apple pie and the fiduciary standard. It’s really that simple – or at least it should be. Shouldn’t our financial advisers be legally required to put our interests before their own and not get any kind of financial incentive from folks who design financial products, some of which might not suit our needs?
As this week’s hearings at the Department of Labor drag their way to a close, it’s clear Wall Street, and a lot of people in Congress, feel it’s more complicated than that.
The battle over the “fiduciary standard” is pitting Wall Street against its critics and could end up making the fights over Obamacare and the Dodd-Frank Wall Street reform bill look like mild tussles by comparison.
In one corner stands President Obama, who sees an ongoing effort by parts of the investment industry, and the Department of Labor, to get all investment advisors to agree to a rule that would put their client’s financial interests before their own as being a part of his legacy. In the other corner is Wall Street, which sees the rule as having the potential to cost it billions of dollars in revenue, at a time when other sources of fees also are under pressure.
As this week’s hearings at the Department of Labor drag their way to a close, it’s clear Wall Street, and a lot of people in Congress, feel it’s more complicated than that.
The battle over the “fiduciary standard” is pitting Wall Street against its critics and could end up making the fights over Obamacare and the Dodd-Frank Wall Street reform bill look like mild tussles by comparison.
In one corner stands President Obama, who sees an ongoing effort by parts of the investment industry, and the Department of Labor, to get all investment advisors to agree to a rule that would put their client’s financial interests before their own as being a part of his legacy. In the other corner is Wall Street, which sees the rule as having the potential to cost it billions of dollars in revenue, at a time when other sources of fees also are under pressure.
In the eyes of the advocates of the fiduciary rule, there’s no question about who is wearing the white hat. It’s those advisers whose only compensation comes from the clients they advise, in the form of fees, and who clearly identify themselves as working as fiduciaries. If you ask your adviser, straight out, to whom she owes her first legal duty of care, and the answer doesn’t come promptly and clearly: “you, as my client”, then odds are that she isn’t required by law to resolve any conflicts of interest that arise in your favor. You can’t be a part-time fiduciary; it’s like being a little bit pregnant.
Does that matter? In practice, it may not; you hope it will never be put to the test. Most of the financial advisers who work for firms like Merrill Lynch or Morgan Stanley are just as honest and competent and thoughtful when they work with their clients. But they have a different set of responsibilities and duties. They may spend most of their time thinking about their clients, but their first legal duty is to the company that employs them. In practice, their work for you is covered by a looser “suitability” standard, which means that whatever investment they suggest simply needs to be more or less appropriate, given your broad financial circumstances.
If the lack of clarity in the “suitability” standard scares you, well, it should. There are many ways in which things can go very, very wrong.
One study by the White House calculated that financial advisers who steered clients into more expensive or less attractive investment products, in response to their financial incentives, ended up costing investors in IRA accounts alone somewhere between $8bn and $17bn in underperformance. The hearings underway this week have heard other tales of what happens when the suitability standard proves inadequate: brokers who design “plans” to generate certain levels of income each week (regardless of the needs of their clients); advisers who persuade their clients to roll over IRAs into accounts that the former can manage on a commission basis, and that then dwindle rapidly.
Nothing can stop an adviser from claiming that he won’t sleep until he has discharged his obligation to his client, or that she’ll work night and day to understand her client’s needs and meet them. But those are just words. They appear a lot in ads, like those of Ameriprise (“our advisers are ethically obligated to act with your best interests at heart”) and Wells Fargo (“a healthy relationship with your financial advisor should make you feel that your best interests are the top priority”). The key words that should trigger alarm bells there are “ethically obligated” and “should make you feel”. Ethically obligated isn’t the same as legally obligated, and feelings aren’t the same as legal requirements.
If anything goes wrong, and you end up facing off against the adviser (and his powerful firm) in an arbitration panel, those words don’t cut the mustard. Indeed, Wells Fargo has made that explicit claim in arbitration proceedings, while Ameriprise has disclosed: “There is an incentive for our financial advisors to sell a fund from a load fund family or a fund that pays a … fee over one that does not … which may influence your financial adviser to recommend certain funds or classes over others.”
Still think that there’s no difference between “suitability” and “fiduciary duty”?
The opponents of requiring all advisers, and not just independent fee-based financial planners, to adhere to this higher standard argue that the costs to both firms and advisers are prohibitive. The Department of Labor has estimated the costs of implementing the change at between $2.4bn and $5.7bn over the next decade, but the Securities Industry and Financial Markets Association (SIFMA) pegs it at $5m to start, plus at least another $1.1bn annually.
Does that matter? In practice, it may not; you hope it will never be put to the test. Most of the financial advisers who work for firms like Merrill Lynch or Morgan Stanley are just as honest and competent and thoughtful when they work with their clients. But they have a different set of responsibilities and duties. They may spend most of their time thinking about their clients, but their first legal duty is to the company that employs them. In practice, their work for you is covered by a looser “suitability” standard, which means that whatever investment they suggest simply needs to be more or less appropriate, given your broad financial circumstances.
If the lack of clarity in the “suitability” standard scares you, well, it should. There are many ways in which things can go very, very wrong.
One study by the White House calculated that financial advisers who steered clients into more expensive or less attractive investment products, in response to their financial incentives, ended up costing investors in IRA accounts alone somewhere between $8bn and $17bn in underperformance. The hearings underway this week have heard other tales of what happens when the suitability standard proves inadequate: brokers who design “plans” to generate certain levels of income each week (regardless of the needs of their clients); advisers who persuade their clients to roll over IRAs into accounts that the former can manage on a commission basis, and that then dwindle rapidly.
Nothing can stop an adviser from claiming that he won’t sleep until he has discharged his obligation to his client, or that she’ll work night and day to understand her client’s needs and meet them. But those are just words. They appear a lot in ads, like those of Ameriprise (“our advisers are ethically obligated to act with your best interests at heart”) and Wells Fargo (“a healthy relationship with your financial advisor should make you feel that your best interests are the top priority”). The key words that should trigger alarm bells there are “ethically obligated” and “should make you feel”. Ethically obligated isn’t the same as legally obligated, and feelings aren’t the same as legal requirements.
If anything goes wrong, and you end up facing off against the adviser (and his powerful firm) in an arbitration panel, those words don’t cut the mustard. Indeed, Wells Fargo has made that explicit claim in arbitration proceedings, while Ameriprise has disclosed: “There is an incentive for our financial advisors to sell a fund from a load fund family or a fund that pays a … fee over one that does not … which may influence your financial adviser to recommend certain funds or classes over others.”
Still think that there’s no difference between “suitability” and “fiduciary duty”?
The opponents of requiring all advisers, and not just independent fee-based financial planners, to adhere to this higher standard argue that the costs to both firms and advisers are prohibitive. The Department of Labor has estimated the costs of implementing the change at between $2.4bn and $5.7bn over the next decade, but the Securities Industry and Financial Markets Association (SIFMA) pegs it at $5m to start, plus at least another $1.1bn annually.
There are some who argue that the high costs of accepting the fiduciary rule mean it will become too costly to continue serving middle-class investors, pushing them into more costly kinds of investment accounts or meaning that they lose access to in-person investment advice altogether. They’re trading on fear, suggesting that advisers might end up firing their clients.
At least one of those who addressed the hearings, Raymond Ferrara, chairman and chief executive of ProVise Management Group, scoffed at the idea that that would be economically necessary. He pointed out that his firm hires individuals with the certified financial planner designation, all of whom, by definition, adhere to the fiduciary duty standard – and that his advisers all serve middle-class Americans. Then, too, there is the fact that many of the Wall Street firms likely to be affected by the move already have been cutting back on their willingness to provide financial advice to smaller clients: it has been nearly four years since Merrill Lynch advisers were told that they wouldn’t be paid for working with new clients with less than $250,000 in assets.
While critics of the fiduciary rule fret about the prospect of Americans ending up limited to websites and “robo advisers” – automated investment services – I’m less anxious. The “robos” have their own problems (one-size-fits-all rarely lives up to its pledge, and I’d watch out for automated providers marketed by companies that have proprietary products to market, like Schwab or Vanguard), but they have a low cost base, can reach and serve that segment of the market that doesn’t need a lot of specialized personal advice, and (with the exception of the caveat above) the potential for costly conflicts of interest is low.
The writing is on Wall Street, and the legions of critics of the fiduciary standard lining up to have their moment in the spotlight this week might want to bear in mind Senator Elizabeth Warren’s remarks to her Republican colleagues, in a very different context, earlier this month. “Do you have any idea what year it is? Did you fall down, hit your head, and think you woke up in the 1950s?”
Replace the 1950s with the 1990s, the last glory decade for Wall Street deregulation, and you could apply the same comment to the fiduciary standard debate. The whole bait-and-switch nature of the “suitability standard”, which allows financial firms to publicize their devotion to their clients in lavishly-produced advertisements, only to back away when those clients later claim in arbitration hearings or lawsuits that they were given conflicted advice and sold costly, inappropriate products, should go the way of the two-Martini lunch and Gordon Gekko’s suspenders.
At least one of those who addressed the hearings, Raymond Ferrara, chairman and chief executive of ProVise Management Group, scoffed at the idea that that would be economically necessary. He pointed out that his firm hires individuals with the certified financial planner designation, all of whom, by definition, adhere to the fiduciary duty standard – and that his advisers all serve middle-class Americans. Then, too, there is the fact that many of the Wall Street firms likely to be affected by the move already have been cutting back on their willingness to provide financial advice to smaller clients: it has been nearly four years since Merrill Lynch advisers were told that they wouldn’t be paid for working with new clients with less than $250,000 in assets.
While critics of the fiduciary rule fret about the prospect of Americans ending up limited to websites and “robo advisers” – automated investment services – I’m less anxious. The “robos” have their own problems (one-size-fits-all rarely lives up to its pledge, and I’d watch out for automated providers marketed by companies that have proprietary products to market, like Schwab or Vanguard), but they have a low cost base, can reach and serve that segment of the market that doesn’t need a lot of specialized personal advice, and (with the exception of the caveat above) the potential for costly conflicts of interest is low.
The writing is on Wall Street, and the legions of critics of the fiduciary standard lining up to have their moment in the spotlight this week might want to bear in mind Senator Elizabeth Warren’s remarks to her Republican colleagues, in a very different context, earlier this month. “Do you have any idea what year it is? Did you fall down, hit your head, and think you woke up in the 1950s?”
Replace the 1950s with the 1990s, the last glory decade for Wall Street deregulation, and you could apply the same comment to the fiduciary standard debate. The whole bait-and-switch nature of the “suitability standard”, which allows financial firms to publicize their devotion to their clients in lavishly-produced advertisements, only to back away when those clients later claim in arbitration hearings or lawsuits that they were given conflicted advice and sold costly, inappropriate products, should go the way of the two-Martini lunch and Gordon Gekko’s suspenders.
This Content was originally posted on Suzanne McGee
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