Why Fiduciary Standards are Important
Why Fiduciary Practice Standards are Important
Stewart S. Koesten, MSFS, ChFC®, CFP®, CIMA®
Recently at a meeting of my study group, The Capstone Group, in Columbus, Ohio we discussed the subject of fiduciary standards. From a client’s perspective there isn’t yet a level playing field in the financial services industry. Not everyone who provides financial advice to individuals is required to maintain a fiduciary standard of practice.
A fiduciary is defined as someone acting in a position of trust on behalf of, or for the benefit of, another party.
The organization Fiduciary360 (Fi360) coined the term “Global Fiduciary Precepts” to denote seven common fiduciary practices - practices as they relate to the financial planner/registered investment advisor who provides comprehensive and continuous investment advice. They are:
1. Know standards, laws and trust provisions.
2. Diversify assets to specific risk/return profile of the client
3. Prepare investment policy statement.
4. Use “prudent experts” and document due diligence
5. Control and account for investment expenses.
6. Monitor the activities of “prudent experts.”
7. Avoid conflicts of interest and prohibited transactions
The fiduciary relationship exists so long as the advisor is engaged in the process of providing advice.
Several industry groups such as the insurance industry with “variable” products they sell and the brokerage industry when dealing with retail client accounts are only required to follow a suitability standard. The suitability standard, which applies only for each transaction entered into, requires that an agent or broker representative have a working knowledge of your circumstances (referred to as “know your client”) and provide a product that is suitable, not necessarily one that is in your best interest. The product may be more expensive than another alternative product or a proprietary product that may pay more to the agent/representative.
Do you want an agent or representative handling your finances with a transaction oriented suitability standard or do you prefer a relationship with an investment advisor who provides full and fair disclosure, puts your interests first and acts on your behalf at all times?
One of the frustrations discussed by our study group is that the U.S. Congress and Senate were on track under recent financial regulatory reform (FinReg) to make anyonewho provides financial advice to adhere to the same fiduciary standards Registered Investment Advisors are held to. The CFP Board of Standards, the National Association of Professional Financial Advisors, and the Financial Planning Association were all in support of the provision.
However, upon insurance and securities industry pressure, the Senate and Congress waffled a bit. The good news is the financial regulation draft agreement allows the Securities and Exchange Commission (SEC) to make the decision as to whether to apply the fiduciary standard to brokers’ representatives and agents. The down side is that it appears the fiduciary standard may only apply to the investment advice given by a broker/agent but not after. That would suggest the standard would not apply to the implementation (sale) portion of the relationship. A study will be conducted by the SEC and decision made in six months. As things stand at this moment both houses of congress have to agree to the compromise which presumably will occur before the 4thof July holiday.
That said, I’m going to make a leap and state unequivocally that you’re better off with a full fiduciary practitioner than one who follows a suitability standard or a less comprehensive fiduciary standard.
Here are some questions Fi360 suggests a client might want to know the answer to:
1. How was your current portfolio’s asset allocation determined?
2. When was the last time you updated your Investment Policy Statement?
3. What type of due diligence was performed on the investment options that exist in your portfolio?
4. What type of periodic monitoring have you applied to your portfolio?
5. Do you understand all of the fees and expenses associated with the various components of your investment program?
Perhaps when individual clients know that a fiduciary standard of practice is a higher standard than a suitability standard they will make their choice to seek out advisors who represent their interests alone and not those who represent the interest of insurance companies and brokerage firms.
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