Setting the Standard
A look at the new fiduciary standard and what it means for your finances.
On June 9, the Department of Labor implemented a new rule for financial advising called the fiduciary standard. And while the wonky term may make your eyes glaze over, understanding what it means is critical to your financial health.
Broker-Dealers vs. Registered Investment Advisors
When it comes to your retirement accounts, there are two kinds of advisors: broker-dealers, and registered investment advisors (RIA). Each one is able to manage your financial investments, but they’re compensated, and regulated, differently.
Registered investment advisors have what’s called a “fiduciary duty” — the highest standard of care — that requires them to act in their clients’ best interests. Seems pretty straightforward, right? They’re working for you, and thus should make the best decisions for your financial investments on your behalf.
“I’d like to believe most people in the financial area are going to be honest that they’re going to treat the client first,” says George Young, partner at Villere and Company, an investment managing firm founded in New Orleans in 1911.
RIAs are registered with the Securities and Exchange Commission (SEC), which shows that they meet certain federal requirements. RIAs work on a fee-only compensation structure, which means they earn a percentage of your account, a flat retainer or an hourly rate. This plan helps eliminate a conflict of interest because the registered investment advisor earns his or her salary based on how well your investments perform.
Broker-dealers, on the other hand, operate under a “suitability standard” – considered less onerous than the fiduciary standard, it means broker-dealers must make investment recommendations that are “suitable” to the client’s personal situation, but not necessarily in their client’s best interest. Not as straightforward.
David Soliman, managing partner at Faubourg Private Wealth, a firm with offices in Metairie, Old Gretna, Larose and Mandeville, explains the suitability standard this way: “It’s kind of like needing a phone and going into an Apple store. Somehow or another, regardless of what kind of phone you need, you’re walking out of that store with an Apple phone.”
Broker-dealers earn a commission-based salary, which means they get paid based on how many sales they make, or they get paid for investing your money in certain accounts, for instance a mutual fund that might not be the best investment choice for you, but pays your broker-dealer a higher commission. Often these fees are passed on to the client.
“Every fund, by definition, has an expense ratio; it costs something, nobody’s doing it for free,” says Young. “Passive funds have the lowest expense rates, they’re something like seven basis points.” One basis point equals one-one hundredth of a percent. That fund is a replication of a passive index, which requires less maintenance by the investment advisor.
“If you buy an active mutual fund it’s going to have a sales load — which is allowable by the SEC and broker-dealers have to be up front about this — but a lot of these can be 5 percent sales loads, and a lot of customers just aren’t aware that that’s what they’re being charged.”
The Obama administration estimated that these compensation fees cost retirement investors up to $17 billion a year, so they developed the new standard — under Department of Labor regulations — to protect workers’ retirement accounts.
“The Department of Labor is, of course, worried about the workforce and making sure they have enough money to retire,” explains Young. “So they said, ‘Wouldn’t it be a great idea to put clients first?’”
Implementation and Compliance
It would be bad business for someone in the investment world to come out and say, “No, we don’t think we should be forced to act in our clients’ best interests,” so the question isn’t if brokers will comply, but how.
The federal government issued the rule saying anyone managing retirement accounts must act in a fiduciary manner, but they didn’t explain how to do it, and the requirements are a little bit vague.
The main requirements for advisors under the fiduciary standard are: maintain impartial conduct standards, keep the client’s best interest at heart, and receive only reasonable compensation. Further, advisors can’t make misleading statements to their clients, and must make sure there’s no conflict of interest.
“We’re seeing a wide amount of response from all across the industry,” says Soliman. “Advisors that have been acting in a fiduciary capacity have been ahead of this rule really for years. It’s not something that we’re finding we have to make a lot of adjustments to how we’re doing business.”
The bigger impact is on broker-dealers. In order to continue managing retirement accounts, firms will have to figure out a way to change their compensation and fee structures so they can be in compliance.
“In a lot of ways these rules have been kind of a wake-up call to the industry,” says Soliman. “This is kind of making a lot of broker-dealers and a lot of advisory firms reevaluate what kind of business they want to be in and what kind of advisors they want to have under their purview.”
The SEC routinely does audits of investment firms to make sure that there are ethical policies in place, and that firms are aware of any new regulations — like the fiduciary standard. Companies would have to demonstrate that they’ve taken steps to enforce the new rule.
“The compliance department at a broker-dealer will say, ‘You now need to document why you chose this fund versus another fund’, which is a real burden on the individual broker-dealer,” says Young. “But that would be a way that they could justify choosing a particular fund, because it was in the client’s best interest that there was reasonable compensation.”
Regardless of compliance and enforcement, Young thinks there will still be hidden fees passed on to investors.
“That’s the reality of the situation,” Young says. “It’s an aggressive business: anytime there’s a lot of money at stake, people are going to figure out a way to keep making that money and make more.”
The Future of the Fiduciary Standard
But even after all of that, the future of the fiduciary standard is unclear. President Trump has said that he intends to undo many reforms that were made under the Obama administration. In February, Trump directed Labor Secretary Alex Acosta to review the rule to determine whether it would adversely affect the ability of Americans to gain access to retirement information and investment advice. The challenge delayed implementation, and full enforcement provisions have been postponed until January 1, 2018.
“We’ve already seen it delayed a couple of times here, we’ve seen it watered down a bit more than what we were initially expecting, and honestly there’s some doubt of whether the rule will even go into effect in its current form,” says Soliman.
“Its difficult for broker-dealers, and advisory firms in general, to build their practices to ensure you’re complying with the rule when you’re not sure what the rule is going to ultimately look like six months from now.”
“It’s kind of toothless right now,” Young adds.
What It Means for Consumers
If you’re already investing with a registered investment advisor, don’t expect much to change in the way your assets are handled, or the fees you pay. But if you’re investing with a broker-dealer, this is a good time to have a conversation about whether they’re holding your account to the fiduciary standard, if they’re putting your best interests in your portfolios, and to really understand what your advisor is doing for you.
“Second to only physical health, financial health is going to be one of the biggest concerns people have,” Soliman says. “If you didn’t understand your diagnosis from your doctor you would ask more questions. If you didn’t trust the information you were getting from your doctor you would ask more questions. Why should your financial advisor be different?”
HOW TO TALK TO YOUR ADVISOR
So you want to have a conversation with your investment advisor but don’t know where to start? Here are a few questions that you should be asking:
Is your advisor a fiduciary?
What credentials and licensing does your advisor carry?
How — and how much — will you be compensating your advisor?
What is the total cost to your portfolio with the underlying expenses in each investment?
What are your fees covering? Full financial planning or just investment management?
Who is managing your portfolio and making the investment decisions?
How is your advisor selecting investment vehicles in your portfolio?
Do you have an investment policy statement and a written financial plan?