What A Fiduciary Standard Could Mean To You

This week's blog is rather lengthy, but it's important, and I hope you find it interesting. Here goes:

You may have heard recent talk about a "fiduciary standard" for financial advisors. The new financial regulation package includes a provision for the Securities and Exchange Commission (SEC) to study the issue for a year. Then, after the study is complete, the SEC will set new rules regarding the fiduciary issue.

So what does this mean, and how does it potentially affect you and other consumers of financial advice? The short answer: It is very important, and it could have a very large impact on all advisors and their clients.

The business of investment advice is highly regulated, and one must be precise in the language and terms used. On the surface, the concept offiduciary duty is pretty simple. The word can be used as a noun or an adjective. It describes a very high duty to act in the best interest of another person-to put that person's best interest above your own or (in the case of financial dealings) your firm's.

My firm is a registered investment adviser. That simple sentence carries subtle but meaningful nuances. (1) Note the arcane spelling of "adviser;" the SEC stubbornly clings to that spelling, although they don't punish firms that spell it with an "o" like everybody else. (2) Aperson cannot be a registered investment adviser/advisor; the firm is the adviser-a person can get in real trouble for using the title to describe himself.

See what I mean about it being a highly regulated business?

Now, here's where the controversy occurs. You see, when it comes to financial consultants, there are two very distinct business models:

The first is the traditional broker: this person, as the name implies, is in the business of brokering transactions. He/she gets paid a commission for facilitating a trade or making a sale. Technically, this person is not even allowed to give financial advice: any advice he/she gives must be purely "incidental" to the sale or transaction. What exactly does that mean, you ask? It means that, strictly speaking, when a broker gives advice to a client, he/she is breaking the law. But everyone knows that brokers give advice all the time.

 The other business model is that of the registered investment advisor (RIA); that's what our firm is. (Notice that I specified the firm as the RIA.) The advisor gets paid a fee for advice and/or portfolio management, and nothing for conducting transactions.

The registered investment advisor firm is subject to a fiduciary duty. The broker is not. His/her duty is simply to be reasonably sure that whatever investment they sell is "suitable" for the client. That's a pretty vague standard, and not very reassuring once you fully understand it; hence the push to subject all financial professionals to the fiduciary standard.

Very few people are even aware that there is a difference between brokers and advisors. Most consumers assume that both are required to act in the client's best interest. So the SEC has been assigned to try to settle the issue.

The brokerage industry is fighting the potential new rules tooth and nail. They say it's impractical. For my part, I'm conflicted about it. While I strongly believe that there should be a uniformly high standard for all, I must admit that the current dichotomy gives me a marketing advantage. (You may notice a fiduciary slant in some of my print advertising.)

But really, I'd gladly give up that advantage if it meant better protection for all consumers. Doesn't it make sense that your "advisor" should always have your best interest at heart?

We'll see what happens. In the meantime, enjoy your week!