April 13, 2015
The Fiduciary Standard – Why the Debate Matters, and Why It Doesn’t
Rockbridge is a fiduciary, meaning that we must always act in the best interest of our clients. We are required to act as a fiduciary because we are registered with the SEC under the Investment Advisers Act of 1940.
The SEC was given authority to propose a uniform fiduciary rule for all brokers and advisors as part of the Dodd-Frank Financial Regulatory Law of 2010. They are still wringing their hands. More recently the White House has been pushing the Department of Labor to establish a rule that would apply only to retirement money. It would require any person giving advice on retirement accounts to act as a fiduciary.
The vast majority of people calling themselves financial advisors, or investment advisors, are not registered in the same way our firm is registered, and are not held to a fiduciary standard.
This can lead to unpleasant surprises, as reported in a New York Times article last October (Tara Siegel Bernard NYT, 10/10/14). A retired couple in their 70’s went to their bank. The teller suggested they meet with the bank’s investment expert, who probably called themselves a financial advisor. The couple was sold a variable annuity in which they invested over $650,000. They didn’t fully understand that the annuities came with a hefty annual charge of about 4% of the amount invested. The bank said the investments were appropriate for the couple, in other words, in compliance with the “suitability standard” to which non-fiduciaries are held. “Like many consumers, they say they didn’t realize that their broker wasn’t required to follow the most stringent requirement for financial professionals, known as the fiduciary standard. It amounts to this: providing advice that is always 100 percent in the consumer’s interest.”
Many people think they are getting fiduciary advice when they are not. The lingo and terminology are bewildering for consumers.
The simple fact is this – whenever an advisor’s compensation is affected by the client’s decision, a conflict of interest arises between what’s best for the advisor/broker, and what’s best for the client.
If you don’t know exactly what determines your advisor’s compensation, they are probably not a fiduciary.
Why does it Matter?
The Council of Economic Advisers published a report in February that supports a fiduciary standard for retirement accounts. The report includes the following statements in its executive summary, based on its review of academic literature:
- Conflicted advice leads to lower investment returns. Savers receiving conflicted advice earn returns roughly one percentage point lower each year.
- An estimated $1.7 trillion of IRA assets are invested in products that generally provide payments that generate conflicts of interest. Thus, we estimate the aggregate annual cost of conflicted advice is about $17 billion each year.
A difference of 1% never sounds like much, but it can mean a difference in lifestyle. For a retired couple with $500,000 invested, it could pay for a nice $5,000 vacation every year.
Why Does it Not Matter?
Regulations do not always have the desired effect. Regulation in the financial services industry often takes the form of “required disclosure.” Think about the reams of extra pages you must sign at a mortgage closing, or the Privacy Statement mailings that no one really reads. That paper is all intended to make you aware of the ways you could be harmed, but as consumers, we pay little attention.
While the SEC might implement a principle-based fiduciary standard, we are more likely to see something that is based on rules – which will require conflicted advisors to disclose those conflicts to consumers.
A similar process occurred recently with “Fee Disclosure” for 401(k) Plans. The intent was that plan sponsors (employers) and participants could make better choices if they simply knew how much they were paying for their retirement plan services and investments. Instead the result is another layer of burdensome paperwork for employers, and a barrage of “disclosures” that leave participants more confused than ever. Have costs been reduced, or investment choices improved? Not really.
The Council of Economic Advisers summed it up well at the end of their report:
Finally, in practice, disclosures of conflicts of interest can actually backfire (Cain et al. 2005, Loewenstein et al. 2011*). Research in behavioral economics and psychology demonstrates that when advisors disclose their conflicts, they may be more willing to pursue their own interest over those of their clients and thus give worse advice. Advisees may interpret the disclosure as a sign of honesty and become more likely to follow their advisors’ biased advice.
*Cain, Daylian M., George Loewenstein, and Don A. Moore. 2005. “The Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of Interest.” The Journal of Legal Studies 34 (1): 1-25
Loewenstein, George, Daylian M. Cain, and Sunita Sah. 2011. “The Limits of Transparency: Pitfalls and Potential of Disclosing Conflicts of Interest.” The American Economic Review 101(3): 423-428
Some lessons can be taught while others must be learned through experience. Unfortunately those experiences can sometimes be costly. I do not think regulation will teach people the value of a fiduciary relationship. At the same time, I remain hopeful that more people will learn the lesson before paying years and years of unnecessary tuition.