What is Your Financial Professional–A Broker or Fiduciary?

Summary:  Athletes understand “off-the-field” distractions.  None are probably worse than those of the financial variety.  Last April, the Department of Labor (DOL) decided that financial professionals giving advice for retirement assets must act in their client’s “best interest”.  Yes. You heard me right. Well, you may be thinking, “I thought my advisor was already acting in my best interest”.  Apparently not all advisors.  The scope of this article won’t cover the long history of the financial services industry (you can get that here).  However, I’ll provide you with a brief one.

A Brief History

Over the last several decades the financial services industry has been split into two camps: the broker-dealer community and the registered investment advisory (RIA) community.  Brokers act as intermediaries between financial companies and consumers.  At a time, they were the only way you could purchase a financial product.  The legal standard to which a broker is held is called the “suitability” standard. This means that any financial product or service sold to the client had to be “suitable”.  Unfortunately, suitability can be vague and was subsequently abused over the years causing some financial professionals to sell products that a client didn’t need.  Actually, this became so bad that Congress blamed the stock market crash of 1929 on abuses of the standard and the subsequent depression of the 1930s and created the U.S. Investment Advisers Act of 1940 (“the Advisers Act“).  This began the formation of the RIA community and the creation of many additional regulations which produced a higher standard–one that was in the “client’s best interest”.  This is why RIAs are referred to as fiduciaries.  In short, the Advisers Act required financial professionals whose business was “giving financial advice” to register with the state(s) in which they did business or the Securities Exchange Commission (“SEC”).  This provided the potential client with access to several pertinent details about the financial professional including methods of compensation.

Fast Forward to Today

More often than not, lawsuits against brokers are lost by clients because of the laxness of the suitability standard.  Brokers can always claim they were giving financial advice solely incidental to the product they were selling and were not in fact “financial advisors”.  Well the DOL rule eliminated this defense.  As a veteran of the financial services industry, I welcome this change and believe it will be a “rising tide that lifts all boats”.  Unfortunately, in each section of the financial services industry we will continue to have bad actors, but this new rule will lessen the promulgation of unsuitable financial products that lose investors money. The rule’s one shortfall at this point is that it only covers “retirement accounts”.  However, I believe that it won’t be too long before the “powers that be” realize that a client may have both retirement and non-retirement assets with a broker and both buckets need to be treated equally.  I have prepared a “Q&A” of sorts to answer what I think may be some of the questions individuals may want to ask.

Q: How can I found out if my advisor is part of a broker-dealer firm or a registered investment advisor firm?

Go to http://brokercheck.finra.org/.  Click the “firm” tab, and then type in the name of your investment professional’s firm. If the firm is a RIA it will say “investment adviser firm”. If it says “brokerage firm”, then your guy or gal is part of a broker-dealer.

Q: What is the main difference between a broker and a fiduciary?

A: The standard each is held to is the major difference. RIA firms comply with the legislation set forth by the US Investment Advisers Act of 1940 and hold themselves out as “investment advisers”. This transparency allows for potential clients to have access to the type of financial business and the methods of compensation the adviser will use. This can all be found on-line for every RIA and is called  the “firm brochure“.  (Look up one here.) Broker-dealer firms are not held to such a standard and there is no transparency on the type of financial business they are in nor the methods of compensation used.

Q. What are the specific changes the DOL is requiring?

A. They are numerous and can be found here. The “cliff-notes” version is this:  by January 2018 (at the latest), brokers engaging in prohibited transactions (see next question) will be forced to execute a “best interest contract” with their clients affirming that the transaction was in the client’s best interest.

Q: What is a prohibited transaction?

A:  There are 3 basic categories: 1) retirement account rollovers that specifically shift from low-fee to a high fee arrangement; 2) rolling assets from a 401(k) to an IRA where the advisor will receive an ongoing fee for management; and 3) switching client from commission based account (i.e. fee charged per transaction) to a fee-based wrap account (for which the advisor receives ongoing revenue).  All these activities are an acts of giving “financial advice”, thus the DOL is now requiring brokers to adhere to the same standard as RIAs.

 Q: Does this new rule apply to all types of accounts?

A: No. Sadly it doesn’t. This rule only applies to retirement accounts for now.

Q: What should I do if my financial professional is not a RIA?

A: This is a good time to have a conversation with your financial professional. Let them address your concerns about the implications of this rule and whether they and the firm they work for are willing to be held to a higher standard. They should be able to demonstrate their willingness to comply with the new rule and acknowledge any past deficiencies.  Need help on what to look for our ask?  Click here.

The ramifications of this new legislation will affect a lot of investors.  You should be aware of it and how you can continue to protect yourself and your assets.

Invest Wisely!