How Brokers May Spin New Fiduciary Rules

The brokerage industry fought the new fiduciary rules from the Labor Department every step of the way.

The battle appears to be over, and it ended in something of a draw. The brokerage industry may not like the new rules for retirement accounts, but it is still free to practice business as usual in taxable accounts. And many mom-and-pop investors remain as confused as ever about whether their broker has a conflict of interest.

These new rules address conflicts of interest from brokers and other financial professionals who offer retirement advice by requiring advisers to abide by a fiduciary standard when managing assets in retirement accounts.

Many laypeople are confused about what this means and which professionals have a fiduciary responsibility to their clients. In its simplest form, a fiduciary standard means that professionals subject to the standard must put clients’ best interest before their own profits when offering financial advice or making investment decisions. For instance, a fiduciary is not only bound to offer appropriate investment choices, but must take special care to avoid conflicts of interest whenever possible and to disclose potential conflicts when they arise. The Investment Advisors Act of 1940 specifically defines a fiduciary’s role, and the Securities and Exchange Commission takes care to enforce the standard thoroughly.

Until the new rules took effect, SEC-registered investment advisers were bound to this standard, but broker-dealers, insurance agents and certain other professionals providing investment advice were not. Instead, they were bound by the less strict suitability rule. This rule requires brokers to make recommendations consistent with the customer’s best interests, meaning they cannot recommend totally inappropriate investments. But they are not bound to place their own interests below the client’s, which allows them to favor more expensive investments or to trade more frequently to generate more commissions. Nor are they required to disclose conflicts of interest.

The new rules subject brokers to the fiduciary standard that applies to RIAs, but only where retirement accounts are concerned. For taxable accounts, the suitability rule still applies.

A well-publicized poll from a few years ago found that many people erroneously believe that financial advisers at brokerage firms are fiduciaries; 76 percent of those surveyed thought so. (1) The same survey suggested that most investors were not aware that different standards applied to investment brokers and registered investment advisers.

Many brokers will take advantage of their clients’ confusion, apathy or both in order to put these mandated changes in the best possible light. For example, a couple I know works with a broker at a major wealth management company. The broker manages their portfolio, including retirement accounts, meaning he is subject to the new rules. He told his clients that the investments in their retirement accounts had been underperforming, so he would be moving assets into better performing and less expensive alternatives.

I asked if the broker had mentioned any other reason for the change, since it seemed obvious to me that the broker was acting in response to the new Labor Department standards. No, I was told, he mentioned no other reasons.

It is not hard to see why a broker would prefer to informally present such a change as his own good idea. We all want to present our professional services in the best possible light, and of course he would prefer to be the hero saving a client money rather than the villain forced to put the client’s interests first because the government said what he’d been doing was no longer legal. Failing to talk through the new regulations is not outright deceptive; many clients may not be interested in a detailed explanation. And the changes are bound to be mentioned in written disclosures, however voluminous they may be. But this does not help investors get a better grip on the situation.

The incident highlights a real, ongoing issue in the world of personal finance, one that the new rules do not effectively address. For many consumers, it is unclear which financial professionals are sitting on their side of the table and which are salesmen first and foremost. Everyone wants to appear helpful; many of the terms and titles tell consumers little unless they dig further. “Financial adviser” can mean a lot of different things, depending on who the adviser works for and which exact services the firm provides.

The Labor Department’s rules require advisers to commit to fiduciary standards, disclose any possible conflicts of interest and institute policies to mitigate any conflicts that do arise. But how many advisers will take the time to make sure clients read and understand the documentation, rather than just flagging the places the client needs to sign what they assume is standard legalese?

For now, proactive clients will still be best served by directly asking their advisers, or potential advisers, whether they are fiduciaries. In fact, it should be one of several questions, such as how often investments are monitored, what the adviser’s underlying investment philosophy is and how their fee structure works. But the concern behind the Labor Department’s new rules is that many investors do not know to ask these questions in the first place.

While the new rules are helpful, they are not enough to ensure that consumers can make the best possible decisions. Consumers need actual education on what a fiduciary is, whether or not their adviser is one and why the distinction matters. We cannot reasonably expect nonfiduciary advisers to voluntarily provide such an education if they are not required to do so.