In a nutshell

In the simplest terms, a fiduciary duty requires the fiduciary to place the interests of the client ahead his own (or his employer’s or shareholder’s or anyone else’s). There are no shades of grey here: this is not about moral but legal obligation, it’s not about disclosing that you have a conflict of interest but about not having one, it is not about disclosure of fees/commission but about finding the best and most cost-effective product that meets the customer’s needs. It is ultimately about providing untainted advice from a position of power with the benefit of asymmetric information. The investor must be prepared to pay explicitly for the advice rather than continue the ostrich policy of thinking/assuming that the advice is free if it’s buried in a transaction fee or mutual fund trailer fees or other opaque mechanisms. John Bogle thinks of the fiduciary principle as: “No man can serve two masters”.

The details

Last week the SEC tabled its recommendations to Congress to create a “common fiduciary standard of care for brokers and investment advisers”. This would “hold brokers to a higher “fiduciary duty” standard (than the current “suitability” requirement) by legally requiring them to put the interests of clients before their own. (RIAs or Registered) Investment Advisers (in the US) are already held to that standard…” (see “SEC study lifts bar for brokers”). “The common standard is needed because many retail investors don’t understand and are confused by the roles played by investment advisers and broker-dealers…” (see “SEC recommends common fiduciary standard for brokers, investment advisers”). (Unlike in the U.S., where registered investment advisers (typically financial planners) already have a fiduciary duty toward the client, there is no class of adviser in Canada which has that explicit requirement, though some individual advisors are prepared to offer advisory services on a fiduciary basis.)

The need and the desired outcome are clear, but there will likely be lots of problems on the way. You can be sure that if Congress accepts the SEC recommendations, the next battle will be around trying to de-claw the definition of fiduciary. The other question that needs to be answered is the need to include under the fiduciary umbrella insurance agents (especially those selling annuities in general and variable annuities with guarantees in particular)…the answer is unequivocally yes. Given the information asymmetry between the financial industry and investors, nothing but a fiduciary standard can insure that investors get their fair share of the available market returns; this information asymmetry surprisingly not only applies to the (manufactured) ‘products’ and ‘services’ by the industry, but also to the ‘roles’ (adviser vs. salesperson vs. counterparty) played by those working in the financial industry.

To be effective, a fiduciary standard must be based on clear laws, a muscular regulatory infrastructure and must be accompanied by credible enforcement to insure compliance. So there will be difficulties with the definition, the scope of its applicability (which roles-adviser/ broker, mutual fund salesman, counterparty, financial planner- and/or products- investment, insurance, etc-), and educating the investors about the importance of working with an adviser who embraces the fiduciary responsibility. But it’s not enough for the adviser to be a fiduciary; she must also have the necessary skills and expertise to carry out the adviser duties.

Can a commissioned salesperson act as a fiduciary? Is the expectation that humans place self-interest below client interest unreasonable? Can an advisor restricted by his employer to offer only in-house products truly act as a fiduciary? Can financial advisers make a decent living and receive fair compensation for their training, expertise, skill and due diligence? The answers to these questions are probably: No, no, no, and hopefully yes. (One could also ask if a wrap account might be a way for the brokerage industry fiduciary responsibility in the context of the brokerage industry. The answer is maybe with an all-in fee of 1%, but not at with a 2.5% fee typically associated with such accounts. Depending on the investor’s asset mix the 2.5% represents 30-50% of the available market returns, which by definition does not feel like the best interest of the client. Whatever relationship you might have with your ‘adviser’, in addition to the cost you better understand if you are getting value for your money: you don’t want to trade off an IPS, a strategic asset allocation and a low cost portfolio implementation, for promises of market timing, alpha vs. beta (stock selection), tactical asset allocation. If you are not getting an IPS, what are you getting for your money?)

As we begin to understand the scope of the changes required to  move the retail financial industry to a fiduciary model, we see that it might be perceived by some as an attack on the industry’s business model (already one of the objections tabled is that government has no right to specify or favour one business model over another one). Whatever the outcome, and clearly I am counting on a meaningful implementation of “fiduciary duty”, no fiduciary standard will solve the problem associated with crooks. Note that in Canada you hear nothing about the need for fiduciary financial services; nothing from the industry of course, but nothing from legislators or regulators.

Can you think of a reason why you would not want to work with a fiduciary adviser? And if you can’t, then why you don’t ask you adviser if he is a fiduciary and if he is not then ask him to at least sign a fiduciary pledge such as the one suggested by Tara Siegel Bernard in NYT’s   “Will you be my fiduciary”. Otherwise perhaps you should go and find another adviser.

In summary

So the issue is complex, and the vast majority in the industry do not conduct themselves in a fiduciary manner and will go to great lengths to avoid having to comply with such level of care toward the client because the model today is primarily commissioned sales or counterparty in a transaction. The biggest problem is that vast majority of clients in the financial industry naively think that they already have a relationship of trust (when they in fact have a sales interface) and the clients are also handicapped by asymmetric information. The advisors’ problem is that potentially the business model has to change to a fee for service approach. While clients are perfectly content to pay $10-15K/yr in MERs for a mutual fund portfolio of $500K at 2.5% MER (for which typically the client doesn’t even get a Investment Policy Statement- the foundation of any credible financial plan), yet many/most clients would probably be unwilling to pay anything close to that in transparent/explicit fees to get an IPS and a low-cost indexed ETF portfolio whose ongoing annual cost would be <0.5%.( In the UK, effective 2012 product cannot have embedded fees in them, thus legally forcing the separation of the cost of advice.)

Of course no law (or pledge) can replace the high integrity of an individual, but the legal requirement can set expectations correctly, which is not the case today (especially not in Canada where no class of advisor/broker is required to have a fiduciary duty like the RIAs in the U.S. or CFPs who have taken on the duty as a professional pledge.)


Here is some additional background reading material which those of you who are gluttons for punishment might find very interesting.

Vanguard’s “Why invest with us”webpage it includes the following:

“Your interests are the only interests we serve: Most investment firms are either publicly traded or privately owned. Vanguard is different: We’re client-owned. Helping our investors achieve their goals is literally our sole reason for existence. With no other parties to answer to and therefore no conflicting loyalties, we make every decision—like keeping investing costs as low as possible—with only your needs in mind.” (Now this is the type of firm that I prefer to do business with. By the way this rare type of corporate setup us the optimum corporate structure, from a client’s perspective, for the financial industry.)

In Investment News’ Why disclosure is insufficient to ensure a fiduciary standard”Knut Rostad writes that:

“… disclosure shouldn’t be presumed to have the same role in a healthy fiduciary relationship as it does in other economic realms. In a healthy fiduciary relationship that involves personalized investment advice, disclosures shouldn’t be viewed as a presumptively effective investor protection tool. They are an aid to the fiduciary relationship, not a substitute for fiduciary responsibility. Fiduciary status isn’t for the faint of heart. Consistent with the record on which the Investment Advisers Act of 1940 was written, it is far more demanding than the commercial standard.

This difference is nowhere more evident than in the responsibility of the fiduciary, as opposed to the responsibility of the salesman, for his or her advice and conduct. In the latter case, the responsibility is shared between the salesman and the consumer. In cases with such significant disparities of knowledge, the responsibility isn’t shared with the investor; it is held by the fiduciary alone. That an investment fiduciary alone should be held accountable for his or her conduct and advice shouldn’t be controversial. After all, no one suggests that either a surgeon or an attorney be relieved of their fiduciary responsibility to put our interests first, merely by virtue of a “disclosure.” “

In an address entitled “Building a fiduciary society” John Bogle says that:

“…enormous costs seriously undermine the odds in favor of success for investors. For the investor feeds at the bottom of the costly food chain of investing, paid only after all the agency costs of investing are deducted from the market’s returns.”

“…what we mean by fiduciary duty, a concept that goes back some eight centuries in British common law. Fiduciary duty is essentially a legal relationship of confidence or trust between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, who justifiably reposes confidence, good faith, and reliance in his trustee. The fiduciary acts at all times for the sole benefit and interests of another, with loyalty to those interests. A fiduciary must not put personal interests before that duty, and must not be in a situation where his fiduciary duty to clients conflicts with a fiduciary duty to any other entity.” And

“Surely it should be made clear to clients whether they are relying on (1) trained investment professionals, paid solely through fully-disclosed fees to oversee their investments; or (2) sales representatives who sell the products and services of the companies that they represent, whether life insurance, annuities, mutual funds, or anything else. Simply put, the first group is representing its clients; the second group is representing its employers. And each firm’s advertising and promotion should make this distinction clear.”

In Fortune’s “What Goldman owes its clients”Ben Stein writes (in the context of Goldman Sachs with whom typically only sophisticated individual or institutional clients would deal with):

“The story coming out from the friends of Goldman Sachs and of Wall Street generally is that Goldman Sachs is a trading house, that any client should know that, and that the client buys from Goldman Sachs knowing that it might trade against him and screw him up any possible way so as to make a buck. This is a nice fantasy and a tough guy version of how the world works. The problem is that it is contrary to law and common decency….But as underwriters, it has a duty to deal fairly and honestly with its buyers, and to deal as a fiduciary, putting clients’ interests first, if the buyer is a client of the firm. It holds itself out to the world that way, too. It holds itself as “adding value” when its works for a pension fund or any buyer by selling him securities. Read the annual report.”

In the journal of Portfolio Management’s “The Fiduciary Principle: No Man Can Serve Two Masters” John Bogle writes:

“We have moved from a society in which there are some things that one simply does not do, to one in which if everyone else is doing it, I can do it too. I’ve described this change as a shift from moral absolutism to moral relativism. Business ethics, it seems to me, has been a major casualty of that shift in our traditional societal values.”

In Forbes’s “Investors misled by brokers masquerading as fiduciaries”Edward Siedle writes that there are sometimes circumstances when even CFA charter holders (and their clients) have to deal with conflict between the requirement by the CFA Institute who holds the members to the “highest fiduciary standards” and their employers as in the case of “brokers employed by the major Wall Street firms, do not acknowledge a fiduciary duty, which requires them to make their clients’ best interests their top priority.” The author then quotes the following explanation from the CFA Institute “You’ve hit upon a dilemma for some of our members, who are bound by our Code of Ethics and Standards of Practice as charter holders and/or members of CFA Institute, but who are employed by firms with business models that apply suitability standards rather than fiduciary standards in their dealings with clients. Our understanding is that in many such instances, the firms do not allow CFA charterholders to display the CFA designation after their name on business cards or other publicly available material, so that clients do not perceive any different standard than what the firm has adopted for all of its employees.” Clearly a very complex subject that is difficult to separate from the business model of one’s employer and the contractual relationship with the client.

Further clarification is provided in CFA Institute Magazine’s “What’s a broker to do?” where Jonathan Stokes (Head of Standards of Practice) addresses the matter as follows. The CFA Institute Code and Standards explicitly states in Standard III (A) Loyalty, Prudence and Care that: “Members and Candidates have a duty of loyalty to their clients and must act with reasonable care and exercise prudent judgment. Members and Candidates must act for the benefit of their clients and place their client’s interests before their employer’s or their own interest.” Stokes writes that “The requirement to act in the client’s best interest, with loyalty, prudence and care, and for disclosure of conflicts of interest apply to all when engaging in their professional activities. What specific conduct is required of members to fulfill these duties will depend on the member’s relationship to the client and the nature of the member’s job functions (e.g. execution only brokers, retail brokers, institutional broker). Although members and candidates must comply with any legally imposed fiduciary duty, the Code and Standards neither imposes such a legal responsibility nor requires all members to act as fiduciaries. In particular, the conduct of CFA charterholders who are broker/dealers may or may not rise to the level of being a fiduciary, depending on the type of client, whether the broker is giving investment advice, and the many facts and circumstances of a particular transaction or client relationship. The specific actions required may vary by job function, but CFA charterholders…must comply with one of the most rigorous and comprehensive codes of conduct anywhere”.

You can read much more on the F-word in the Investment News’ “From the Fiduciary (FI360)” by Bennett Aikin. Also Blain Aikin who heads FI360 has “coined the term “Global Fiduciary Precepts” to denote these seven practices. They are:

1. Know standards, laws, and trust provisions.

2. Diversify assets to specific risk/return profile of client.

3. Prepare investment policy statement.

4. Use “prudent experts” (for example, an Investment Manager) and document due diligence.

5. Control and account for investment expenses.

6. Monitor the activities of “prudent experts.”

7. Avoid conflicts of interest and prohibited transactions.”

In TD Ameritrade’s “The Standard of Care for Investment Advice”contains a good table explaining the differences (in the US context) between an RIA (Registered Investment Advisor) and a “registered representative” (likely a broker). Well worth a read for those interested in the subject.

In SmartMoney’s “Bogle: American Capitalism is Doomed” John Bogle is quoted as:

“For years, says Bogle, the U.S. had a system in which capital was the property of owners. Those who bore the risk reaped the rewards. That system, which he calls the ownership society, has been transformed in the past 50 years into the so-called agency society. Now investors swallow the risk while managers collect more than their fair share of the rewards. Along with that has come the era of phony accounting, stock-option mania and inflated executive compensation.” (Bogle’s book “The battle for the soul of capitalism’)

MSN Money’s “Can you trust your financial adviser?”  explains the cost of being too trusting and looks at job titles which may or may not come with fiduciary responsibility.

An finally (while not perfect, since it implies that disclosure of conflicts might provide dispensation for doing the inappropriate thing,, in the NYT’s   “Will you be my fiduciary”Tara Siegel Bernard suggests that “the next time you’re shopping — whether it’s for a broker, a mortgage, an annuity or a full-fledged financial plan — ask your provider to sign it. Here it is:

The Fiduciary Pledge

I, the undersigned, pledge to exercise my best efforts to always act in good faith and in the best interests of my client, _______, and will act as a fiduciary. I will provide written disclosure, in advance, of any conflicts of interest, which could reasonably compromise the impartiality of my advice. Moreover, in advance, I will disclose any and all fees I will receive as a result of this transaction and I will disclose any and all fees I pay to others for referring this client transaction to me. This pledge covers all services provided.




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