Who says it is always in the best interests of consumers to do business with fee-only financial advisors? We’ve seen dozens of financial advice columns “warning” consumers that registered representatives do not adhere to a strict fiduciary standard. For trustworthy (and better) advice, they typically claim, investors must avoid registered representatives compensated by commissions. Maybe we shouldn’t be surprised that these articles, almost invariably, are written by or rely on interviews with fee-only registered investment advisers (RIAs).
In one recent example, Barry Ritholtz, who in his day job works as chief investment officer at Ritholtz Wealth Management, wrote a column for the Washington Post entitled, “Find a financial adviser who will put your interests first.”
It contains a number of statements about RIAs, registered reps, the fiduciary standard and the suitability standard that are repeated so often in these types of columns that they threaten to enter the realm of “common-knowledge,” even though they may be incomplete, misleading or even wrong.
Let’s take a closer look at several of Mr. Ritholtz’s claims.
- “The fiduciary [standard] legally obligates the registered investment adviser to act at all times for the sole benefit and interest of the client.”
Even if we allow for some hyperbole, this claim stretches an RIA’s fiduciary duty well beyond what it really does. Does anyone believe Mr. Ritholtz and other RIAs, who often call themselves “wealth managers,” receive no benefit from their practices? They are not charities and certainly do not work for the “sole benefit” of their clients. Financial advisors, whether registered reps or RIAs, are professionals who provide valuable services for their clients. They deserve to benefit from their work by being compensated. There is no shame in that.
There is some dispute about whether a fiduciary may receive commissions as compensation. Fee-only advisors, like Mr. Ritholtz, tend to argue that they cannot. A Department of Labor fiduciary rule, which was proposed and then quickly withdrawn in 2011, would have prevented many retirement-fund advisors from receiving commissions.
However, the idea that commissions are inherently not in the client’s interests is wrong. Studies have shown that a majority of middle-market investors prefer commission-based advisory services to paying fees. Many fee-based advisors do not accept accounts with minimum balances below $200,000 (often higher), shutting out many middle-market and small investors. A fiduciary requirement focused on the way advisors are compensated ignores the fact that different investors may benefit from different products, services and payment structures.
- While Mr. Ritholtz calls fiduciary a “straightforward” standard, in reality it is anything but.
There is no agreed-upon definition of what a fiduciary duty for financial professionals looks like. It is often defined as “looking out for the best interests of the client.” Is the lowest cost investment always in the client’s best interests? How about the most tax-advantaged investment? The one with the highest yield? Would that be a short-term yield or long-term yield? There are no clear answers. And just who decides what is in the client’s best interests? The short answer is the courts. An investor claiming a breach of fiduciary duty can hire a lawyer, file a lawsuit and let the courts decide whether the claim has merit.
- Ritholtz writes about the suitability standard that “the bottom line is that the client’s best interest is not part of the equation.”
In fact, NAIFA members who are registered representatives tend to build long-term relationships with their clients. They help clients plan and protect their financial security on an ongoing basis. They also rely on referrals from existing clients to sign on new clients. A registered rep who fails to look out for his or her clients’ interests is not likely to stay in business for long. Their entire business model is based on providing for their clients’ financial security. See NAIFA’s new publication, “Securing America’s Financial Future.”
- Mr. Ritholtz says that in his experience, the suitability standard “costs much more than services provided under other standards.”
An Oliver Wyman assessment conducted on behalf of SIFMA found: “On average, investors have historically paid 25-75% more for fee-based advisory services than commission-based brokerage, depending on asset levels.” Also, as noted above, many RIAs require minimum balances beyond the means of smaller and middle-market investors. There is a reason they often call themselves “wealth managers.”
Registered reps, on the other hand, tend to work with these under-served markets. A NAIFA-American College survey found that for 53 percent of registered representatives the majority of their securities clients have portfolios of $100,000 or less. For 83 percent, the majority of their securities clients have portfolios of $250,000 or less.
- The suitability standard “creates an inherent conflict of interest between the adviser and the investor,” Ritholtz writes.” … Any conflict of interest between an investor and their client is extremely problematic.”
Let’s be honest here: despite what fiduciary proponents would have us believe, no advisor-client relationship is completely free of conflicts of interest. Many RIAs are paid a percentage of their clients’ assets under management. It is therefore in the interest of these advisors for clients to maintain assets in their accounts, even if it may be in the best interest of the client to use funds elsewhere — for the purchase of life insurance, for example. That is a conflict of interests.
The key is for investors to be aware of and comfortable with the unavoidable conflicts of interest and to work with an advisor who understands and satisfies their individual needs.
- “The SEC enforces the standards for fiduciaries – but brokers, aiming to head off more regulations, created the suitability rules themselves.”
Suitability, as enforced by the Financial Industry Regulatory Authority (FINRA), is a very robust standard. Registered reps must comply with regulations covering nearly every aspect of their businesses, from how they communicate with clients to how they interact with senior citizens, from how they advertise to how they keep and maintain records. The suitability standard is governed by no fewer than six FINRA rules and more than a dozen Regulatory Notices and Notices to Members. It requires registered reps to compile and regularly update detailed investor profiles for each client. Registered reps must get to know their clients and have a strong understand of their clients' needs and interests.
Registered reps face near constant scrutiny and annual compliance reviews by their broker-dealers. The broker-dealers, in turn, are subject to detailed FINRA examinations approximately once every two years.
SEC regulation of RIAs is not nearly as stringent. The Commission has said that it examines fewer than 9 percent of investment advisers each year, and more than a third of investment advisory firms have never undergone SEC examination. In addition, SEC rules regulating RIAs are not nearly as detailed and comprehensive as FINRA rules for broker-dealers and registered reps.
FINRA, though it is a “self-regulatory organization,” is certainly no pushover, which is probably why RIAs have fought tooth-and-nail to avoid having to comply with the sorts of compliance rules that registered reps deal with routinely.
- “But fiduciary rules protect investors from adviser malfeasance, while suitability rules protect brokers from investor lawsuits.”
Unlike a fiduciary standard, under which claims of a breach are investigated only after the fact, the suitability standard is rules-based and forward-looking. It aims to prevent malfeasance before it occurs.
Unfortunately, there are bad apples in every walk of life. A sense of fiduciary duty and the threat of a lawsuit or even prosecution will not deter someone intent on committing fraud. Fortunately, the vast majority of financial advisors, no matter what their standard of care or whether they are paid by fees or commissions, are honest, hard-working and committed to providing financial security for their clients.
Clients are best served by developing a relationship with a financial advisor they can trust – one who is a member of a professional organization, such as NAIFA; one willing to get to know them and understand their financial goals and needs; and one who provides the products, services and compensation method that suits those needs.