Why the Fidiciary Standard Matters

Hanging prominently on the wall when you walk into the lobby of our office is a pledge called the Fiduciary Oath. You can read the wording of it here, but it basically says that we promise to always put our clients first, even if that might mean we have to put our own interests last. In reality, it’s more than just a promise. As investment advisors, we are legally bound to uphold that ideal, a concept called the “Fiduciary Standard.”

It’s easy for investors to assume that their financial professional–with his warm smile, confident demeanor, and fancy credentials–could only have their best interests in mind, right? Surely when he makes an investment recommendation, he does so because he genuinely believes it’s the best course of action? However, unfortunately most professional advisors are not held to the highest standard. In a recent article for Bankrate.com, Sheyna Steiner explores this issue and reveals the sometimes scary implications for investors.

“Studies have shown that individual investors don’t know who is a fiduciary or what a fiduciary actually is,” she says.

The investing public is largely ignorant of this vital distinction between advisors. There are two basic ethical standards that financial professionals are required to uphold — the suitability standard and the fiduciary standard.  The suitability standard is a minimum requirement — it only requires advisors to recommend (i.e. “sell”) investments that are “suitable” to the client. The fiduciary standard, however, is much higher: it legally obligates them to act in the client’s best interest, regardless of whether that conflicts with their own interests or their employer’s.

“‘You can satisfy the suitability standard by recommending the least suitable of the suitable options, as long as it falls within the general suitability test,’ says Barbara Roper, director of investor protection for the Consumer Federation of America.

The suitability standard invites conflicts of interest pertaining to compensation, which can vary greatly from one product to another.

‘And you don’t have to disclose your conflicts of interest. You don’t have to appropriately manage your conflicts of interest or minimize your conflicts of interest. So what that means is often the products that are best for the broker have higher costs for the investor,’ Roper says.”

So why is there so much confusion? I don’t believe most advisors are actively trying to cheat or mislead their clients. Obviously, there are a few very bad apples out there, but generally-speaking most professionals genuinely want their clients to succeed. But the question isn’t about intentions; it’s about safeguards. What safeguards are in place that prevent even the most ethical of professionals from fighting temptations to meet their monthly sales quotas by recommending higher commission, less suitable products to unsuspecting customers. Very few non-professional investors fully understand the range of complex financial products on the market, and it’s well-known that some products are less-than-forthcoming about their expense structures.

Another reason for the confusion is rampantly misleading TV advertising:

“For broker-dealers that are held to a suitability standard, the compensation system is set up in a way that can lead to conflicts of interest. But TV advertising suggests otherwise.

‘You can never educate investors to understand that their financial adviser is a salesperson who doesn’t have to act in their best interest when multimillion dollar marketing campaigns are designed to lead them to exactly the opposite conclusion,’ says Roper. ‘The titles and the descriptions of the services are designed to make them think they are in a trusted advisory relationship.'”

So, how do you find out whether your advisor is held to the fiduciary standard?

“There is an easy way for them to find out an adviser’s level of accountability. [Just] ‘ask one simple question: are you acting under the fiduciary standard, and will you put that in writing?’ says Tim Hatton, president and founder of Hatton Consulting and author of ‘The New Fiduciary Standard: The 27 Prudent Investment Practices for Financial Advisers, Trustees and Plan Sponsors.'”

Or, another way is to find out if he/she is a member of the National Association of Personal Financial Advisors, or NAPFA, which requires all its members to operate under a “Fee-Only” model and refuse to take commissions from Wall Street. In addition, members are required to sign a Fiduciary Oath and subscribe to a stringent Code of Ethics.

I am and have been a member of NAPFA for many years, and operate proudly under the fiduciary standard of care towards all clients of JPH Advisory Group. For more information, check out my Form ADV, which is filed with the SEC.