Defining My Fiduciary Standard

What does it mean to be a fiduciary? That’s a question that’s being debated in the wake of Bernard Madoff’s criminal behavior and the current call for financial industry reform. However, in my mind, the definition is simple. When you are a fiduciary, you put the needs of your clients ahead of your own—in all cases. I am proud to call myself a fiduciary, and I have always believed that investors should accept nothing less from advisors who manage their money.

Recently, I discovered my position expressed extraordinarily well by a presenter at the National Association of Personal Financial Advisors (NAPFA) National Conference in Washington, D.C. Professor Steven Blum, a business ethics professor at the Wharton School of the University of Pennsylvania, discussed the difference between fiduciary standards, where the advisor works solely for the benefit of clients, and suitability standards that govern stockbrokers and registered representatives (i.e., employees of banks, insurance companies, brokerage firms, and mutual fund companies).

A little background will help you appreciate both Professor Blum’s observations and my commitment to you. The Investment Advisor Act of 1940 states that anyone who gives investment advice must be registered and do business as a registered investment advisor. (As you know, Bernhardt Wealth Management is a registered investment advisor.) With that registration comes a fiduciary duty to clients. That’s pretty straightforward, but there are a number of interesting exceptions. For example, writers and teachers can discuss finances without acting in the role of a fiduciary. And while it makes sense that journalists not be held to the standard of a registered investment advisor who is compensated by individuals for providing financial advice, there is a problematic exception under the Act. Broker dealers and their representatives are exempt from the rule if the investment advice they give is “solely incidental” to the conduct of their business as broker dealers and they do not receive special compensation for their advice.

In my view, exempting stockbrokers from the fiduciary rule is an excellent example of a slippery slope. As Professor Blum asked, “Stockbrokers and securities dealers are in business to sell stocks, mutual funds and various other financial products, but we are to assume that in most cases they offer no guidance on which investments are better, riskier or likely to make more money?” He further concluded, “The suitability standard creates a loophole big enough to drive an industry through.”

A lawyer with an advanced degree in taxation and accustomed to his own fiduciary role, Professor Blum also explored the curious notion that the Securities and Exchange Commission (SEC) allows some advisors to choose when they are acting as a fiduciary, whereas the legal profession does not accept the notion that a lawyer can “switch hats” and abandon his fiduciary role in the course of a client relationship. Observing that the fiduciary duty works for the legal profession because lawyers study ethics and are socialized with their fiduciary duty, Professor Blum asserted, “It’s not enough to say the words, ‘I am a fiduciary.’ You have to live it.”

I agree that the fiduciary commitment should be absolute and ingrained in financial advisors to the point where we don’t have to consider how to act. To get to that point, our industry needs to accept that acting as a fiduciary encompasses both a duty of care and a duty of loyalty. As Professor Blum explains, the duty of care is the need to be competent with the necessary knowledge, skills, and training. The duty of loyalty—what’s missing from many advisory relationships—is the need to put the client’s interests ahead of our own.  For example, he noted that an advisor should not be able to sell a product with a large commission if there is something better out there with a small commission or no commission. Moreover, advisors must be more loyal to clients than to their employers (i.e., banks, insurance companies, broker/dealers, or mutual fund companies).

Like Professor Blum, I agree that it is unwise to place your financial matters in the hands of someone who operates with something less than this full definition of fiduciary duty. After all, what would someone who acknowledges no fiduciary duty do with your money, especially given the fact that people tend to respond to their own economic interests?  Even so, in some cases the SEC seems to view conflicts of interest as an unavoidable part of a business relationship, requiring only that advisors warn consumers about the potential for conflicts of interest.  We can and must do better. As Professor Blum asserts, “Conflicted advice can never be the best advice.” I would add that the very idea that the potential for conflicted advice exists prohibits trust-building in the professional relationship I enjoy with my clients.

So, as the nation pushes for reform (in addition to doing away with settling for investments that are merely “suitable”) I submit that to become a true profession, our industry needs to wipe out the notion that “full disclosure of possible conflicts of interest” is fair play. As Professor Blum admonishes, we must, “Live up to a commitment to do what’s best, not to simply tell the client in advance that we may fail to do so.”

Of course, this change will take some doing. Professor Blum notes, “The financial services industry has not created sufficient safeguards against conflicts of interest. The industry was built on a model of selling investment products.” I agree that for too many years, the government has allowed the rules to be skewed in favor of big brokerage firms, a favorite-child status that recently was underscored with the massive infusion of money from the Troubled Asset Relief Program (TARP) to financial institutions dubbed “too big to fail.” It’s ironic that institutions too big to fail are not big enough to put their clients’ needs ahead of their own.

Yet, the tide may be changing. The Obama administration’s white paper, “Financial Regulatory Reform: A New Foundation,” proposes heightened regulatory supervision for large firms. The proposal includes a real fiduciary standard that would be applied to brokers as well as registered investment advisors and the creation of a new Consumer Financial Protection Agency charged with preventing harmful financial products from entering the marketplace. It’s a start in transitioning from a broker-centric to a client-centric industry, but there will be a battle between advisors who always put clients’ interests first and the big Wall Street firms that view consumer protection as a profit-reducing policy. It’s my hope, however, that the pendulum has swung beyond full disclosure being the gold standard.

To be the true professionals our clients need and deserve, our industry needs to embrace Professor Blum’s new definition of a professional. “A true professional uses his or her ability and power solely to advance the best interests of the client. When the professional’s interests diverge from those of the client, the professional always follows only the client’s interests.”

I have embraced this definition in my career, and it is one I hope will soon be more widely practiced. The investing American public deserves nothing less.

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