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Updated on Friday, November 22, 2019
When a professional agrees to become a fiduciary and abide by fiduciary duty, it means they have agreed to put the interests of their clients ahead of their own. For financial advisors managing your life savings, this seems like an obvious requirement. But right now, it’s not.
Today, financial advisors may choose to be a fiduciary or not. However, the fiduciary rule could change that very soon. Both federal and state regulators are reviewing different fiduciary rules that would set tougher requirements regarding how advisors can invest your money.
This is not the first time regulators have tried to pass a fiduciary rule. Read on for our coverage of the past and present status of the fiduciary rule, plus a look at what might be coming in the future.
How would a fiduciary rule impact financial planning?
Not all financial advisors work as fiduciaries, which means they don’t have to put your interests first when they recommend products. Depending on their qualifications, an advisor may only need to follow a suitability standard instead of a fiduciary standard. Under the suitability standard, a financial advisor can suggest products and investments that fit your needs but aren’t necessarily the very best option available for you.
A classic example would be an advisor who offers two investment funds that are similar in performance and both fit your needs, but one charges a higher fee and gives the advisor a larger commission. A fiduciary would need to recommend the low-cost option, whereas a suitability advisor could recommend the higher-priced one.
If an industry-wide fiduciary rule was passed, it would prevent conflicts of interest like this. For more information on how fiduciary duty works for the industry, as well as what advisors already work as fiduciaries, check out this guide.
Why is a fiduciary rule needed now?
The fiduciary rule is needed more now than ever. Americans today are far more involved in managing their retirement investments than was the case in generations past, when people were much more likely to have had employer-managed pensions. Employer-sponsored pensions fall under the scope of the Employee Retirement Income Security Act of 1974 (ERISA)Employee Retirement Income Security Act of 1974 (ERISA), a government rule that requires the person supervising the pension to have fiduciary duty for employees covered by the plan.
But ERISA does not apply to personal financial advisors, which creates a fiduciary gap. This is why there has been a push by both federal and state regulators to change the rules and protect investors who need to be involved in managing their own retirement savings.
Nicholas Hofer, a financial advisor and CFP from Boston, sees this shift as a good thing. “There is no question that being held to a fiduciary standard is important,” he said. “If firms are not willing to put their client’s interests first, the entire financial advisory industry is in jeopardy.”
Implementing the fiduciary rule could also help the industry as a whole, according to Harold Pollack, a University of Chicago professor and financial author.
“The rule helps consumers distinguish sales pitches from unbiased advice,” said Pollack. “If you’re charging consumers $250 per hour for genuinely valuable advice, it is hard to compete with a nominally free or cheap financially-conflicted competitor whose business model is to steer her consumers into unwise or overpriced investments.”
Are there downsides to a fiduciary rule?
While a standard fiduciary rule can seem like an overall good thing, past proposals have faced their share of criticism. Since many firms and advisors work under a looser standard, a stricter ethical code could hurt their profits and reputation.
“Firms that rely on fees and commissions for profits could face fallout if their clients have not been fully informed about their business model,” said Hofer. As a result, not all advisors are happy about the change.
Though you may not be that concerned about an advisor’s profit margins, this could lead to firms increasing other fees or tightening up their standards for what kind of clients they’d accept, as smaller accounts may no longer earn enough to cover overhead costs. For example, an advisor may set a limit where they only accept clients with at least $250,000 of assets, meaning middle and lower-class investors could be priced out of the financial advisor market.
Having a strict fiduciary rule could also limit what kind of investments are available, as everyone would be shoe-horned into the supposedly “best” low-cost approach. Investors who want to try something different would potentially struggle to find advisors willing to meet their express preferences.
Finally, what counts as the best investment isn’t always clear, something the SEC Chairman Jay Clayton pointed out in a recent speech on the subject: “Many different options may in fact be in the retail investor’s best interest, and what is the “best” product is likely only to be known in hindsight.” But despite these concerns, government regulators have decided to press forward with a few fiduciary rules.
The Obama Administration fiduciary rule
The Obama Administration first proposed an industry-wide fiduciary rule back in 2016. This law would have applied to any financial advisor selling products or giving advice for a retirement plan, like a 401k or an individual retirement account (IRA). It didn’t apply to financial advisors giving investment recommendations for a regular brokerage account, though.
Some ways advisors would have needed to meet the fiduciary standard under this rule included:
- Putting the client’s interests first for investment recommendations.
- Avoiding potential conflicts of interest for commission and fees.
- Properly disclosing how they are compensated, such as whether they are fee-only or fee-based.
- Being transparent about why they were proposing different options.
When the current administration took charge in 2017, it moved to review the rule as part of its drive to reduce government regulations. While the Department of Labor initial continued implementing the Obama Administration’s rule, industry groups sued the government and a federal court ultimately struck the law down in 2018.
The Securities and Exchange Commission (SEC) fiduciary rule
After the cancellation of the Obama administration’s fiduciary rule, the SEC decided to take its own look at implementing a fiduciary rule. In June of 2019, the SEC proposed an update to its regulations for advisors depending on the services they offer: Broker-dealers, who make money selling products and investments, versus advisors, who make money charging for advice.
Before the new proposed ruling, firms that registered with the SEC, known as Registered Investment Advisors (RIAs), had to follow a fiduciary standard. Broker-dealers could just follow a suitability standard for recommending products.
The SEC ruling would toughen the standards for broker-dealers — now they need to make recommendations in the “best interest” of clients. While not as strong as a fiduciary duty, it is tougher than the suitability standard. Brokers must be able to justify the risks, costs and benefits of a recommendation to prove it’s in a client’s best interest. Both types of financial advisors would also need to provide a standardized disclosure form explaining their fees, services and potential conflicts of interest.
The proposed SEC fiduciary rule is not as strong as the Obama fiduciary rule, which would have put the fiduciary standard on broker-dealers selling products for retirement accounts The SEC fiduciary rule is currently scheduled to launch in June 2020.
The Department of Labor (DOL) fiduciary rule
The DOL has not given up on launching its own fiduciary rule. While it has yet to formally propose anything, Secretary of Labor Alexander Acosta has said the DOL is studying the SEC ruling to guide a new DOL fiduciary standard.
The Obama DOL fiduciary rule was tougher than the SEC regulations, as it covered broker-dealers selling products. Any additional DOL fiduciary rule could further tighten standards for the industry. But while the government is making some moves, Pollack is still disappointed that the DOL let the Obama fiduciary rule die in court.
“I favor the strongest possible fiduciary standards,” he said. “To the extent that SEC and DOL rules are weaker than the Obama administration sought to impose, I regret these departures.”
State fiduciary rules
With the federal fiduciary rule up in the air, several state governments decided to pick up the slack and launch their own regulations for advisors operating within their borders.
New York has passed tougher standards for life insurance and annuities, so advisors selling these products need to meet a best interest standard. Nevada, New Jersey and Massachusetts are also reviewing or preparing to launch laws that would make a fiduciary standard apply for broker-dealers and investment advisors in their states. Maryland considered a similar law, but the bill didn’t pass.
This creates a tricky landscape because the way your financial advisor can make recommendations may depend on where you live.
The fiduciary rule: What’s next?
Creating an overarching fiduciary rule for investment advisors will not be easy but Eric Roberge, CFP® and founder of Beyond Your Hammock, thinks the industry badly needs one as there’s too much confusion regarding who offers what.
“I don’t think there’s anything inherently wrong with professionals who sell products, but what we do need in the industry, for the benefit of the people who need professional services, is more transparency,” he said. “Without a standard fiduciary rule, consumers have a very hard time distinguishing who is there to provide objective, in-your-best-interest advice — and someone who is a more of a salesperson with the financial incentive to sell products.”
Hopefully, the future fiduciary rules can achieve these goals so consumers can feel more confident in taking recommendations from financial advisors. In the meantime, since this is not yet the industry standard, make checking whether an advisor is a fiduciary one of the questions you ask before signing up.