Not everyone who gives financial advice in the US has a duty to actually help those who have no sense of their financial best interests
Does your financial adviser have a legal duty to give advice that’s in your best interests? The chances are that you think the answer to this question is “yes.”
Chances are, you’re wrong.
Not everyone who gives you financial advice has a duty to actually help you. The technical term for the true helpers is ‘fiduciaries.’ That means it’s their legal duty to always put their client’s best interests ahead of their own.
Two sets of regulators – the Labor Department and the Securities and Exchange Commission – have been examining what kinds of financial consultants should count as fiduciaries. Is your stockbroker a fiduciary? Is your financial adviser?
Here’s the tangle: the Labor Department has jurisdiction over retirement accounts, and the Securities and Exchange Commission governs brokerage accounts. They have been separately looking into expanding the fiduciary standard to cover the vast majority of financial product pushers – stockbrokers, financial advisers, consultants – only to hit repeated push back. Chalk it up to Washington’s reliable ability to confuse the best interests of the financial services industry with that of the 315m-plus Americans who need protection in everything from college savings strategies to retirement planning.
The problem, as it always is, is money. The financial services industry wants to protect the fees it receives from selling financial products to people who sometimes have no good reason to be buying them. A fiduciary should be able to tell you that you don’t need to buy something – but the financial services industry wants to make room for people who can sell you things with very little thought for what they might do to your finances.
There are some financial helpers who are fiduciaries already. That includes certified financial planners and Registered Investment Advisors – usually known as RIAs. Their job description includes warning you away from any financial cliffs. Unfortunately, these people are a small part of the financial advice world – they make up less than 20% of the universe.
When most of us go looking for help with our investments, whether we go to the bank or the friendly professional we first heard about via a commercial on CNBC, we encounter people who call themselves financial advisers. That’s a fancy word for a salesman.
These salesmen are not fiduciaries, but they do need to adhere to something called the suitability standard.
Think about it this way: say you are shopping for a dress or a suit. If you went to the store where a saleswoman was working to the fiduciary standard, she would have to sell you the best fitting, least costly outfit that’s most appropriate for the occasion.
The store working to the suitability standard? It could be the most expensive item in the store, in need of costly alteration, but as long as it sort of fits and sort of looks good … hey, it’s okay. At least it’s not sitting on the rack any more.
It gets better. The financial services industry has been arguing that they should not be subject to the fiduciary standard as it is currently written; they believe that if they are forced to act in the best interests of their clients, they will not be able to give advice while making a profit.
But surely people enter the financial services industry with the goal of helping, right? Well, about that … the incentives are not tilted toward you. As I pointed out in my book Pound Foolish: Exposing the Dark Side of the Personal Finance Industry, brokerage Edward James promises recruits that “excelling here doesn’t require a finance degree or a financial background” since, after all, brokers have “unlimited earning potential” as a result of “commissions based on sales” not to mention “incentive travel opportunities.”
This sort of stuff has an impact. Let me refer to one of my favorite studies here, the dryly titled “The Market for Financial Advice: An Audit Study,” a working paper published last year by the National Bureau of Economic Research.
A group of academic researchers devised sample portfolios and hired a group of actors to take them around to various banks and brokerages.
The result? Brokers missed very few chances to get it wrong, almost routinely recommending changes even when the sample portfolio was fine and promoting high-cost managed mutual funds over lower-cost index funds. “Our evidence suggests that adviser self?interest plays an important role in generating advice that is not in the best interest of the clients,” the paper concluded.
Oh, and the “best” part? The majority of testers, when queried, said they thought the subpar advice they received was so good, they would consider returning to the financial adviser with their own real-life portfolio.
This demonstrates why we need the fiduciary standard as it is currently written to apply to all sellers of financial service.
No matter how many well-meant personal finance articles are published, most consumers have no sense of what is in their financial best interests. Not only are those unsophisticated investors likely to fall victim to a persuasive technique, they are unlikely to ever figure out they received less-than-ideal advice – until, that is, real damage is done.
Think about it for a moment. We don’t ask patients to wonder if their doctors are recommending one sort of treatment over another because they have a financial stake in it. In fact, if a doctor recommended a second-tier treatment because she had a financial stake in it and it turned out badly for the patient, it’s unlikely a jury hearing a malpractice case would be sympathetic to the defense that the treatment was suitable enough.
But when it comes to financial advice, well, good luck to you. We somehow expect everyone to be an instant expert at exotic financial instruments.
So what’s next? Well, we can all wait for the SEC to issue some guidance. Or we can keep our fingers crossed that the Labor Department will have better luck when, as expected later this year, they once again attempt to take steps to make the fiduciary standard apply to Individual Retirement Accounts. While we wait, the financial industry is lobbying heavily against the move to expand the fiduciary standard; they could lose millions of dollars if it goes through.
How much Congressional enthusiasm is there for this? Well, a bill was recently introduced into Congress that would force the Department of Labor to wait until the SEC announces its changes to the fiduciary standard. That would effectively stop the process for quite some time into the future. The proposed legislation’s name? The delightfully Orwellian “Retail Investor Protection Act.”
Only in Washington would protecting the consumer really mean protecting the financial services industry.