Most Americans take for granted that their financial advisor will represent their best interests, but this is less true than you might think. In fact, up until recently, the people we trust with our money have been free to accept kickbacks for steering clients into retirement plans based on what's most profitable for the broker, not necessarily the investor.
That changed with a rule passed by the Obama administration. Set to take effect in April, it's called the fiduciary duty rule, and it looks like the Trump administration is gearing up to do away with it.
A fiduciary duty is the "highest standard of care" the law requires. Also applied in fields such as law and business, it requires practitioners to serve the best interests of their client above all others. Professions generally apply this standard to jobs that meet two criteria: first, a high degree of specialty and knowledge, such that the layperson cannot necessarily understand or competently overrule the advice being given. Second, the ability to do great harm through self-interest.
These criteria broadly establish the two most common elements of a fiduciary duty: the duty of care and the duty of loyalty.
In many circumstances, the need for this rule is obvious. Otherwise a lawyer could sell out his client in exchange for political favors, or an executive could tank the company's stock price to get a plum job with a rival corporation. By contrast, despite the specialized nature of his job, the average mechanic is not held to a fiduciary duty because the scope of harm is minor relative to the damage one could do with power of attorney.
In 2015, Obama's Department of Labor announced that it would apply this standard to financial services, creating a rule which held that financial advice must first serve the best interests of the client. It has been unpopular with both brokerage firms and the political right virtually since inception.
Calling the rule a "one-size-fits-all regulation," Speaker of the House Paul Ryan's blog noted that this "disastrous fiduciary rule… requires an enormous amount of paperwork and makes record keeping more expensive. Like Obamacare, it will result in higher costs and fewer options for small businesses trying to get up and running. Families with modest bank accounts seeking expert advice will no longer be able to justify the expense."
It is, Ryan said in an interview, "an example of massive overkill by the federal government."
The opposition to this rule comes from a common practice by which funds pay a commission to financial advisors who steer in new investors. The benefit, say opponents of the rule, is that by opening up new sources of revenue these commissions make financial advice more affordable for the layperson.
The danger, say proponents, is that this practice creates adverse incentives on the part of the firm. Without a fiduciary duty, advisors may well steer clients into risky or ill-fitting investment strategies in order to pursue more profitable commissions. In other fields, the concept of a fiduciary duty exists specifically to prevent these conflicts of interest.
The need for a fiduciary duty rule in investing is self-evident, and the industry's opposition deeply concerning. Here's why: a fiduciary duty does not stop the principal (in this case, the financial advisor) from acting on multiple parties' behalf, as long as he principally represents his client. If the best possible strategy for the client also offers a commission, the advisor is free to disclose and accept. A fiduciary rule would only interfere if and when financial advice conflicts with the best interests of the client.
Viewed in that light, the opposition to this rule takes on a downright sinister cast. In moving to rescind it, the Trump administration is announcing its support for brokers who, from time to time, act against the best interests of their client. And we're only talking about people's retirement accounts here.
The people who oppose this rule do make a legitimate point regarding big-picture consequences. If firms increasingly have to steer clients away from lucrative, commission bearing investments, they might have to correspondingly raise their client-side rates. What's more, those funds might eventually begin to phase out commissions altogether, making them unavailable even for legitimate investment opportunities and pushing prices even higher.
This is true, but it cannot possibly outweigh the risk and costs of predatory behavior.
In a competitive market, there will always be room for advisors to try and beat each other when it comes to rates. If politicians such as Ryan are correct and financial services industry cannot afford its current business model under a fiduciary duty rule, that would in and of itself reveal an industry deeply dependent on kickbacks and adverse incentives. Catastrophic rate hikes would beg the question of just how many clients are getting fleeced and for how much.
There's a saying in the news industry that sunlight is the best disinfectant. The corollary to this is that the harder someone tries to hide his behavior, the more scrutiny it probably deserves. Under a fiduciary duty standard, financial services firms would be free to continue accepting commissions for steering your money into specific funds, they would just have to disclose that and place your best interests first.
This will often mean passing on riskier funds with higher commissions, in exchange for safer, long-term strategies that will better secure your money, and you should be very worried about any broker who has a problem with that.
With people's life savings and retirement accounts on the line, it's the very least we can do. Indeed, it's a far lesser standard than that applied to lawyers, who give similarly specialized advice. Choosing your financial advisor shouldn't be a shell game, but for years it has been, costing Americans an estimated $17 billion per year. Although a fix was on the way, it looks like that casino will stay open.
And we'll all continue to pay for it.