“I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that a man cannot serve two masters.”
Though these words were uttered 75 years ago by Supreme Court Justice Harlan Fiske Stone, they are perhaps even more relevant today as Congress prepares to address comprehensive financial reform.
As part of the overhaul of the financial services industry, the Obama Administration has proposed holding anyone who offers investment advice to individuals to a fiduciary duty – a legal standard that requires acting in the client’s best interest.
Though this is the core standard by which Truepoint Inc. and other Securities-and-Exchange-Commission-registered advisors operate, stockbrokers and sales representatives of banks and insurance companies are currently held to a much less stringent “suitability” standard – which does not mandate placing the client’s interests ahead of their own.
Brokers are primarily regulated by the Financial Industry Regulatory Authority (Finra). Under Finra’s rules, brokers can sell any product which they deem “suitable” for the client. However, this does not include disclosing conflicts of interest, such as when the broker’s compensation increases as a result of recommending an investment vehicle with significantly higher fees than its nearly identical alternatives.
Unfortunately, given the lenient “suitability” standard, conflicts of interest are pervasive in the financial services industry. These conflicts are best allayed in the fiduciary environment of an independent, privately owned advisory practice that is fully controlled by the same professionals who serve the clients of the firm.
Because stricter regulation could force the retail brokerage industry away from very lucrative product distribution and into more restricted client-oriented advice, the brokerage industry is hard at work lobbying to maintain its broad exemptions from the fiduciary standard. Though a House Financial Services subcommittee plans to discuss advisor issues at an October 6th hearing, observers believe that Congress will turn the fiduciary standard issue over to the Securities and Exchange Commission (SEC) in order to focus on other financial reform legislation this fall. Advisors fear that the SEC will then pass the buck to the Finra, which largely represents the interests of the brokerage industry.
Regardless of the legislative and regulatory outcome, individual investors should accept nothing less than an advisor who acts at all times in the sole benefit and interests of the client. All actions of a trusted advisor should be held to a fiduciary standard.