There’s been a great deal of discussion over the past several months about financial advisors acting as fiduciaries, which is, simply, the practice of placing the interests of the client ahead of their own. What has been left out of this discussion is that many advisors who promote themselves as a fiduciary are, in fact, only working as a part-time fiduciary, at best.
It’s complicated, to say the least. Here’s why.
Many fee-based financial advisors maintain licenses to sell both commission-based securities and insurance products. They may be affiliated with a registered investment advisory firm, but they may also be affiliated with a broker/dealer. And therein lies the paradox.
In their capacity as investment advisor representatives, they have a legal obligation to put their clients’ interests ahead of their own personal or professional interests. Yet when they operate as representatives of a securities firm, they need only adhere to a vague “suitability” standard, meaning they can sell a financial product that may not be best for their clients, so long as it doesn’t actually do them harm.
In the past couple of weeks, I’ve come across a common transgression that illustrates the problem this sort of dual-relationship presents.
A financial advisor at one of the major, national firms had long had the vast majority of his clients in fee-based managed accounts. These accounts contained only publicly traded securities of mutual funds and exchange-traded funds. The accounts were liquid and transparent and the advisor needed to hang on to these people in order to continue to receive his management fee.
At some point, this advisor, for obvious reasons, convinced his clients to take several million dollars from their fee-based accounts and use that money to buy non-traded real estate investment trusts. In doing so, the money that was previously invested in liquid, transparent vehicles was subsequently placed in a partnership product where their money would be tied up for years.
As a result of these transactions, the advisor received hefty upfront commissions in the range of 6 percent to 8 percent of the money invested.
The investors in this situation undoubtedly approved these transactions, but they probably didn’t realize that, somewhere along the way, their advisor essentially took off his fiduciary hat and put on his broker’s hat. Once done, he was no longer required to position his clients’ interests ahead of his own.
Are you, as an individual investor, concerned?
Another situation that I noticed in the past year was that of an independent advisory firm that often advertised the benefits of working with a fiduciary. This advisor was previously a licensed securities broker but had to give up that license after he was barred from the industry for five years. This person established a new firm as a RIA and proceeded to market himself as a fiduciary.
In addition to acting as a fiduciary advisor, this individual was licensed to sell insurance products. When investors, particularly the elderly, would come to him in need of financial advice, he would sell them high-commissioned indexed annuities with huge surrender penalties.
Last year, the Department of Labor issued some new guidelines that would have required all financial advisors to use a fiduciary standard when offering advice on IRAs and other retirement accounts. A recent executive order from President Trump has placed the new rules in limbo, so it’s anyone’s guess what the future holds.
But, remember, even if the new rules do still go into effect, they only impact retirement accounts, not the money that investors have accumulated outside of their qualified, tax-advantaged retirement savings.
So what can an investor do to ensure that their advisor is always placing their interests first?
For starters, find out if your advisor is licensed to sell securities and/or insurance. Assuming your advisor is working with a RIA, you can easily research online and review the firm’s regulatory filings, which should illuminate potential conflicts. (You’ll typically find these in what is known as an ADV. You can find this information on the Securities and Exchange Commission website.)
Second, ask your advisor if he or she receives any sort of compensation in addition to the management fee that is being charged to the account. If so, that could be a giant red flag. (What you must find out here, is whether your advisor can receive higher compensation by offering one type of investment over another.)
Third, have your advisor put in writing that he or she will always act as a fiduciary to you.
Finally, stay away from any investment that doesn’t price regularly and trade on an exchange. In this day and age, there is really no reason to tie up your money in illiquid products.