Studies and surveys regularly show that the vast majority of American investors don't know what a fiduciary is, let alone if their advisor is one. What they do know is whether they trust their advisor—and that's what matters to them.
"Consumers don't understand the concept of a fiduciary," said Paul Auslander, a certified financial planner and director of financial planning at ProVise Management Group. "They understand the idea of doing the right thing."
The long-running debate over whether all investment advisors should operate as fiduciaries—persons required to always act in the best interests of their clients—is back on the front burner.
The Department of Labor—and, specifically, Assistant Labor Secretary Phyllis Borzi—is leading the charge.
The DOL, on April 20, reissued a proposal to expand the definition of a fiduciary to include a wider range of people providing financial advice to defined benefit pension plans, defined contribution 401(k) plans and individual retirement accounts.
The proposal will radically change the ground rules for those advisors. It will also likely prompt the Securities and Exchange Commission to issue a new uniform standard of conduct for advisors to retail investors—something the Dodd Frank Act charged the SEC with studying—and that SEC staff ultimately recommended that the commission undertake. SEC Chairperson Mary Jo White has recently indicated that she plans to make it a priority going forward.
"How can the SEC not do something?" asked attorney Marcia Wagner, founder of the Wagner Law Group, a firm focused on Employment Retirement Income Security Act (ERISA) law and employee benefits. "Some ... agency never involved in standard-setting is saying, 'You're not doing your job.'"
The issue might seem arcane, but it could have huge effects on consumers and financial service providers, and no issue is more politically charged in the industry.
Financial advisors are currently regulated under two different standards of conduct.
Investment advisors registered with the SEC or a state securities regulator are fiduciaries, subject to the duty of loyalty and due care with their clients. They are typically compensated by asset management fees and are expected to act in the best interests of their clients. If they don't, they can be sued in a court of law.
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Stockbrokers, broker-dealer representatives, insurance agents and others who provide investment advice, on the other hand, are regulated by the private-sector organization Financial Industry Regulatory Authority (FINRA) or by state insurance regulators and are subject to a "suitability" standard of conduct.
Their investment recommendations must be suitable for investors based on their financial profiles, but those advisors are not required by law to act in their clients' best interest. They are often compensated by commissions on transactions that can put them in conflict with the interests of their clients.
The rules governing the standard of suitability are more detailed than for fiduciaries, and disputes between advisors and clients are resolved through FINRA arbitration panels.
The unequal regulatory oversight and responsibility of advisors and brokers has been an issue since the SEC passed the so-called Merrill Rule, which exempted broker-dealers such as Merrill Lynch from regulation as fiduciaries under the Investment Advisers Act of 1940. As long as brokers offered only advice "incidental" to their investment recommendations, they would not be regulated as fiduciaries.
The Financial Planning Association, which represents financial planners predominantly operating as fiduciaries, successfully sued the SEC over the exemption and forced fee-based brokerage accounts offering financial advice to be registered with the SEC and made subject to the fiduciary standard.
The issue of regulation of commission-based brokerage accounts, however, has remained unresolved. "We support the idea of financial advice being given under the fiduciary standard, and we support extending it to the broker-dealers," said Karen Nystrom, director of advocacy at the FPA.
The proposal from the DOL is a major step in that direction. It doesn't redefine the role of fiduciaries, but it will force a lot more retirement plan advisors currently operating under suitability standards to adopt more rigorous fiduciary obligations.
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"The [Department of Labor] proposal didn't change the fiduciary duty, but it changed the definition of advisors subject to it," said Duane Thompson, president of Potomac Strategies and a former managing director of the FPA. "It will sweep in thousands of brokers and firms currently operating under suitability rules."
It will also price low- and middle-income Americans out of the market for financial advice, suggest opponents to the proposal. "The [Department of Labor] proposal is unworkable," said Kenneth Bentsen, president of the Securities Industry and Financial Markets Association, which represent a wide range of financial service providers.
Bentsen said SIFMA and the industry support the idea of a uniform fiduciary standard for brokers and advisors but suggested that the Department of Labor proposal would force many retirement plan advisors to move smaller accounts over to more expensive fee-based platforms or to stop serving those accounts altogether. "Consumers would be left to their own devices," he added.
Many consider that criticism a scare tactic, but there is no question that the Department of Labor proposal and/or a uniform fiduciary standard from the SEC would have major effects on financial service providers across the industry. "It will be massively disruptive and very expensive to the wirehouses, broker-dealers and product manufacturers," said Wagner at Wagner Law Group. "Margins in the industry have already been compressed [since the financial crisis]."
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SIFMA's Bentsen said the reworked DOL proposal, which attempts to create more flexibility for advisors to receive exemptions for prohibited transactions, is still a nightmare for advice providers.
"They added in conditionality and restrictions on assets that can be invested in and created a disclosure regime that no one has ever seen before," he said. "The net effect is that this is still unworkable."
The comment period on the DOL proposal has been extended to July 21; clearly, politics will have a major outcome on how both the department and the SEC proceed with the issue.
Rep. Ann Wagner, R-Missouri, is already sponsoring a bill to withhold funding for the DOL if it doesn't relent with its proposal.
—By Andrew Osterland, special to CNBC.com