Defining “Best Interest” in the Client’s Best Interest: The New Proposed Financial Industry Standards and What They Mean for You
Many investors remember the discussion surrounding President Trump’s January 2017 decision to delay implementation of a rule proposed by the Department of Labor (DOL) to require any financial professional providing investment advice to holders of IRA accounts to operate according to a fiduciary standard. The rule, often shortened to “the fiduciary rule,” would have mandated that anyone providing investment advice or products for IRA accounts was required to give advice that was in the client’s best interest. This is a higher standard than the “suitability requirement,” which merely requires that advice be suitable for the investor. Many in the financial industry, including some of the largest firms on Wall Street, objected to the fiduciary rule for IRAs because of the costs it would impose on broker-dealers, who were previously only required to observe the suitability standard. Ultimately, President Trump halted implementation of the DOL rule, and it was subsequently struck down by the Fifth Circuit Court in March 2018.
About a month after the fiduciary rule for IRAs was struck down, the Securities and Exchange Commission proposed new standards for the financial industry that were aimed, in part, at addressing what many perceived as a gap between conduct required by fiduciaries—which include a Registered Investment Advisor (RIA), CERTIFIED FINANCIAL PLANNERTM (CFP®), Chartered Financial Consultant (ChFC), and Accredited Investment Fiduciary (AIF®)—and other financial practitioners, such as broker-dealers. One of the chief aspects of the proposed regulation is the imposition of a “best interest standard” for broker-dealers, which would replace the current suitability standard.
On the face of it, this might seem to be a good outcome for everyone. Adhering to a best-interest standard would require not only fiduciaries—who have always operated according to a “client’s best interest” test in all investment advice and recommendations—but also broker-dealers to make only recommendations that are, in the words of the proposed regulation, “in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the [firm/agent] ahead of the interest of the retail customer.”
But, as is often the case, the devil is in the details. One fault that some observers find with the proposed regulation with regard to broker-dealers is that it fails to adequately define exactly what constitutes acting in the client’s best interest. It does list required disclosures the broker-dealer would have to make, including the method of compensation, the limits to the scope of the broker-dealer’s relationship with the customer, any conflicts of interest that may exist between the broker-dealer and the customer, and a requirement to mitigate or eliminate any of these conflicts of interest to the extent possible. Do you see the problem? How does disclosing conflicts of interest mean that broker is acting in your best interest like a fiduciary is required to act?
But other differences in the standard remain. For example, the fiduciary standard requires registered, certified, or chartered advisors to continually evaluate whether a client’s best interests are being served throughout the duration of the relationship. On the other hand, the proposed standard for broker-dealers would only require them to ensure the client’s best interest “at the time of the recommendation.” In other words, there is no requirement for broker-dealers to revisit their advice or recommendations after the initial investment or other transaction. This could raise problems for investors over time, as their circumstances, goals, and even risk tolerance levels inevitably change. A fiduciary advisor is required to maintain a level of vigilance over time that broker-dealers are not. It seems worth asking: Is a standard that deals only with the initial exchange or transaction, and not its long-term implications, really in the best interest of the individual investor?
Another aspect of the proposed regulation is that it mandates certain disclosures to only the “retail customer.” The act defines “retail customers” as “a prospective or existing client, who is a natural person (that is, an individual) ... The definition would also include a trust or similar entity that represents natural persons.” This means that a broker-dealer would be required to make the disclosures to certain types of customers, but not others. Disclosures would be made to a trust representing an individual, but not to a trustee for a company 401(k). A high-net-worth individual investor would receive them, but a pension fund would not. Here again, a question arises: Why should those making investment recommendations be permitted to withhold important disclosures from certain types of investors, rather than providing the same level of transparency to all?
One of the greatest risks of the proposed regulation is the extent to which it blurs the line between the level of care required by the fiduciary relationship and other standards. A client who learns that a particular financial professional is “required to act always in the customer’s best interest” may feel reassured without really understanding the nature of the relationship or the expertise of the person providing the service. Of course, it is also true that a true fiduciary could be guilty of misconduct or a lack of competence, but the standard by which fiduciaries are judged has been very clear since it was established by the Investment Advisers Act of 1940.
The best advice for those considering the services of any financial professional is to ask the right questions and listen carefully to the answers: “How are you compensated for your service?” “Are there financial incentives for you to recommend certain financial products?” “What are your credentials and how did you earn them?” “What is your level of commitment to my long-term financial health?” “How many of your clients have characteristics similar to mine?” “How long have you been offering your service?” “Can you provide references?” “How often can I expect to hear from you?” “Can I expect to speak with you within a reasonable amount of time if I have a question or concern?”
The most valuable asset you can have is sound, market-tested, research-based advice from a professional advisor who is committed to putting your needs first. If we can provide additional information or answer any questions, you are invited to contact us with your questions or requests.