Do Shareholders Deserve An Even Break?: It's Time for Brokers to Become Fiduciaries

When an investor buys shares in a mutual fund, how do they know they are getting objective advice from their financial adviser?

They don’t. And that is the root of a serious reform movement which wants to hold broker-deal registered reps to the fiduciary standard. If this new standard is adopted, broker-dealer registered reps will have to alter their first level of loyalty from their firms to their customers.

They also will have to demonstrate that an investment recommendation is both suitable and in the best interests of their clients. Currently, registered reps use a suitability standard which does not manage conflicts of interest on behalf of the investor.

While this may seem like a subtle semantic distinction for most individual investors, investment advisers already must abide by the fiduciary standard.

It is the registered reps of broker-dealers who are generally not following the higher standard which calls for disclosing and managing conflicts of interest which arise when selling investment products.

Basically, a fiduciary puts the investor’s interest ahead of their own. In practice, this means a broker would recommend a mutual fund which is most appropriate for a specific client in terms of risk, performance, costs and the thorniest issue, commissions, revenue sharing deals and other under-the-table rebates.

The downside of too many client-financial advisers’ relationships is that are tainted by conflicts of interest. As shown in detail in the Deception Series on this Web site, one fund company paid a revenue sharing commissions to advisers to sell its proprietary fund, in addition to paying them 12b-1 fees. This double commission arrangement has been in effect for a decade and it skirted the issue of authentic, forthright disclosure, as defined in Webster’s.

As ethicist Julie Anne Ragatz, a fellow at the American College Center for Ethics in Financial Services in Bryn Mawr, Pennsylvania, noted, this revenue sharing deal (aka the Advisor Paid Fee), created an unnecessary conflict-of-interest between the investor and their financial professional. This conflict was in addition to the one which existed due to 12b-1 remuneration.

According to Knut Rostad, a member of the Committee for the Fiduciary Standard, this is the right time to advance the adoption of the fiduciary standard for brokers so that investors’ interests can be put before those of the investment professional and the mutual fund company.

As cited by Kathleen McBride, editor of Wealth Manage magazine, and a Committee member, the five core fiduciary standard principles are:
• Put the client’s best interests first;
• Act with skill, care, diligence and good judgment of a professional;
• Do not mislead clients; provide conspicuous, full and fair disclosure of all important facts;
• Avoid conflicts of interest;
• Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

Adopting this higher standard of professional conduct is more important now than in the past since individual investors deserve some objective advice as they resurrect their investment portfolios. Without objective advice, investors can easily be convinced that more expensive, under-performing funds are better suited to their needs than a no-load fund or ETF simply because the investment professional is getting a larger commission to push one fund over a better-suited alternative.


Give the Client a Break
Fiduciary standards are not new. They were originally developed during the Crusades to protect the property of knights who went to recapture the Holy Land. Yet while they were on a religious quest, those who were entrusted to manage their estates during the years they were away from home succumbed to temptation. Their trustees sold the knights’ properties or refused to return them. These bad practices earned the attention of the King of England who pushed for conduct that eventually became the fiduciary standard.

Flashing ahead, fiduciary standards were most visibly injected into the investment business as part of the landmark ERISA legislation in 1973. As a staffer at the Teamsters Central States Pension Fund in Chicago during the mid-1970s, I saw ERISA standards at work first-hand. In one case, pension fund trustees attended a board meeting and as part of their entertainment, changed some golfing items on their hotel tabs, which were eventually paid by the pension fund. This was a clear ERISA violation. It activated an investigation by the U.S. Justice Department, U.S. Treasury, and U.S. Department of Labor.

Years later, a fund company employee saw mutual fund wholesalers charge items which became their personal property on their corporate charge cards to the mutual fund company. These charges were eventually paid from 12b-1 fees, yet this activity was considered perfectly appropriate. Why the double standard?

Here are the specifics of the Committee document, and also a petition to sign which will be sent to the appropriate federal regulators.

Comments can also be directed to Ms. McBride at kmcbride@wealthmanagerweb.com