Saturday, April 30, 2016

DOL Fiduciary Rule: What "Best Interests" Means, Impacts on Financial Services


Congress will not stall the DOL Rule in 2016. What occurs in 2017 may well be determined by the upcoming Presidential election, and even then great uncertainty exists as to whether the DOL's Conflict of Interest Rule would or could be timely repealed by a new Administration. Court challenges to the DOL Rule will occur, but their likelihood of success is below 50/50. As a result, all firms and advisers should be seeking to adapt to the new Rule.

In adapting, firms and advisers should take care to fully comply with the Impartial Conduct Standards required under the Best Interests Contract Exemption. Given the substantial academic research regarding the impact of fees and costs on investor returns, and the express language used by the DOL in announcing BICE, the receipt of additional third-party compensation - without fee offsets - may be problematic. The result will likely be a substantial movement toward AUM fees, and to the selection of low-cost investment products.

Congress Continues to Serve Wall Street, Not Main Street - But Congress Will Not Stop the DOL Final Rule.

As the Republicans in Congress continue to vote on resolutions and bills that would seek to stop the implementation of the DOL's Final Rule, permit me to briefly comment on this political state of affairs.

I have always been for government of a small size. There are a great many things that government fails to do well. Yet, there are areas where laws and regulation, carefully crafted, are required.

The DOL's "Conflict of Interest Rule" (a.k.a., "Fiduciary Rule") is altogether necessary. In this most complex financial world, the vast information asymmetry between financial/investment adviser and client cannot be overcome through financial literacy efforts, nor through disclosures. The application of fiduciary standards to such a relationship is a natural consequence, supported by many public policy goals. Just as attorneys are not permitted to take advantage of unsuspecting clients, neither should investment advisers.

Congress is 2017 will not succeed. It will make many efforts, but all will stall in the U.S. Senate or be vetoed by President Obama. Republicans, in undertaking these many but doomed legislative efforts, will continue to be seen as under the control of Wall Street. (Although, to be fair, a large number of "corporate Dems" in Congress have also been viewed as under Wall Street's influence). It could be said that voters of tired of the compact between Congress and monied interests - hence the rise of such polarizing personalities as Donald Trump and Bernie Sanders.

And, as I set forth later in this post, Congress has been misled by Wall Street on the DOL's rule-making effort. (As Congress has previously been misled by Wall Street and the insurance companies, many times over.) You think Congress would learn. Then again, monied interests continued to possess outsize influence over our policy makers.

Other developments could stop the DOL's Final Rule. Lawsuits are certain to be filed, probably with the insurance industry leading the way. But I would put their likelihood of success, in stopping the DOL Final Rule's implementation, at less than 50/50.

And, a new Administration could seek to enact a new rule in 2017, that effectively would repeal the DOL's April 2016 Final Rule. But there is no assurance that such would occur, regardless of who is elected. Also, government rule-making in adherence to existing laws defining the scope of review and public commentary, takes tremendous time - far more time than the 2-1/2 month window between the installation of a new Administration and the April 1, 2017 effective date of the core of the DOL's rule's requirements.

A new Congress could also enact legislation that more quickly and effectively stops the DOL's Rule, but getting enough votes in the U.S. Senate, in which neither party will likely possess a fillibuster-proof majority, may be problematic.

The DOL's Admirable "Sole Interests" Application of the Fiduciary Standard.

As as a principles-based rule, the DOL Final Rule sets forth principles that must be followed in the course of a relationship of trust and confidence. Even Adam Smith, the founder of modern capitalism, supported ethical rules of conduct.

Ignoring the several exemptions the DOL promulgated, the Final Rule, at its core, is an example of the best form of government regulation. It applies ERISA's tough sole interests fiduciary standard of conduct, by requiring conflicts of interest to be avoided. ERISA's tough prohibited transaction rules are also applied, in the context of the statutory exemption from same that permits "necessary" services for "reasonable compensation."

In essence, the DOL's Final Rule is elegant in its simplicity and in its application. It is an example of government getting things right.

"BICE" - The "Best Interests" Version of the Fiduciary Standard - Did the DOL "Get It Right"?

In contrast to the core of the DOL's Final Rule, the DOL also issued or modified several class exemptions. These exemptions, requested by the financial services industry, are far more complicated than the rule itself. (Wall Street complains about this complexity, but the DOL was only trying to meet Wall Street's requests while still availing consumers of ERISA's mandate that they be protected.)

The "Best Interests Contract Exemption" is an attempt by the DOL to accommodate the wearing of "two hats" by a fiduciary - i.e., serving as the purchaser's representative while also permitting the receipt of third-party compensation (commissions, 12b-1 fees, payment for shelf space, soft dollar compensation, and other revenue-sharing). It seeks to ban the worst practices (sales quotas, prizes and trips and awards for reaching certain sales targets for a product, etc.), while permitting compensation by different means. In so doing, despite many changes to the rule, it mandates many disclosures to individual investors (although we all know such disclosures are largely ineffective as a means of consumer protection).

However, in the Best Interests Contract Exemption (BICE) the DOL quite explicitly applied its strict "Impartial Conduct Standards." When you read the language of the BICE release carefully, you will find a strong (and correct) application of the "best interests" fiduciary duty of loyalty. In essence, the client cannot be harmed by the receipt of third-party compensation. Given the substantial (some would say overwhelming) academic research that higher fees and costs associated with investment products lead to lower returns for investors, one can easily conclude that the only way for a firm to receive additional compensation and fulfill BICE's requirements is to offset additional compensation against other fees the client pays.

I believe most advisers, and eventually most firms, will conclude that either fee-offsets must be undertaken (to return the arrangement to agreed-in-advance reasonable and levelized compensation), or they will simply switch to some form of level fee arrangement (assets-under-management percentage fee, annual retainer, fixed fee for discrete advice, subscription-based fees, and hourly fees). In other words, I suspect BICE will not be used all that much.

There is much to like about the final version of BICE and some of the changes the DOL undertook. For example, I like the fact that the DOL abandoned having a "legal list" of investments, and instead relying upon the required due diligence of investment advisers to properly formulate investment strategies and to select investment products. I also admire the DOL's elicitation of the best interests fiduciary standard, and the DOL's resistance to Wall Street's many attempts to redefine "best interests" as a version of suitability.

I remain concerned about BICE's enforcement. It remains to be seen whether broker-dealers will be subject to more (successful) class action claims, given the difficulty of certifying a "class." The removal of punitive damages as a remedy, with only compensatory damages available, may lead firms to regard the costs of failing to comply with BICE's fiduciary duties as just a mere "cost of doing business." (Sadly, many individual advisers will see their reputations ruined in the process, while firms just trudge along.) And, FINRA's mandatory arbitration - with its emphasis on a "fair" or "equitable" remedy (appropriate when dealing with the weak suitability standard) - may serve to substantially weaken the enforcement of the fiduciary standard of conduct, and especially the enforcement of the BICE's Impartial Conduct Standards.

I would also have preferred to see BICE sunset, in 6-7 years, as a temporary measure as the industry adjusts; I fear that, over time, BICE will be interpreted incorrectly and will then permit certain nefarious practices. We can only hope that a future Administration will repeal BICE, while preserving the Final Rule itself, once the industry has move much further toward the provision of advice under levelized compensation arrangements.

The Interrelationship Between BICE's Impartial Conduct Standards and Academic Research

A further "deep dive" into BICE is appropriate, in considering how to comply with its many requirements.
A key aspect of the U.S. Department of Labor's Final Rule ("Conflicts of Interest") and its related Best Interests Contract Exemption (BICE) Final Rule deserve further analysis: "What does the term 'best interest" mean? And, how is it possible to comply with BICE'S Impartial Conduct Standards?"

I was struck by an article appearing at written by David Armstrong, "Fiduciary Rule Takes Center Stage in Nashville," regarding comments made at the NAPA 401(k) summit in mid-April 2016. Leaving aside the credit that NAPA took for getting the streamlined exemption in place for level-fee advisers (the credit goes to many others, in my opinion, who were far more influential in both identifying the need for this and in promoting it to the DOL), the article stated:
  • "Leaders of the association, the largest trade group for retirement plan advisors in the country, kicked off the three-day event with a muted victory lap."
  • "'Ultimately, firms are going to have to decide if they are 'full BIC or BIC light' ... There is no third option.' There is more flexibility in how an advisor is compensated if they are using the full best interest contract exemption, but also more liability from trial lawyers. There’s less flexibility in compensation under the streamlined level-to-level version, but less liability.'”
  • "RIAs will go for the BIC light version, while deep-pocketed wirehouses will likely chose the full BIC version. 'How hybrid firms thread that needle remains to be seen,' Graff said."
  • "“One thing the DOL did not take away was the ability of trial lawyers to file class-action lawsuits” against firms thought to be in violation of the best interest contract exemption. “We have to see it as a cost of doing business,” he said.
Additionally, over the past couple of weeks, I have spoken to many securities lawyers and compliance consultants. Many of these attorneys and consultants seem to be focusing on BICE's "policies and procedures," rather than the substantive requirements of the Impartial Conduct Standards applicable under BICE.

Consultants have further stated to me that insurance company executives are "O.K." with BICE, and that insurance company executives are not troubled by its greater transparency requirements. And others have stated that BD executives believe not much will change, for their firms, in the end - under BICE.

It seems to me that far too many BD and insurance company executives, and even the compliance / securities law consultants that provide advice in this area, have opined that it will be largely "business as usual" in dealing with IRA accounts. I suspect they are wrong. Please permit me to explain why.

ERISA's sole interest standard is tough - it prohibits any conflicts of interest. In turn, the prohibited transaction requirements of ERISA serve to strengthen this requirement. If it were not for the statutory 408(b)(2) exemption, even fee-only advisers could not provide services to plans covered by ERISA.

Yet, ERISA permits the DOL to issue class exemptions from the prohibited transaction rules - as the DOL has done with the Best Interests Contract Exemption (BICE). Yet, the requirement for a class exemption is that the exemption is "in the [best] interests of the plan and its participants and beneficiaries." Another requirement for a class exemption is that the exemption is "protective of the rights of particiapnts and beneficiaries of such plan." 29 U.S.C. Sect. 1108(a).

Under state common law, and English law from which American common law is derived, technically the existence of a conflict of interest is a breach of a fiduciary duty. Under the sole interest (trust law-based) fiduciary standard, there is no method to cure for the breach by the fiduciary. Any conflict of interest is, per se, wrongful. And recession of the transaction, even when the entrustor (beneficiary, or client) is a remedy frequently applied.

But, under the common law's best interest fiduciary standard, the conflict of interest are strongly disfavored, but is permitted in certain instances. A conflict of interest is a breach of one's fiduciary duty, but the assertion of a defense to the breach can occur. In essence, the breach of the fiduciary obligation can be "cured" - by only by demonstrating that the clients' best interests were not subordinated. Several steps are required for such a cure, including: (1) affirmative disclosure of the conflict of interest and all material facts regarding it; (2) ensuring the client understands the conflict (a burden placed on the adviser, not the client, recognizing that the duty to read when receiving advice from a fiduciary is somewhat abrogated, and that even with extensive counsel some clients may not be able to understand the material facts and the conflict of interest and its ramifications); (3) the client's informed consent; and (4) even then, that the transaction remain substantively fair to the client. And the courts take the view, properly so, that clients would never provide informed consent to be harmed.

If you delve into the Final Rule and BICE, the DOL in its releases has a lot of language which sets forth that, although commission-based compensation might be acceptable (although I have concerns about the reasonableness of compensation for larger transactions), and differential compensation can be paid to a firm, still the client cannot be harmed.

Just consider these excerpts from the DOL's release:
  • The advice must be provided “without regard to financial or other interests of the Adviser, Financial Institution, or any Affiliate, Related Entity or any other party.
  • Financial Institutions must refrain from giving or using incentives for Advisers to act contrary to the customer’s best interest.
  • Stated differently, “[t]he Adviser may not base his or her recommendations on the Adviser’s own financial interest in the transaction.”
  • However, the DOL noted that BICE’s “goal is not to wring out every potential conflict, no matter how slight, but rather to ensure that Financial Institutions and Advisers put Retirement Investors’ interests first, take care to minimize incentives to act contrary to investors’ interests, and carefully police those conflicts that remain."
  • As to the use of the phrase “other party,” the DOL stated that it “intends the reference to make clear that an Adviser and Financial Institution operating within the Impartial Conduct Standards should not take into account the interests of any party other than the Retirement Investor – whether the other party is related to the Adviser or Financial Institution or not – in making a recommendation. For example, an entity that may be unrelated to the Adviser or Financial Institution but could still constitute an ‘other party,’ for these purposes, is the manufacturer of the investment product being recommended.”
  • The DOL noted that “full disclosure is not a defense to making an imprudent recommendation or favoring one’s own interests at the Retirement Investor’s expense.”
  • The DOL provided a specific example of the application of these requirements: “[F]or example, an Adviser, in choosing between two investments, could not select an investment because it is better for the Adviser’s or Financial Institution’s bottom line, even though it is a worse choice for the Retirement Investor.”
  • The DOL also cited several decisions addressing the requirements when a conflict of interest is present: “Donovan v. Bierwirth, 680 F.2d 263, 271 (2d Cir. 1982) (“the[] decisions [of the fiduciary] must be made with an eye single to the interests of the participants and beneficiaries”);
So, here's the rub. Where does additional (differential) compensation paid to the firm come from? From the products that are recommended. And, all things being equal (i.e., same asset class, same characteristics), that product will have higher expenses, to pay for such additional compensation to the firm recommending the product under BICE.

Please note that an overwhelming body of academic research reveals (and, I would say, concludes) that higher fees and costs for mutual funds (and, by extension, to other products) results in lower returns to the investor. Witness the following research in this regard:
  • Actively managed funds tend to underperform their benchmarks after adjusting for expenses, and the probability of earning a positive risk-adjusted return is inversely related to expense ratios. (Haslem et al., 2008).
  • Although a small number of early studies find that mutual funds having a common objective (e.g., growth) outperform passive benchmark portfolios, Elton, Gruber, and Blake (1996)  argue that most of these studies would reach the opposite conclusion if survivorship bias and/or adjustments for risk were properly taken into account.
  • Expense ratios and turnover are negatively correlated with return. (Carhart, 1997 ; Dellva & Olson, 1998 ; O’Neal, 2004).
  • Loads are also negatively associated with fund performance (Carhart, 1997 ; Dellva & Olson, 1998 ).
  • Load funds underperform no-load funds by an estimated 80 basis points (bps) per year (Carhart, 1997).
  • Transaction costs also decrease the potential benefit of active management (Carhart, 1997).
  • Opportunity costs exist due to cash holdings by funds. Hence, part of this underperformance is because actively managed mutual funds have higher liquidity needs for frequent purchases and redemptions. (O’Neal, 2004).
  • Lower performing fund have higher fees, and high-quality funds do not charge comparatively higher fees. (Gil-Bazo & Ruiz-Verdu, 2008).
  • As a result of lower expenses, broad index funds tend to outperform actively managed funds with equivalent risk. Therefore, the best way for most investors to improve performance is to have a broad index fund with minimal costs (Malkiel, 2003).
  • As stated in a 2011 paper, using data on active and passive US domestic equity funds (the sample included a total of 13817 funds while the CRSP Mutual Fund Database) from 1963 to 2008, the authors observed: “Similar to others, we first show that fees are an important determinant of fund underperformance – that is, investors earn low returns on high fee funds, which indicates that investors are not rewarded through superior performance when purchasing ‘expensive’ funds. We explore a number of hypotheses to explain the dispersion in fees and find that none adequately explain the data. Most importantly, there is very little evidence that funds change their fees over time. In fact the most important determinant of a fund’s fee is the initial fee that it charges when it enters the market. There is little evidence that funds reduce their fees following entry by similar funds or that they raise their fees following large outflows as predicted by the strategic fee setting hypothesis. We also do not find evidence that higher fees are associated with proxies for higher service levels provided to investors. Overall, our findings provide little evidence that competitive pricing exists in the market for mutual funds.”
  • Vidal et. al., 2015: High Mutual Fund Fees Predict Lower Returns. “[We confirm the negative relation between funds´ before fee performance and the fees they charge to investors. Second, we find that mutual fund fees are a significant return predictor for funds, fees are negatively associated with return predictability. These results are robust to several empirical models and alternative variables.” Marta Vidal, Javier Vidal-García, Hooi Hooi Lean, and Gazi Salah Uddin, The Relation between Fees and Return Predictability in the Mutual Fund Industry (Feb. 2015).
  • Sheng-Ching Wu, 2014: High-Turnover Funds Have Inferior Performance. “[F]unds with higher portfolio turnovers exhibit inferior performance compared with funds having lower turnovers. Moreover, funds with poor performance exhibit higher portfolio turnover. The findings support the assumptions that active trading erodes performance….]
  • Blake, 2014 (UK): Average Fund Manager in UK Unable to Deliver Outperformance Using Either Selection or Market Timing. “[U]sing a new dataset on equity mutual funds [returns from January 1998–September 2008] in the UK … [we] find that: the average equity mutual fund manager is unable to deliver outperformance from stock selection or market timing, once allowance is made for fund manager fees and for a set of common risk factors that are known to influence returns; 95% of fund managers on the basis of the first bootstrap and almost all fund managers on the basis of the second bootstrap fail to outperform the zero-skill distribution net of fees; and both bootstraps show that there are a small group of ‘star’ fund managers who are able to generate superior performance (in excess of operating and trading costs), but they extract the whole of this superior performance for themselves via their fees, leaving nothing for investors.”
  • Ferri and Benke (2012). Using the “CRSP Survivor-Bias-Free US Mutual Fund Database … maintained by the Center for Research in Security Prices (CRSP®), an integral part of the University of Chicago Booth School of Business … In all portfolio tests, there was some benefit to using low-cost actively managed funds, but not as much as we expected, given the reported impact that fees have on individual fund performance. The probability of outperformance by the all index fund portfolios remained above 70% in all scenarios … We speculate that filtering actively managed funds may shift the probability curve closer to an all index fund portfolio as in the low-expense example, but we are not convinced that any filtering methodology will significantly alter the balance in favor of all actively managed funds. This may be an area for future research … A diversified portfolio holding only index funds in all asset classes is difficult to beat in the short-term and becomes more difficult to beat over time. An investor increases their probability of meeting their investment goals with a diversified all index fund portfolio held for the long term.”
Please note that I am not stating that index funds are required to be utilized. I don't believe the body of research regarding the use of low-cost actively managed funds has been fully developed, yet. And, some index funds suffer from substantial market impact costs during reconstitution. More research in this area is required, and I believe we might suggest that low-cost index funds are (usually) a prudent choice for advisers. Yet, very low-cost actively managed funds might also be prudent, and some research appears to support this view.

Yet, given the strong academic evidence available, I believe it is reasonable to conculde that, to the extent investment advisers believe that they can recommend higher-cost products that pay their firm more, with no harm to the client, these investment advisers are not acting as expert advisers with the due care required of a fiduciary. And, if those higher-cost products result in additional compensation to the adviser's firm, that's also a breach of the fiduciary duty of loyalty.

So, under BICE - the allowance of differential compensation cannot, under the express language the DOL has utilized in its release, in several places - harm the client. Yet, the academic research is clear - higher compensation flows for recommending higher fee/cost products which, all things being equal, result in lower returns to the investor. Many experts from the world of academia will be available to testify for this proposition.

The DOL did set forth examples on how to cure the breach of fiduciary duty that flows from the conflict of interest resulting from differential compensation. For example, the receipt of additional compensation could serve to offset other fees - essentially returning to a level-fee arrangement. When banks were permitted around the early 1990's to convert common trust funds to proprietary mutual funds, the approach taken by many (but not all) state legislatures was to require proprietary fund management fees to be credited against trustee fees. (Although, the presence of relatively high fund administrative fees, paid in part to affiliates, reveals a weakness in enforcement of the principles involved, by the FDIC and OCC.)

In essence, the way I read the DOL's Best Interests Contract Exemption, most firms and advisers should embrace AUM fees. However, for the very small clients (perhaps with accounts of $25,000 or less) a commission-based platform could be used - provided the commissions for all products on the platform are the same (at least for similar products) (otherwise, a conflict of interest exists that cannot be properly managed).

I have heard BD execs say, "We are not worried about increased transparency" or "higher disclosure burdens." Of course, this is because disclosures are largely ineffective.

I have also heard BD/insurance company execs state that should clients complain about the conflicts of interest / higher-fee products, that resolving such complaints is just a "cost of doing business." The DOL Final Rule prohibits punitive damages, which would serve to deter bad conduct. And rescission as a remedy is also unavailable. [Class actions are permitted, but under what circumstances can you certify a class of IRA owners? That's an open question.]

Additionally, concerns exist regarding the efficacy of arbitration. One might argue that arbitration, with FINRA's instruction to arbitrators to be guided by equity (i.e., to do what is "fair"), can easily diminish the fiduciary protections, which should be strictly enforced. This remains to be seen. (One can also argue that the pursuit of "fairness" also helps complainants, in arbitration, to prevail when the low "suitabiity" standard would not permit recovery.)

This sets up an interesting dynamic. Firms won't fully comply with the Impartial Conduct Standards' requirements, in order to secure more profits. And they will litigate/settle complaints, as a cost of doing business, given that the size of any compensatory damages awards would be far less than the additional profits firm make by ignoring the Impartial Conduct Standards. Any reputational risk at the firm level is mitigated - first by settlement "keep quiet" clauses - and next by large advertising budgets and the short memories of the public.

Yet, advisers will see preservation of their reputation as a most important factor driving their business and everyday decisions. Individual advisers will not want to see complaints that lead to their U-4s being tarnished.

Also, note that differential compensation will be paid to the firm, but not passed on to the adviser, as under BICE the individual advisers cannot be incentivized to do harm.

So, what will happen? If BD firms don't move to fee offsets, or (preferably) AUM platforms with low-cost investment products (with no product provider compensation to the BD firm), then in all likelihod individual brokers will be conflicted - and worried about their reputation. And these individual brokers will speak with their feet - by departing the firm.

As a result - in order to retain advisers (and reduce compliance and litigation costs) - I suspect that some, perhaps the majority, of larger BD firms will embrace largely conflict-free AUM platforms for their registered reps to use. These AUM platforms will use low-cost ETFs and low-cost funds that provide no additional compensation to the BD firm or its representatives.

But, many BD firms will not properly adopt a true fiduciary culture - and the reps in those firms will suffer, or depart, or both.

If I am correct, then the DOL rule - with its application of the fiduciary standard to DB, DC and IRA accounts - about 60% of publicly traded investments in the US (if you exclude bank deposits) - will be transformational in financial services. It will accelerate the move toward fee-based compensation that was already largely underway.

In the end, the DOL's rule-making efforts will force investment products to compete on their merits, not on the basis of how much commission is paid or how much revenue sharing or "marketing support" payments are paid to the BD firm.
The DOL's Fiduciary Rule: Impacts Upon Financial Services.

The DOL's Fiduciary Rule, if properly applied and enforced, will serve to transform the financial services industry. We have already seen a major shift in recent years toward levelized compensation arrangements, and the DOL's Rule will only accelerate this process. We have already seen low-cost products gain market share, and we have seen competitive pressures (via new applications of technology, and otherwise) force adviser's compensation lower.

As the DOL's rule is applied, and firms continue to adjust, greater competitive pressures will emerge over time. leading to even lower fees and costs associated with investment products and the receipt of investment advice. This is good for consumers. And, as greater capital accumulations will result, this is good for the U.S. economy.

The provision of investment advice continues to migrate toward a professional services business model. Yes, there will still be "mega-firms" of advisers, much of the same size of the largest broker-dealer firms today. But, similar to the legal and accounting professions, many mid-size regional and local firms will continue to expand in number. And, it is likely that the majority of advisers will reside in 1-5 person firms.

One huge consequence of the DOL's Final Rule is the need to justify (and document), in the IRA rollover context, the value of the services provided. As a result, firms will continue to expand their value-added service offerings, including all-important financial and tax planning services. With the rise in financial planning services will come increased demand for new financial planners; this bodes well for our universities as they accelerate enrollment in their undergraduate financial planning programs.

Additionally, all advisers need to get better at due diligence, in both investment strategies and investment product selection. Greater scrutiny is required of the strategies and products already utilized by advisers, and greater inquiry is needed into the universe of strategies and products to discern the very best that can be employed to serve client needs.

Finally, if we continue to evolve toward a model in which consumers can trust their financial services providers, and if we continue to get better in our expertise, there could well be an explosion in the demand for financial planning advice over the next decade.

Eventually financial planning may become a true profession, bound together by the fiduciary principle. Many steps remain, but the DOL Fiduciary Rule is a significant advancement toward that goal.

Thursday, March 10, 2016

DOL Conflict of Interest Rule: A Message to Congress

Executive Summary: What Wall Street Does Not Want Congress to Know.
  • Brokerage firms and insurance companies are already adapting to the DOL's Conflict of Interest (Fiduciary) Rule - rolling out programs to serve clients both large and small with reduced-fees-and-cost, largely conflict-free platform offerings.
    • Some firms started to adapt even before the release of the Final Rule in early April 2016.
    • Many brokerage firms have already lowered, or are in the process of lowering, the fees of their advisory platforms.
    • Many brokerage firms are reducing their account minimums, so that they can serve even smaller clients.
  • It is clear that the Rule will benefit business owners (plan sponsors), by substantially reducing the risks they face in excessive fee litigation cases. Expect more 401(k) plans to be offered.
    • Business owners currently possess little or no recourse against their "retirement plan consultants," most of whom escape liability under the weak "suitability standard" that largely protects brokerage firms and insurance companies from liability for the advice they provide. As a result of the DOL fiduciary rule, business owners won't be "left hanging and out to dry" for relying upon the recommendations made by these "retirement plan consultants."
    • Both large and small business owners should be entitled to rely upon the advice they receive, as to the investment options to include in their company's retirement plan.
    • The fiduciary standard operates as a constraint on greed. "Bad choices" - i.e., expensive, inappropriate, rent-seeking investments - will be done away with under the fiduciary standard.
    • With the ability to trust the investment adviser to the plan, and with reduced risks, more business owners are likely to start and maintain qualified retirement plans.
  • Because the level of trust in financial services will rise, and lower fees and costs will mean greater returns for investors, a new era of increased capital formation will occur. This, in turn, will accelerate the growth of the U.S. economy over the long run, further boosting prosperity for all Americans.

Dear Members of the U.S. Congress:

In the ongoing battles over the U.S. Department of Labor's enactment of its "Conflicts of Interest" (fiduciary) rule, over and over again I have observed Wall Street firms, insurance companies, and their lobbying organizations (SIFMA, FSI, and NAIFA) spout various misleading and often downright false statements.

In this blog post I point to many of the sources in which Wall Street's lies are unmasked, and their double-talk is revealed.

I hope you will do your own review of the evidence, and ascertain that - once again - Wall Street is intentionally misleading you.

Prior to examining Wall Street's statements in more detail, please permit me to dispel any misconceptions you may possess about the SEC and the DOL working together - they intensively engaged in meaningful, cordial discussions, and their dialogue led to a better rule.

I've scanned the 2,500+ pages of emails and correspondence between the two agencies. My scan reveals two agencies working together well, offering thoughtful insights and suggestions to each other.
  • The fiduciary standard under ERISA is a "sole interests" standard, augmented by ERISA's prohibited transaction rules. The fiduciary standard under the Investment Advisers Act of 1940 is a "best interests standard." While similar in most respect, differences exist. Hence, absent major Congressional action that changes either ERISA or the Advisers Act, the U.S. Department of Labor's application of the fiduciary standard will be different from that of the U.S. Securities and Exchange Commission.
  • Despite these differences, the DOL and SEC have conferred on the DOL's rule-making, extensively. While the Majority Staff of the U.S. Senate Committee on Homeland Security and Governmental Affairs issued a 40-page critical of the extent of communication, one need only review the over 2,500 pages of e-mails, drafts circulated between the DOL and SEC (and comments thereon), attendee lists of joint meetings of the DOL and SEC staff, and much more, to ascertain both the huge breadth and depth of the communications between the two agencies over several years time. 
  • Furthermore, while the Majority Staff report was critical of a dialogue between two economists, who has never known two economists to not disagree? Additionally, from the perspective of this writer (a professor of finance and financial planning), the DOL's economist's statements in the two economist's written exchanges were correct, while the SEC economist appeared to lack knowledge of how the financial services industry works, the huge body of academic research relating to the behavioral traits of consumers, and much more.
Let's More Closely Examine Wall Street's Many Misleading and False Statements about Fiduciary Rule-making.
  • A STATEMENT COMPLETELY UNTRUE AND THE REVERSE OF WHAT WILL ACTUALLY HAPPEN: "SMALL BUSINESS OWNERS WILL BE HARMED." Yet, all logic dictates otherwise, as I've explained here and here). The reality is that business owners both large and small are exposed to excessive fee litigation lawsuits, often with no recourse against their "retirement plan consultant" who hide behind the "suitability shield" and who do not possess fiduciary obligations to the plan sponsor (i.e., business owner). The DOL's Conflicts of Interest Rule corrects this situation, so that plan sponsors are not "hung out to dry" for relying upon the recommendations of a "retirement plan consultant." I predict that more 401(k) plans will be formed by small businesses, not less, given the greatly reduced liability exposure of plan sponsors when such plan sponsors (small business owners, generally) receive advice as to investment selections for the plan under a fiduciary standard.
  • A GROSSLY FALSE ASSERTION: "FEES AND COSTS WILL RISE FOR INVESTORS." This is exactly the opposite of what will actually occur, as explained by numerous economic studies. This is also confirmed by my own personal observations, from observing hundreds and hundreds of clients over the past 15 years. I observe that clients' total fees and costs fall usually in the range of 30% to 70%. Fees and costs matter to the returns investors secure, as I've explained here. Under the fiduciary standard, the adviser becomes the steward of the client's wealth, with the obligation to incur only reasonable fees and costs. (See also the discussion below, where new fee structures have already emerged under the fiduciary standard from broker-dealer firms, in which fees have been lowered.)
  • A STATEMENT CONTRARY TO ALL THE EVIDENCE! "SMALL INVESTORS WON'T BE SERVED." Yet, I provide insights into entire networks of fiduciary, fee-only advisers that already serve small investors, in "How to Choose A Financial/Investment Adviser: A Checklist for Consumers." In addition to these networks, as well as newer online investment advice platforms that have emerged, we have seen many existing firms already adopt new platforms to serve smaller clients:
    • The Wall Street Journal reported on March 16, 2016, that brokerage firms are actually LOWERING their minimums, and LOWERING their fees, for SMALL CLIENTS! 
      • "The brokerages are trying to avoid losing small-balance, commission-based retirement accounts because of the rule, while also positioning themselves to gather more fee-based revenue. LPL Financial Holdings Inc., based in Boston, said ... that it would lower its minimum for certain fee-based accounts by $5,000, to $10,000, this year, while also cutting some of the costs associated with those accounts."
      • "Edward Jones plans to roll out new low-cost accounts that charge an annual fee to investors with as little as $5,000, according to Jim Weddle, the firm’s top executive. D.A. Davidson & Co. of Great Falls, Mont., is in the process of developing a similar product, according to an executive."
    • Ladenburg Thalmann, one of the country's largest independent broker-dealers, is rolling out $ymbil, its new digital advice platform. The self-service portfolio account will be made available to its advisor network and will require a minimum  of only $500 investment to open an account.
    • Margarida Corral of Financial Planning magazine reported on March 31, 2016: "CUSO Financial Services and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings." 
    • Further evidence of the adjustments already taking place at broker-dealer firms can be discerned from a May 15, 2016 article from GlobeNewswire, where it was noted: "FolioDynamix offers a solution that can help firms transition their commission-based business into advisory accounts. There are even options for smaller-balance accounts that might not normally meet managed account thresholds. Key firms have already begun taking advantage of this solution ...."
    • Industry consultant Cerulli Associates "anticipates large broker/dealers (B/Ds) will use developing technology to serve smaller accounts on a flat-fee basis, and insurance companies will be forced to lower variable annuity expenses and commissions to be in line with other financial products."
      • "CUSO Financial Services  and Infinex Financial Group are planning to not only lower minimums and adjust pricing on advisory accounts but are making arrangements to partner with digital advice providers – all in an effort to serve the widest range of customers in the new regulatory environment, including small investors with modest savings.
      • With the expected shift to fee-based advisory business, firms want to make sure that their advisory offerings are competitive in terms of both their account fees and minimums.
      • Infinex, for instance, is in the process of lowering its minimum balance requirements on all of its advisory products so that it "can offer advisory products to a wider audience," says Stephen Amarante, president and CEO of the broker-dealer.  He noted that Infinex is rolling out more tiered pricing to appeal to a broader range of clients, despite the fact that the firm's pricing is already extremely competitive, especially on the lower end.
      • CUSO Financial is also looking into changes to its advisory offering with a view to helping smaller clients who don't have assets to meet program minimums. "We have been looking at tweaking programs and developing new programs that will have lower minimums and lower fees to work best with this segment of our clients," says Peter Vonk, CUSO's chief compliance officer and executive vice president of business services. 
      • For the smallest customers, both CUSO and Infinex are planning to use robo technology platforms.  An investor who is adding just $50 a month to his 401(k), for example, might be better served under a digital platform, Amarante notes. While these smaller accounts would be served using automated technology, they would still be managed by an advisor, he says.
      • CUSO is in discussions with several digital advice providers and anticipates having a platform implemented long before the final rule becomes effective. "We expect to have solutions to continue to meet everyone from the ultrahigh-net-worth to the folks who are just starting out on their investment journey," Vonk says."
    • Large Wall Street Firms Have Already Transitioned Much of Their Business to Fee-Based Accounts! The Wall Street Journal's columnist, Jason Zweig, wrote on April 4, 2016: "Giants like Morgan Stanley and Bank of America Corp.’s Merrill Lynch are already moving away from commissions, because fee-based revenue is more stable and less tied to market swings. Morgan Stanley’s wealth-management division, for example, already has 40% of client assets in accounts that charge an annual fee. That helped it generate $8.5 billion in fee-based revenue last year, or 70% of its total. In January, Morgan Stanley projected a 5% to 13% increase in pretax profitability at its wealth unit in 2017, partly as a result of its continuing shift to fee-based accounts."
  • ANOTHER MISLEADING STATEMENT: "CHOICE IS ELIMINATED." Only bad choices will be limited. At its core, the fiduciary standard operates as a restraint on greed, as I've explained here. Even Adam Smith recognized the need for standards of conduct! And, the fact of the matter is that new, lower-cost products will emerge for investors - as has already occurred both before and after the announcement of the DOL Final Rule!
  • A MISLEADING STATEMENT. IN FACT, IF "COMPLEXITY" IS A PROBLEM, IT'S ONE OF WALL STREET'S OWN MAKING! - "THE RULE IS TOO COMPLEX." At its core, the application of the fiduciary standard to retirement accounts (qualified plans and IRAs) is done through a principles-based standard grounded in centuries of legal precedent. The core rule is simple, straightforward, and elegant.
    • The "Best Interests Contract Exemption" (BICE) - which Wall Street and the insurance companies complain about as being "too complex" - only exists because of the DOL's effort to accommodate Wall Street's business practices. Even then, the core of BICE - found in its Impartial Conduct Standards - remains a straightforward, elegant elicitation of the core fiduciary standards of conduct. Wall Street decries BICE, however, for its "complexity" and the requirement of "more disclosures." Yet, if Wall Street does not desire to operate under BICE, all they need to do is operate under ERISA's principles-based standard, with no additional exemption required - as thousands and thousands of investment advisers already do, every single day!
  • AN UTTERLY FALSE STATEMENT: "THE RULE DETERS CAPITAL FORMATION." Wall Street argues that capital formation will be deterred. But, the opposite occurs, as more wealth is accumulated as excessive rent-taking is reigned in, thereby accelerating the retention and growth of capital. This in turn provides the fuel for future U.S. economic growth, as I've explained here). An added bonus is that the capital markets become more efficient in allocating capital, as greater due diligence is undertaken among various investments by expert advisers.
Wall Street's hypocrisy gets even worse. Let's examine conflicting statements from ICI.

Insights can be gleaned from the Investment Company Institute (ICI) in its Nov. 15, 2013 letter in opposition to the California Secure Choice Retirement Savings Program. ICI represents large asset managers, many of whom will see their revenues fall as a result of the rule and the shift to lower-cost investment products. While ICI now opposes the DOL's fiduciary rule, and its application of ERISA's fiduciary standards to 401(k), certain other qualified retirement accounts, and IRAs, just look at what ICI stated in 2013 regarding the benefits of ERISA:
  • "ERISA's purpose is to protect the benefits of private sector workers and we see no justifiable reason to deny these fiduciary protections to workers ....";
  • "Many financial services providers .... offer low-cost 401(k), 403(b) and IRA-based plans to employers large and small";
  • "We question whether denying Program participants the fiduciary protections or ERISA would benefit private-sector workers"; and
  • "In our view, to essentially give workers participating in the Program no recourse to hold any party responsible for the decisions made and actions taken with respect to their retirement savings would be unfathomable" [yet, this is what occurs, de facto, under the current extremely low "suitability" standard of conduct, which lowers the standard of care of brokers and permits them to sell often-high-cost and inappropriate products to consumers, as I explained here].
Many Others are Pointing out Wall Street's Misleading Statements and False Assertions.
  • fi360 and ThinkAdvisor have for several years conducted a survey of financial advisors. The survey summarizes its findings: "The fiduciary model works for advice and money management – registered investment advisers have been profitably providing advice that’s in the best interest of their clients since 1940. However opponents of the fiduciary standard say some brokers would leave the industry, or charge investors more for advice, or wouldn’t work with small investors if regulators extended the fiduciary standard. Findings of the fi360 Fiduciary Standard Survey do not substantiate those fears."
  • Senator Warren and Representative Cummings blasted the insurance companies in theIr Feb. 11, 2016 letter to the DOL and OMB. Pointing out the insurance companies' contradictory statements,  Sen. Warren and Rep. Cummings stated: "In contrast to their public doomsday predictions, industry leaders have told their own investors that they 'don't see this as a significant hurdle,' 'will once again respond to marketplace or regulatory changes effectively,' and that they are well-positioned to 'adapt to any regulatory framework that emerges.'"
  • "Senator Warren Calls for SEC Investigation Into Financial Services Providers Over Contradictory Statements on the DOL Conflict of Interest Rule": Senator Warren, in a March 31, 2016 letter to the SEC, questioned whether insurance companies (who also act as broker-dealer firms, through a subsidiary) were violating federal securities laws by making misleading statements to shareholders. Senator Warren pointed out that, in one instance, a firm "saying almost simultaneously [to the DOL] that the rule would be 'unworkable' and [to its shareholders] that the rule would not be "a significant hurdle." Senator Warren's letter further set forth these examples:
    • In July 2015, Dennis Glass, the president and CEO of Lincoln National said in his comment letter that the proposed rule was "immensely burdensome" and "extremely intrusive," and would be "so burdensome and unworkable that financial advisors and firms will not be able to use it."; while two months earlier, Mr. Glass told investors that he didn't "see [the proposed rule] as a significant hurdle for continuing to grow that business."
    • In July 2015, the president of Jackson National Life Insurance Company said in his DOL comment letter that the proposed rule would "be very difficult, if not impossible for financial professional and firms to comply" with; then, in August 2015, the president of Jackson's parent company told investors that a similar rule in the United Kingdom actually led to an increase in retail sales and that the company was positioned to "build whatever product is appropriate under that set and adapt faster and more effectively than competitors."
    • In July 2015, the president and CEO of Transamerica' s Investment and Retirement Division said in a comment letter that the proposed rule was "unworkable"; then, a month later, the president of Transamerica's parent company told investors that the company had "shown ... flexibility and ... expect[ed], with that flexibility, [to] remain very strongly positioned in a market that is providing products that millions of customers in the U.S. continue to need."
    • In July 2015, Prudential Financial's Executive Vice President and General Counsel wrote in a comment letter that some of the proposed rule's provisions posed a "significant challenge" that "will significantly increase" the firm's servicing expenses; that same month, another Prudential Financial official told investors that the proposed rule would not stop the company from "mak[ing] these offerings available on terms that work for everybody." 
  • Industry commentator Bob Clark recently unveiled how Wall Street speaks double-talk about commissions resulting in lower fees to investors, when in reality commissions (and other revenue-sharing arrangements, in addition to commissions) result in far greater compensation to brokers (and, as a result, less returns to investors).
  • Josh Brown, a former broker - now a fiduciary - unveils "The Most Horrendous Lie on Wall Street"- stating in part: "The incentives paid by fund companies to brokerage firm sales forces across the country are a cancer that must be rooted out."

The fact of the matter, the rule is good for individual consumers, and good for the future economic growth of America, and the prosperity of all Americans.

This is an example of prudent regulation that possesses huge benefits for Americans and America, far in excess of the one-time costs associated with its implementation.

The DOL's rule may possess an impact on some broker-dealer firms, some insurance companies, and some asset managers - but only if they don't change their conflict-ridden business models. Those firms that embrace change and react proactively to the rule will likely gain market share, attain a more stable stream of revenue, and thereby increase the value of their business entities.
  • [By way of explanation, brokerage firms charging commissions, predominately, are typically valued at 1x gross revenue. But firms charging primarily fees, such as annual asset-under-management fees, because of the stability of the income stream and the greater depth of relationships with their clients, typically are valued at 2x-5x gross revenues. Brokerage firms can actually increase the price of their shares, and benefit their shareholders, by moving to fee-based accounts.]
As discussed above, the fact of the matter is that many broker-dealer firms and insurance companies are already adjusting to the new rules. Some are even lowering minimums for new clients - as well as lowering fees!

In summary, the DOL's Conflict of Interest Rule will:
  • restore the trust of Americans in their financial and investment adviser;
  • reduce the excessive rent-taking by Wall Street from individual investors;
  • benefit business owners, both large and small, by reducing the risks they face in connection with qualified retirement plan accounts;
  • lead to substantially better retirement outcomes for our many friends and neighbors as the reduced fees and costs result in higher returns for individual investors; and
  • result in greater capital accumulation, fueling an explosion of economic growth in the United States over the long term.
Members of the U.S. Congress - Do The Right Thing! ... Support the DOL's Conflict of Interest Rule.
Support a government action that is long overdue, and that fosters a hugely positive and beneficial result for your fellow Americans.

Support an elegant rule that will promote America's future economic growth. 

Ron's past speaking engagements, webinars and articles/posts since the DOL Final Rule was announced:
  • Financial Planning magazine, webinar with other participants
  • Garrett Planning Network, webinar (April 2016) (membership in GPN required)
  • AICPA - podcasts and white paper (April 2016) (registration required)
  • The Wall Street Journal - Ron answers questions with other experts about the DOL's Final Rule in this series of articles:
Please note the upcoming speaking engagements by Professor Ron A. Rhoades. Attend these presentations to learn more about the DOL Conflicts of Interest (Fiduciary) Rule and its impact on financial services and business practices:
  • FPA Kentuckiana, Louisville, KY - Sept. 2016 (date tentative)
  • FPA of Portland and SW Washington - Sept. 2016 (date tentative)
  • FPA of Southwest Florida - Estero Country Club - Oct. 20, 2016 presentation
[If your organization is interested in having Professor Rhoades speak about the rule, please contact Ron at: Thank you.]

Dr. Ron A. Rhoades is an Assistant Professor of Finance and Director of the Financial Planning Program, Gordon Ford College of Business, Western Kentucky University, in Bowling Green, Kentucky. Over the past decade he has undertaken substantial legal research and writing regarding the fiduciary standard of conduct, as applied to investment and financial advisors. Dr. Rhoades is a frequent speaker on the fiduciary standard at financial planning and investment industry conferences.

(This blog represents the personal views of the author, and not necessarily the views of any institution, organization or firm with whom the author may be associated.)

Tuesday, March 1, 2016

How to Choose a Financial/Investment Advisor: A Checklist for Consumers

The following is one of my most popular blog posts, updated to emphasize the necessity for thorough diligence in one's search for an advisor.

There are many, many advisers who profess to offer "objective" or "trusted" advice, but who don't operate as fiduciaries. And - due in large part to a weak U.S. Securities and Exchange Commission - even those who are required to be "fiduciaries" by law often "disclaim away" their fiduciary obligations.
This article, and checklist, can be utilized by consumers to TEST their current financial or investment adviser, or used as they shop for an adviser. Good luck with your search?


Several readers have asked me for a list of questions which consumers can ask, when interviewing a financial or investment adviser. In forming this checklist, I emphasize that the chosen adviser should, at all times:

  • function in a fiduciary capacity, AND
  • without any waiver or disclaimer of their fiduciary obligations.
Consumers should realize that some who call themselves “fiduciaries” don’t actually practice in such manner. For example, they may take additional compensation from third-parties, in situations where client harm results – an indefensible practice in my view. Others "disclaim" away their core fiduciary duties. Fore example, many "fiduciary" advisors state that they don't provide tax advice in any form - even though a tax-efficient investment portfolio is often key to long-term success for their clients.

Hence, I suggest additional questions consumers can, and should, ask of their current or prospective financial and/or investment adviser.

[Preliminary note: The term “adviser” and “advisor” are used interchangeably. Technically a “registered investment adviser” is spelled that way, while in current United States English the spelling “advisor” is more often seen. Over the last decade the American usage is migrating to "adviser."]


With the increased availability of bona fide fiduciary investment advisers and financial planners available today, I urge consumers to choose only those “financial advisors” (also called “financial consultants” or “financial planners” or “investment advisers” or “wealth managers” – and similar terms) who can answer ALL of the following questions correctly.

Moreover, consumers should ask their current adviser these questions. Many, many consumers falsely believe that their current advisor is acting in their best interests, and as a fiduciary, when such is not the case. In fact, nearly a third of consumers in the SEC’s Rand Study thought that their advisor received no compensation at all – when in fact the advisor was receiving generous compensation from third parties, undisclosed to the client.


I emphasize attention to fees in this checklist. Why? First, because fees and costs are, to a large degree, controllable. Second, a tremendous body of academic research compels the conclusion that the higher the fees and costs, the lower the returns for the investor. Moreover, over a long period of time even paying 1% a year more than necessary can result in an accumulation of wealth far below that of other investors not burdened by such an incremental fee.

This does not mean, however, that knowledgeable, expert financial and investment advisers shouldn't be well-paid. It takes years and a great deal of study to acquire the knowledge and skill possessed to assist clients to identify, prioritize, and achieve their financial goals. Navigating the intricacies of the capital markets is difficult and requires substantial expertise. Expert fiduciary advisers should be rewarded with professional-level compensation. And truly expert fiduciary advisers can add value.


It is important for each investor to be completely comfortable with the investment strategy recommended by the adviser.

I believe most individual (and institutional) clients possess a reasonable expectation that the investment strategy which is recommended satisfies the due diligence requirements under the “prudent investor rule.” In this regard, the adviser should submit to the client, upon request, the evidence (either academic research, summarized, or back-testing in an objective manner) which supports the proof that the requirements of the prudent investor rule are met.

This does not mean, however, that all investment strategies must meet the prudent investor rule. In fact, only a few specific investment strategies for an overall portfolio (or for the equity or fixed income or other parts of a portfolio) likely currently meet the prudent investor rule – at least to level of the Daubert standard under which an expert witness would be able to testify to that effect in court. Hence, when a strategy is utilized which does not meet the dictates of the prudent investor rule, the additional risks inherent in such strategy should be disclosed to the client, and the potential rewards also explained. Such an explanation should be thorough, in my view, given the importance of this issue.


Don’t take any excuses here. As a consumer, it is very difficult to later prove what is not in writing. Require your (prospective or current) financial adviser to place his or her answers to these questions in writing. If they don’t or won’t, chances are they have something to hide, and don't want to reveal the truth about their practices.

If you cannot obtain the answers to these questions in writing, then just walk away!

  1.  Are you a fiduciary under the law, and will you continue to be my fiduciary at all times during the adviser-client relationship we will enter into, and with respect to all of my accounts with you and all of the advice you provide to me?
Mandatory response – “Yes.”  

If the adviser is unwilling to act as a fiduciary to you – i.e., meeting the standard of due care as an expert adviser, acting with the highest degree of loyalty to you and in your best interests at all time, and with complete candor and truthfulness – this adviser does not deserve your consideration. Period. End of story.

Explanation.  There are two types of relationships under the law:
  • fiduciary relationship, in which the adviser acts on your behalf, “stepping into your shoes” and always acting in your best interests; or
  • salesperson/customer relationship - the person before you  seeks to use planning, education or advice as a means of selling products to you. In this instance the person is not a fiduciary. While “suitability” applies (“everything recommended to you will be ‘suitable’ for you”), this is a very low standard that does not require that the best investment products are recommended for you (in fact, many very expensive, poor products are recommended under the suitability standard).
There are many in the legal community who believe that “financial advisors” should not seek to act as both a “fiduciary” in some aspects of the relationship with the client, while not in other aspects of the relationship. This is called the “wearing of two hats.” Indeed, many a jurist has opined that a true fiduciary cannot wear two hats. The roles of "seller" and "purchaser's representative" are simply diametrically opposed.

Nor should a fiduciary try to remove the “fiduciary hat” once it is placed on. Can you just imagine this conversation: “I am now a fiduciary, required to act in your best interests. I want your permission to not be a fiduciary anymore, so I am no longer required to act in your best interests.” WHY WOULD ANY CONSUMER (who is informed about the necessity of fiduciary status) EVER PERMIT THEIR ADVISER TO TAKE OFF THEIR FIDUCIARY HAT - AND NO LONGER OPERATE IN THE CONSUMER'S BEST INTERESTS?

Please note that many a salesperson will try to convince you – the consumer – that “requiring me as your adviser to act as a fiduciary will be more expensive for you.” Don’t buy this false argument. In fact, only fiduciaries have the requirement to ensure that all of the fees and costs you pay are reasonable. In my experience, nearly always (99% of the time) the total fees and costs paid by clients relating to their investments and the advice they receive are substantially lower when a fiduciary adviser is utilized. In contrast, the fees and costs present when a non-fiduciary adviser is utilized are often hidden and often clearly excessive.

Another argument sometimes made by non-fiduciary "advisers" is: “The only way this product can be obtained is through a sales process, not as a fiduciary.” This excuse is often asserted when life insurance, long-term care insurance, or other forms of insurance are sold. Yet, while many insurance products are sold only through a sales channel and on a commission basis, there are many “low-load” and “no-load” insurance products out there. And, more importantly, there are now an increasing number of “insurance consultants” willing to act on a fiduciary basis to assist you to select the right form or type of insurance and to structure any insurance premiums in a manner that can save you a bunch of money in premiums.

A lot of other excuses will often be provided, which don’t hold water. Such as, “I am a bound to represent the interests of my firm, to whom I possess a fiduciary duty. That may be true, but it is possible to order fiduciary relationships. In other words, there is NO REASON both the firm and the individual adviser cannot possess a fiduciary duty to act in your best interests, and any duty owed by the individual adviser to the firm can be subservient. Many, many advisers already operate this way!

If your adviser asserts any other “reasons” for why he or she cannot act at all times as a fiduciary to you and bound to act in your best interests, you as a consumer should realize this … there are many, many other investment and financial advisers out there who will promise to be a fiduciary to you at all times. In essence, don’t fall for any rationale a non-fiduciary adviser gives for not adhering to the fiduciary standard – there simply is no good reason for an adviser to not act in a fiduciary capacity to you at all times. Any “explanation” for why he or she cannot – while it may sound plausible to you – will not hold up under expert scrutiny.

2. What services will you provide?  Can “financial planning” advice be separated out from your “investment advisory” services?

Mandatory Answer:  Get the list of services provided in writing. These are usually set forth in the written advisory contract you are required to sign.

Review that contract carefully – and make certain you understand all of the services you are receiving (or not receiving). Discuss each service with your advisor. Have your advisor revise the written agreement to reflect any detail, as to services provided, which might not yet be in the document.

If you are receiving advice relating to financial planning issues (i.e., tax planning, how much to contribute to various types of accounts, how much to withdraw from various accounts, retirement planning, estate planning, insurance planning, etc.), ask if you can pay for such services separately – through a negotiated flat project fee, or an annual retainer, or for hourly fees. Compare the fees for the financial planning services you require to those of other firms.

For investment advisory fees – where an advisor undertakes an “asset allocation” for you, chooses asset classes to invest in, recommends specific securities or investment products to you, and/or monitors your investments and undertakes periodic or targeted rebalancing and/or tax loss harvesting – fees can vary tremendously. Find out how much the investment advisory fees are, and compare fees for similar services offered by other firms.

While many firms choose to “bundle” their fees for financial planning and investment advice, in the view of some industry observers a better approach is to charge for these two types of services separately. Although financial planning and investment advice are inherently related, they can also be “unbundled” – at least to a large degree.

Often a financial plan is a prerequisite to the design and management of an investment portfolio. The adviser cannot really know how to design an investment portfolio for you until after other issues have been addressed, such as: “Should you pay down debt instead of investing?” or “Do you have an adequate cash reserve?” Hence, at least some financial planning is, in my view, required prior to designing an investment portfolio.

Yet, more comprehensive financial planning services can usually be "unbundled" or separated from investment advisory services.

More comprehensive financial planning can also be undertaken in a variety of different ways:

  • For clients with greater planning needs, realize that the financial planning process, for a new client, can take time. It may be a “comprehensive financial plan” presented all at once, or the financial planning recommendations may be presented and reviewed in a series of meetings in which certain specific issues are addressed at each meeting.

  • After an initial financial planning is undertaken, for some clients revisions to that plan may not be required for several years (absent some change in your circumstances). In such a circumstance, expect to pay more for financial planning in the first year, and less in subsequent years.

  • For other clients, however, financial planning needs are ongoing. In this sense, financial planning is not an "event" or a "plan" - but rather a "process." Financial life coaching is often provided under these types of arrangements. Ongoing tax advice is also likely to be provided.
In contrast to financial planning, investment advice is easier to compare. In essence, investment advisory fees reflect the same approximate level of service each year to most clients. Some advisers believe that every client, large and small in terms of size of the client's portfolio, should be charged the same amount, as the time spent on investment advice does not vary tremendously from one client to another. I would argue that, since an investment adviser bears more responsibility for larger accounts, some increase in fees is merited as the account size grows larger.

3. What conflicts of interest do you, your firms, or any affiliated firms possess with respect to the advice you may provide to me? Do you or your firm receive any material third-party compensation when I choose your investment advisory services or invest in investment or insurance products recommended by you?

Mandatory Answer – “Neither our firm, nor any affiliates of our firm, nor any of our individual advisers, receive any material compensation from third parties. All advisers may possess a conflict of interest that arises from time to time, but we seek to keep our conflicts of interest to a minimum.”

Explanation: If your adviser receives payments from a mutual fund, brokerage firm, or other source, whether called a 12b-1 fee, "revenue-sharing payment," or otherwise, when recommending an investment to you, this represents an insidious conflict of interest.

True fiduciary advisers know that the mere receipt of material compensation from anyone else, other than the client, could influence them (consciously or unconsciously) when they make a recommendation to you. This means that the adviser may not be acting in your best interests, but rather in the adviser’s interests. And, as explained below, fees and costs matter.

Your investment adviser’s Form ADV, Part 2A sets forth any conflicts of interest your adviser may possess. Nearly all financial and investment advisers possess some conflicts of interest. For example:

  • Should you invest funds you possess, or pay down debt instead?
  • Should you make lifetime gifts to others, and if so how much?
  • Should you purchase a lifetime immediate annuity?
Decisions resulting from these and other questions might affect the level of investment assets managed by your adviser, and hence the compensation your adviser receives. The proper way for an adviser to manage such unavoidable conflicts of interest is to ask himself or herself: "What advice would I give to my mother, father, brother, sister, children, nieces or nephews, if one of them were the client in this instance?" Additionally, advisers can check with other advisers, when a conflict of interest occurs, to seek confirmation that the advice they are providing is not skewed by any unavoided conflict of interest.

Note that educational and other services or software are often provided to advisers by custodians (brokerage firms your adviser may work for, or with) or mutual fund or other companies. Your adviser should fully disclose these conflicts, in writing, as well as whether in the adviser’s view the amount of benefits received by the adviser might skew the advice provided to the client. Typically the amount of non-monetary benefits received is very minor, compared to the revenue of the adviser or his or her firm.

There are some forms of third-party compensation which, in my view, should be avoided at all costs by fiduciary advisers (and their firms, and any affiliated firms).  These include:
·         12b-1 fees;
·         Payment for shelf space;
·         Soft-dollar compensation;
·         Sponsored trips to educational or other conferences;
·         Payment toward the costs of client marketing seminars; and
·         Any prizes or awards provided by custodians (typically, brokerage firms at which client assets are held) or product manufacturers.

4. Will you be recommending any “proprietary products” to me?  Will you be engaging in any “principal trade” with me?

Mandatory answer – “No.”

Explanation. A proprietary investment or insurance product is one that is manufactured by the firm you are dealing with, or affiliated firms. While all of these products are not necessarily “bad,” in my estimation at least 95% of proprietary products are not the best products available in the marketplace today.

Moreover, the simple truth is that proprietary products result in additional compensation to the adviser or his/her firm. While some fiduciary advisers credit all or part of the management fees of proprietary mutual funds to the client’s account, often the administrative fees (which are not credited to the client’s account) paid to other affiliates of the fund complex are excessively high.

The truth of the matter is that fiduciary regulation in the United States has not yet evolved sufficiently to place strict and proper limits on the utilization of proprietary investment products by fiduciary advisers. There is no requirement, for example, that a fiduciary adviser demonstrate that there is no other product better or as good as the firm’s proprietary product prior to recommending same.

Hence, at the current time the recommendation of proprietary products is another insidious conflict of interest which can, and should be, avoided. With thousands and thousands of mutual funds, ETFs, and other investment products available today, it is likewise hard to imagine that any one firm’s products are all “best-in-class” investments – or for that matter than even one such product is likely to be the “best-in-class” investment.

Likewise, it is difficult to imagine, when thousands of dealers in securities exist, and with such a broad selection of products to choose from, that any firm needs to sell you investment products out of their own “inventory.” Even in the fairly illiquid municipal bond market there are normally many, many sources of bond inventory. The fact is that broker-dealer firms make a lot of money from “principal trades” – much more so than acting as your agent to secure the best possible price for you. And “dumping” of unwanted securities by a firm is, unfortunately, far too common an occurrence. Again, this is an area where enforcement of securities laws has been far too lax when the advisor acts in a fiduciary capacity. The U.S. Securities and Exchange Commission and state securities regulators permit far too much abuse to occur – to the harm of tens (if not hundreds) of thousands of individual investors.

There is only very rarely (less than 1%, if that) any valid reason for a fiduciary adviser to engage in the sale of proprietary products or recommend a trade between you and her or his firm. “Just say no” to proprietary products and principal trading.

5. What are the “total fees and costs” I will pay with regard to my investment portfolio – including the fees and costs charged by the products you recommend, as well as your own advisory fees – on an annual basis?

Answer:  A very thoughtful, well-researched presentation of the “total fees and costs” of the advisory services, and of the products recommended to you, should be presented to you, in writing. You should be able utilize this "total fees and costs" analysis as a comparison tool to other service providers.

Here’s a suggested maximum amount of the total fees and costs for investment advisory services for different sizes of an investment portfolio. There are many investment advisers who provides investment supervisory services for less than the TOTAL FEES AND COSTS shown below:

Size of the Portfolio
Maximum Total Fees and Costs
Under $75,000
2.00% or less
$75,000 to $200,000
1.75% or less
$200,000 to $500,000
1.25% or less
$500,000 to $1,000,000
1.20% or less
$1,000,000 to $2,000,000
1.10% or less
$2,000,000 to $3,000,000
0.95% or less
$3,000,000 to $5,000,000
0.80% or less
Over $5,000,000
0.75% or less

NOTE: The following should be included in any "total fees and costs" analysis provided to you:

  • The effect of sales loads (commissions) for the holding period of the investment product (or, for a maximum of 10 years);
  • The annual expenses, as shown in any disclosure of "annual expense ratio" or similar. For a mutual fund, these might include:
    • fund management fees;
    • fund administration costs;
    • 12b-1 fees;
  • The "implementation shortfall" costs of management of any pooled investment fund, which can be estimated by a firm or adviser for each fund the firm/adviser recommends. These might include:
    • Market impact costs;
    • Bid-ask spreads and/or principal markups/markdowns;
    • Opportunity costs due to delayed or canceled trades;
    • Brokerage commissions paid for effecting securities transactions within the pooled investment fund;
  • Opportunity costs due to maintenance of cash holdings within a fund;
  • Offsets to fees occurring due to securities lending ratios;
  • Costs of hedging the portfolio, if hedges are utilized; and
  • Costs likely to be incurred if redemption fees apply.

NOTE: The above fee table does not include fees for extensive financial planning services, which services - if provided - might be "unbundled" and charged separately.

Explanation. Fees and costs matter. As the founder of Vanguard Funds and consumer advocate John Bogle recently stated, “the magic of compound returns is overwhelmed by the tyranny of compounding cost. It’s a mathematical fact.” In his article, "The Tyranny of Compounding Costs," John Bogle used the following illustration. If an individual made a $1,000 investment at age 20 and received 8% annualized returns, the account balance would grow to $109,358 by age 80. If a 2.5% annual management fee was added into the equation, the ending account balance would only be $26,206. Over the 60 years, these annual management fees eat up a staggering 76 percent of what the investor would have earned with no management costs.

Many investment advisers would argue that the “total fees and costs” I propose in the table above are far too low. Yet, there are many investment advisers out there who offer good investment advice and who utilize low-cost products for “total fees and costs” within the levels set forth above, and often for far less.

What is included in the “total fees and costs”? Every fee or cost present, whether "disclosed" or "hidden," and whether quantifiable or which is subject to estimation. For example, with respect to stock mutual funds and stock exchange-traded funds these fees and costs include:
  • The advisor’s separate advisory fee (whether paid as a percentage-of-assets managed fee, as a flat annual retainer, as a project fee, or on an hourly basis);
  • The mutual fund’s annual expense ratio – which is the sum of the fund’s management (investment advisory) fee, administrative fees, and 12b-1 fees (which, as I’ve noted above, should be avoided);
  •  The mutual fund’s brokerage commissions resulting from trading within the fund (these can be discerned and quantified by an expert advisor) - an up-front commission might be divided by 10 to determine the long-term impact of the commission (i.e., in determining the annual impact of the commission); a higher denominator might be utilized if the mutual funds sold are not typically held for 12 years or longer).
  • The mutual funds’ transaction and opportunity costs, relating to trading within the fund. Market impact and transaction costs can be estimated by an expert advisor, based upon the level of trading volume actually occurring within the fund and based upon the asset class in which those stocks are located. Opportunity costs due to cash holdings within the fund can likewise be estimated.
Consumers should request that their advisor provide to them, for each investment product recommended, a break-down of all of the estimated fees and costs. This “point-of-recommendation” document should not just be the prospectus, but rather a one-page summary detailing not only the disclosed fees and costs associated with the advisor and the investment product, but also an estimate of any hidden fees and costs.

Note that all consumers should avoid any investment in a product in which fees are presented as either a “commission,” “sales load,” “contingent deferred sales charge,” “surrender fee,” “12b-1 fee,” or “marketing fee.” Fiduciary advisers simply avoid products that incur such forms of fees, as they create otherwise avoidable conflicts of interest and/or result in unnecessary fees or costs incurred by the investor and/or restrictions on liquidity.

Many consumers assume that higher-cost products mean higher returns. THIS IS A FALSE ASSUMPTION. Substantial economic research reveals that the higher the fees and costs the lower the returns to the investors. When an adviser says, “Yes, it’s expensive, but it’s good,” or if the adviser says, "Overlook the (high) fees and costs, and consider the benefits," don’t believe it. Every investment adviser worth her or his salt knows of the overwhelming academic evidence demonstrating that higher fees and costs generally result in lower returns for the investor.

By way of further explanation, suppose your horse (investment product, with any adviser fees attached) is running in the Kentucky Derby. Shortly before the race begins, your jockey is required to wear a vest containing lead weights, so that the weight of your jockey (and clothing) now exceeds the weight of the other jockeys (and their clothing) by fifty pounds. Does this mean that your horse cannot win the race? No. Perhaps, occasionally, an exceptional horse so saddled with the extra weight will rise to the occasion and win. But, nearly always, this makes the horse with the heavier burden extremely likely to run in the back of the pack, especially as the horse race get longer. Don’t hire heavy jockeys, or saddle them with extra weight!

In summary, don’t let Wall Street siphon off a huge portion of your returns. Keep your total fees and costs reasonable, and reap the substantial rewards of a low-cost, prudent investment strategy over time. Require your advisor’s fees for investment advice to be reasonable, and further require your investment adviser to choose only those investment products which possess low total fees and costs.

6. What are your qualifications?

Answer: A list of the adviser's qualifications.

I recommend that consumers receive advice from only expert financial advisors and/or investment advisers. How can a consumer judge this? It’s difficult.

One way to assure at least a baseline level of competency is to seek out certain certifications or designations. There are hundreds of financial services designations out there, but in my view at the present time there are only three a consumer should seriously consider:
                Certified Financial Planner™ (CFP)
                Certified Public Accountant / Personal Financial Specialist (CPA/PFS)
                Chartered Financial Analyst (CFA)

Each of these programs requires a rigorous course of study, usually involving thousands of hours of work for an advisor who completes the program.

However, please note - rely upon these designations ONLY for their indication of competency. Not all holders of these designations practice as "bona fide fiduciaries" in my view.

This is not to say that there are not some fine – and exceptional – financial planners and investment advisers out there who don’t possess any of the foregoing marks. For example, there are some older advisors who began practice while these designations were of much less import than they are today.

Nor do I say that other designations and certifications are unimportant. Yet, far too often designations can be obtained after passing a course of study in which the time commitment is measured in terms of “two days” or “fifty hours of study” or just a few hundred hours of study. If an advisor touts a designation not on the list above, as a “comprehensive” knowledge base, research the designation and see if it requires thousands of hours for completion of the required course of study, as the foregoing designations likely require of most applicants.

7.  Have you ever been cited by a professional or regulatory governing body for disciplinary reasons?

Mandatory answer: Here is my record, which includes any disciplinary history by any professional oversight regulator or organization.

Disclosures of disciplinary history can be found in Form ADV, Part 2B (the “Biography” disclosure document of an investment adviser), and on the advisor’s Form U-4. Ask for and review both of these documents.

A consumer can conduct an online check of an advisor’s disciplinary history through the FINRA BrokerCheck® at This provides the information found on an individual adviser's U-4. (Note: those individuals licensed solely as insurance agents do not appear in this database.)

There has existed ongoing controversy over the number of "expungements" of complaint history which are permitted by the broker-dealer self-regulatory organization, FINRA. Hence, the absence of the indication of a complaint in the database does not ensure that no complaint was ever filed against the person. Perhaps one way to counter excessive expungements is to do a Google search of the adviser's name (perhaps with the name of her or his firm, and/or her or his location - such as town or city - of her or his office). However, since many firms have mandatory arbitration agreements, and seek to keep arbitration awards "secret" (i.e., non-disclosed to the public), a Google search is not a guarantee, either.

8. Will you sign this fiduciary oath?

I believe in placing your best interests first. Therefore, I am proud to commit to the following five fiduciary principles:

      (1)  I will always put your best interests first.

(2)  I will act with prudence; that is, with the skill, care, diligence, and good judgment of a professional.

(3)  I will not mislead you, and I will provide conspicuous, full and fair disclosure of all important facts.

(4)  I will avoid conflicts of interest.

(5)  I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.

                Advisor:                            ____________________________
                Firm Affiliation:              ____________________________
                Date:                                 ____________________________

Mandatory answer: “Yes.”  If not – walk away.

Explanation: This Fiduciary Oath is from The Committee for the Fiduciary Standard, a volunteer group of individuals who advocate for the fiduciary standard of conduct before Congress, the U.S. Securities and Exchange Commission, U.S. Department of Labor, and other agencies. There is not a single word in this document which any fiduciary advisor should find objectionable.

(By way of disclosure, I currently serve on the Steering Group for The Committee for the Fiduciary Standard. I receive no compensation for performing this role, nor any ownership interest in the organization, which is composed solely of volunteer members.)


There are other obvious questions any consumer would want the answer to.  These include:
  • How long have you been in business?
  • How many clients do you possess?
  • Do you engage in any other business activities?
  • In what accounts (i.e., with what custodian) will my investments be held? What safeguards exist to ensure my funds are not stolen?
  • Who in your firm will be working with me? You? A junior advisor? A team of advisors? Others?
Since each of these answers has no clear “yes” or “now” or other quantitative answer, the consumer should take any responses provided and compare them to answers other advisors provide.

Again, I stress that these answers should be obtained in writing from your financial/investment adviser and/or her or his firm. Far too often in arbitration proceedings verbal statements made by advisers, to their clients, are not admitted into evidence, as the contract (client services agreement) signed by the client contained a "merger" clause. More often than not, in arbitration proceedings verbal statements made by the advisor are also denied. Get it in writing!


There are three industry organizations which, in my view, have established and maintained high standards of competence and ethics for their members - i.e., their members are obligated to act as bona fide fiduciaries, and in practice the members of these group seek to avoid most major conflicts of interest. 

Consumers searching for an adviser are much more likely to find advisors who correctly answer all of the questions above by visiting these web sites:
National Association of Personal Financial Advisors ( – and specifically its “Find An Advisor” search function located at  (By way of disclosure, I am a NAPFA academic member, previously served on its National Board of Directors, and currently serve on its South Region Board of Directors. NAPFA has over 2,500 advisers around the U.S.))

Garrett Planning Network ( – and specifically its “Search For Advisors” search function located at (By way of disclosure, I serve as a consultant to, and as a member of, this organization, which has over 300 advisers around the U.S. as of March 2016.)

Garrett Investment Advisers ( - and its "Find An Advisor" search tool. (By way of disclosure, in March 2016 I transitioned by own practice into this firm, which has a few dozen advisers around the U.S. as of March 2016.)

XY Planning Network ( - and its "Find An Advisor" search tool. This organization has grown rapidly, and has over 200 firms as of March 2016.

Alliance of Comprehensive Planners -, and specifically to its "Find an Advisor" search function located at The Alliance has a few hundred advisers, I believe, as members as of March 2016.

What About the CFP Board and the Financial Planning Association? Be aware that being a certificant (with the Certified Financial Planning Board of Standards, Inc.) may guarantee a baseline level of competence, but does not ensure that the advisor follows a bona fide fiduciary standard at all times.

Nor does membership in the Financial Planning Association ensure that the advisor follows a bona fide fiduciary standard at all times.

While both of these organizations provide valuable benefits to their members, consumers should not rely upon the "find an advisor" tools of these organizations.

Likewise, several other organizations often tout the "fiduciary status" of their members, or state that their members are required to act "in the best interests" of the member's clients. As indicated earlier in this post, there has been a denigration of the fiduciary standard over time - some would say an evisceration. Hence, it is important to not assume that just because someone calls themself a "fiduciary" or states that they will "act in your best interests" does not necessarily mean that they adhere to the highest standards of prpfoessional conduct. Use the questions above to determine if the person is a true, bona fide fiduciary who avoids (rather than just discloses) conflicts of interest, and who is a true expert, and not a mere "pretender."


The most important financial decision an individual investor can undertake is in selecting the right financial and investment advisor.

I hope that the checklist above, and other information provided, can serve to guide consumers in the right direction - toward true fiduciary advisors who are both experts and keep their clients' best interests paramount at all times.

All consumers should interview several advisers before deciding. Fees and costs are a primary determinant, but not the only one. Expertise should be ascertained. And the adviser's investment philosophy should be aligned with your beliefs and comfort level.