Are Some Advisors Selectively Applying the Fiduciary Standard?

As seen in Advisors Perspectives

The heated nature of the rhetoric surrounding the fiduciary standard has reached a new high, focusing on whether investment advisors should offer certain investment products and how they should be compensated. We contend that firms must also consider whether their succession plans and service offerings meet the fiduciary standard.

The rhetoric has been fueled by the recent decision of the Department of Labor to apply this often misunderstood standard to professionals who are advising retirement plans and accounts. Increasingly, consumers of financial advice are realizing that receiving investment advice from an advisor subject to the fiduciary standard is substantially different from receiving advice from an advisor subject to the less rigorous suitability standard. The former must always place a client’s interests first; while the latter may recommend investments that are “suitable” for a client even if those investments are not in the client’s best interests.

The recent hype also is attributable to an increasing number of fiduciary advisors actively marketing and trying to educate clients and prospects about the difference in the two standards. In fact, some of these marketing efforts are taking the form of outright preaching about the superiority of the fiduciary standard and disdain for advisors who follow the suitability standard.

Yet, it is not clear that all advisors subject to the fiduciary standard – even those who actively crusade for it against the rival suitability standard – understand the full extent of their obligations as fiduciaries. Sure enough, they are likely to understand the fundamental concept, that they must put their clients’ interests first as they provide investment advice. But how far are they willing to take their understanding of the “best interests” concept?

Consider from the perspectives of succession and service the example of an advisory firm, “FiCo,” that legally is subject to the fiduciary standard. The firm offers basic investment advice to its clients and is operated by a handful of principals who, for the past 30 years and with the support of a few administrative employees, have been offering roughly the same scope and level of advice.

A fiduciary view of FiCo’s succession challenge

FiCo is doing satisfactory work for its clients, but suppose that its principals, despite now being in their sixties, have avoided any succession planning because they have been comfortable running their own firm and do not want to think about anyone else “taking over.” In their minds, by acknowledging that someone else could take over – even at some unknowable point in the future – they would consciously or subconsciously be losing some of the security that they feel about their own value.

Does FiCo have a succession plan? No. The principals are leaving their clients in danger because the principals have failed to place their clients’ interests ahead of their own and, in turn, have failed to create a succession plan for their benefit. While the principals may understand that they are subject to the fiduciary standard, they have underestimated the extent of its applicability by failing to discharge their obligation to provide for their clients’ long-term benefit – ahead of their own.

Let’s try a second variation of that theme. Suppose there is a second-generation advisor working at FiCo. This second-generation advisor is a good technician but lacks the experience and broad-based knowledge that FiCo’s clients have come to expect from the company’s principals. Nevertheless, the principals have satisfied themselves that this second-generation advisor can and will be at the center of their succession plan. They assure themselves that they have a succession plan and that they never will lose control – even if they have unspoken doubts about how effective their plan ultimately will be.

Does FiCo have a succession plan in place now? In form perhaps, but substantively the answer remains ”no.” The principals may believe they put a succession plan in place. However, they know, or should know, that their succession plan is not likely to be effective from their clients’ perspective. They chose it in an attempt to put something into place while prioritizing their emotional and other needs over those of their clients.

Interestingly, the SEC and state regulators are now busy educating advisors that their fiduciary duties do require that they have a viable succession plan in place. Thus, the principals would be under pressure to create a viable succession plan. Would those principals be in compliance with SEC guidance and the fiduciary standard generally even though their plan is not necessarily the best possible plan for their clients? In all likelihood, the answer would be “no” as, again, they have failed to place the interests of their clients before their own.

A fiduciary view of FiCo’s service challenge

Let’s look at the service offering. The FiCo principals continue to offer only basic investment advice because that is all that they are capable of offering. While the principals are highly qualified and experienced, they do not have the capacity for anything more given their limited resources. They know that their clients might benefit from a broader investment approach, including in-depth financial planning backed by state-of-the-art technology. They could try to add resources and build these capabilities themselves, but they are late in their careers and do not necessarily have sufficient profits to reinvest in their practice without dramatically reducing their own incomes. The FiCo principals have been approached multiple times by larger, more capable companies looking to join forces with them; but they do not want to lose control, and they are unwilling to entertain the possibility of no longer being indispensable to their clients and employees.

Does FiCo have an adequate service offering? This is where things get more complicated. The principals are providing adequate but sparse services to their clients, and they know that they could do better for their clients if they merged with or otherwise joined forces with another firm. On the face of it, proper application of the fiduciary standard would require them to opt for a merger or similar transaction in order to ensure that their clients are getting everything they need. Nevertheless, it is not that simple.

The principals of FiCo will state and think that they are fully discharging their duties as fiduciaries to their clients, but they probably are not. The fiduciary standard calls for the FiCo principals to consider the totality of the circumstances objectively while placing the interests of their clients first. The proper conclusion may be that they must merge in order to give their clients what they need. Alternatively, they need to reinvest in developing more comprehensive capabilities for the benefit of their clients.

None of this is to say that fiduciary-based advisors are intentionally doing anything wrong. Quite the contrary, in the majority of cases they genuinely are trying to do what is best for their clients. Nonetheless, they must reevaluate their understanding and application of the fiduciary standard.

True fiduciaries are never satisfied that they have done enough for their clients. In placing their clients’ interests first, they must be prepared to make the hard decisions for the benefit of their clients and not just the easy ones that allow them to maintain the status quo.