What is a Fiduciary?

Fiduciary is a legal term that unfortunately has multiple definitions depending on whom you are applying the term to. The most basic definition for a fiduciary is one who puts the needs of the client before their own needs. Many consumers know to ask if their advisor is a fiduciary, but don’t understand that most advisors use it as a marketing term. I’ve heard about the practices of many “fiduciaries” who don’t actually put their clients first. So don’t be fooled by a statement, know your rights, and the expectations that are placed on your financial advisor.

Don’t all financial advisors have to put the client first?

No. There are actually three “standards of care” in the financial services sector with varying degrees of stringency and enforceability.

Standard of “Reasonableness”

Insurance agents are not regulated in the same way that investment professionals are, and they are NOT fiduciaries. There is a standard of care, but is based in common law negligence, not in a specific national law established to protect consumers. Generally the standard of Reasonableness requires that someone putting themselves out as a professional can be assumed to have a greater knowledge about the area that they are a professional in. As such they are required to act in the way a “reasonable and prudent person” in the same area of expertise would act in the same or similar circumstances. This differs some from state to state because of the lack of a national standard, but usually this means that the following are required in regards to working with the insured client:

  • Do NOT misrepresent insurance coverage (i.e., don’t lie)
  • Diligently attempt to procure requested insurance
  • Notify the client of inability to procure requested insurance
  • Maintain the requested insurance (i.e., notify the client of changes to the policy)
  • Inform the client when it’s time to renew
  • Investigate the insurer’s financial solvency (i.e., don’t place a policy with a company on the brink of bankruptcy)

In other words, don’t hide information from the client or blatantly lie to them. But selling something that does not fit the needs of the client, is too expensive, or results in you getting a large bonus are all okay (legally).

Standard of “Suitability”

The most prevalent standard for investment advice is Suitability. Basically this standard, which applies to broker-dealer representatives, requires that the professional only recommend products that are “suitable” to the client. This means the professional needs to consider the client’s situation (age, risk tolerance, financial situation, investment experience, time horizon, etc.) and then recommend a product that is suitable to the situation, but they are NOT fiduciaries.

So if you fit a particular profile then they can recommend that you buy X investment. X investment does not need to be the best for you, and could even have a rather large incentive for the salesman. This means a professional held to this standard should not sell someone with a short time horizon, a low risk tolerance and capacity, and no investment experience a risky investment, but a high fee annuity with a low guaranteed rate of return and a high commission payout is okay (legally).

Standard of “Fiduciary”

A Fiduciary has the duty to put their client’s interests ahead of their own. Taken to an extreme this means that a fiduciary has a duty to reduce their own fees because it is better for the client. However, most fiduciary standards allow financial professionals to make a living and charge fees, but certain standards require those fees to be “reasonable”.

One of the problems with the word Fiduciary, is that the specific standards have one of many levels.

The lowest level of Fiduciary standards are those applied by the SEC to Registered Investment Advisors (RIAs). The SEC Fiduciary standard requires RIAs to disclose what they charge, any outside business activities, and any potential conflicts of interest. There’s no requirement that you not be involved in the conflicts of interest, simply that you disclose them. So if you tell a client what you are doing (say in a lengthy contract filled with legalese) then what you are doing is okay (legally).

The next highest form of Fiduciary standards is the one required by the CFP Board of CFP certificants. The standard is relatively high, it applies to all areas where you engage the advisor, and it requires that the advisor be providing “material elements of financial planning.” The reason this is not higher in this list is the lack of enforcement. First these standards only apply to CFP professionals. So when I was in a firm owned by a non-CFP, I was held to this standard, but the owner was not. Second, the enforcement of these standards is by a body that has no regulatory authority. So they can take action, but not legal action, based on these standards. So no matter what you do you’re okay (legally); you just may be publicly shamed and lose your professional marks.

An even higher standard is the ERISA-defined Fiduciary Standard. This is the standard that the Department of Labor (DOL) is attempting to apply to all retirement plans, but currently only applies to 401(k)s and similar ERISA plans. This standard is stringent enough that it actually has to have a clause allowing the advisor to make reasonable compensation from working with the client. The problem with this standard right now is the scope of enforcement. It does not apply to most of your engagement with an advisor, only advice that they provide to an ERISA plan, or a participant in an ERISA plan. This rule will be more far-reaching (supposedly) in 2019, and that is a good thing for all retirement savers because the investment advice they receive on their IRAs will finally require the professional to live up to this standard.

The peak of the Fiduciary Standard is actually shared by multiple groups. These are the voluntary fiduciaries. Many groups like the XY Planning Network and NAPFA require members to sign a fiduciary oath, one that is more stringent than the CFP fiduciary standard, but again this in and of itself only means the professional can lose membership in the group by breaking the oath. The real value in a voluntary fiduciary is one that will sign an agreement with you stating that they acknowledge their position as a fiduciary, and agree to uphold that standard. This “fiduciary contract” then gives you legal grounds to go after the professional if they do anything that is not in your best interest in any of the areas that they engage you in.

So should I seek out a fiduciary standard in my advisor?

Yes. But not just the standard that comes from being an RIA, or from belonging to a professional group that asks members to take a fiduciary oath. Ask for a signed document stating the advisor’s position as a fiduciary and question why they have to be the one to sell you insurance instead of having a low-load insurance broker sell it to you based on their advice. Personally, I'm a fiduciary four times over, but the SEC standards are simple to pass, and the CFP Board, XYPN, and NAPFA can at best kick me out of their respective clubs. SO I have built into my Advisory Agreement (the contract that makes someone a client of mine) an acknowledgement that I am a fiduciary, which means that if I break that duty my clients have a far stronger case to hold me liable in the court of law.

In the end, a fiduciary standard only really matters if it is BOTH stringent and enforceable. In my opinion the ONLY time that this occurs is when a financial advisor signs a voluntary “fiduciary oath” with you the client (assuming it doesn’t set the bar as low as the SEC does) so that you have a contract that gives you the option for legal recourse.