Stairway to Heaven

The recently announced ethical standards that will govern financial professionals who invest your 401k and IRA assets didn’t come easily: The Department of Labor fought with Wall Street for six years before finalizing them. The document detailing the new rules, a change to the definition of “fiduciary” under the Employee Retirement Income Security Act, is 1,000 pages long. And reports are already emerging about how Wall Street lobbyists watered down its enforcement provisions. Even so, these rules mark a watershed in the history of financial regulation—one likely to redefine the relationship between financial advisors and their clients.

What’s the Need?

Too few people know that the financial services industry has had two primary distribution systems with two very different ethical standards. There are financial advisors, who fall into two groups: registered investment advisors or investment advisor representatives. They provide advice and ongoing services for fees. These advisors are held to the higher fiduciary standard of care, meaning that they are required to put the interests of their clients before their own. They could not, for example, sell a client a financial product that generates revenue for the advisor if there were a more appropriate or less expensive option.

Registered representatives—stockbrokers—sell investment products for commission. They are held to a lower ethical standard labeled “suitability.” This vague standard is almost impossible to enforce. Three advisors could make different recommendations, all deemed “suitable.” Stockbrokers are not required to prioritize the best interests of the client. Wall Street employs or licenses hundreds of thousands of sales representatives who are held to this lower ethical standard.

The DOL regulation mandates a fiduciary standard for any advisor or representative who provides financial advice, services or investment products for retirement assets that are held in qualified plans (401k) and individual accounts (IRAs).

Wall Street’s Dilemma

While Wall Street does not want its sales reps locked out of the lucrative retirement asset markets, it also does not want the increased liability associated with a higher ethical standard. The industry was able to influence the final result, however.

Fiduciary Contract

In the original version of the fiduciary regulation, the investor and advisor enter into a written contract based on the investor’s best interests. It would be relatively easy to sue advisory firms if the contract were breached.

But the final version of the regulation deleted the straightforward language of a contractual relationship and replaced it with “breach of fiduciary duty” language, making it vague and difficult to enforce. The dilution of enforcement provisions also makes the regulation less powerful. But there are still significant benefits for investors in the DOL’s move.

Wake-Up Call

What’s at stake is financial advice you can trust for your retirement assets. The fiduciary standard does not guarantee competent, ethical advice with no conflicts of interest. You still have to select the right advisor and monitor your performance, risk exposure and expense ratios.

Still, one consequence of the new regulation is that investors will be more aware of these ethical standards. More demanding investors will insist upon a fiduciary standard of care for all their assets, including those that are unprotected by the DOL regulation. Step one is to ask your current advisor to confirm in writing that he or she is acting in a fiduciary capacity when providing financial advice and services. It’s the best way to ensure that the advice you receive benefits you first.

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