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Ryan R. Bradley
Ryan R. Bradley
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Boiler Rooms in Hot Water–Making Sense of the New Fiduciary Rules for Brokers


The Department of Labor has proposed new rules increasing the duty owed by brokers to clients from “suitability” toward “fiduciary” standards, but Questions Remain with Insurance Products

Believe it or not, your broker may not have to have your best interest in mind.  This may come as a shock to some, but under the current rules, a broker only has to ensure suitability when they are selling insurance products or securities.

We live in a new economy.  The stock market swings up and down at a rate that most people will never have a chance of following, and unless you happen to have a super computer and the ability to participate in so called “flash trading” managing investments and creating a return has become increasingly difficult.  Furthermore, more traditional forms of investments from banks such as CD’s and highly-rated bonds are not currently providing a return necessary to ensure a comfortable retirement for most people.  Adding to the investment quandary is the veil of uncertainty surrounding the FED and interest rates and when or if the economy will ever return to “normal.”

Clearly, individuals wishing to plan for their retirement and establish any level of comfort in the future are well-advised to seek the advice of a financial advisor–but maybe not a broker.   While the proposition is simple, choosing an advisor is anything but.  Investors are bombarded with a menagerie of individuals selling various products, usually from insurance companies and securities brokers, that seem to fill the gaps in a portfolio and the individuals selling these products often represent themselves “advisors” when in fact they are brokers with a very different standard of care.   The dichotomy of standards of care is common place in the world of attorneys, but not so much for the investing public.  This month however, the Department of Labor has undertaken a rule making process to raise the duty level of brokers and make them Fiduciaries.  This would “level the playing field” for investors saving for their retirement by allowing the peace of mind that come from knowing that an adviser and now brokers have the best interest of the client in mind. Still, even with this rule change, there are some question that remain unanswered.

The term fiduciary is defined generally as an individual in whom another has placed the utmost trust and confidence to manage and protect property or money.  No doubt this is a high standard.  Based on this definition, a fiduciary has the obligation to put the interest of the other (client) before his or her own.  In brokerage terms this means that the fiduciary must put the client before the commission.  One would hope that any individual offering financial advice, services, or products would abide by this standard anyway, but this is not the case.    Therefore, while a registered financial advisor owes a fiduciary duty, insurance brokers and agents do not, and up until the Obama Administration stepped in, neither did securities brokers.  This is the problem that the Department of Labor is trying to solve.  But why is it even a problem at all?

Imagine a situation wherein a dispute arises between a securities broker and a client, the investments recommended must be suitable for investors, but they are not required by law to act in their clients’ best interests. Thus, any disputes between brokers and their clients are settled through an arbitration process.  This deprives the client a right to access the court system.  Further, in a world where insurance and securities and brokers are driven by larger and larger commissions, the tendency for the broker would be to maximize commission so long as the investment is “suitable” rather than do what is best for the client.

The new rule is keyed off of the definition of Fiduciary in ERISA and is primarily targeted at broker-dealers that manage retirement plans and advise individual clients.  Since American investors have approximately $12 trillion invested for their retirements, the Department of Labor is the applicable rule making body.  To accomplish this end, the rule will likely focus on the Best Interest Contract which essentially allows the broker to disclose fees and commissions to the client and receive an exemption from the fiduciary standard.  Still, given that brokers are, at the end of the day, salespeople, simply disclosing the potential conflict of a high commission may not provide enough protection from a seasoned broker trained the art of sales.

Not surprisingly the broker dealer industry is arguing that the new systems required to monitor advisors and produce better disclosures for clients will cost a lot of money — some of which will almost certainly be passed along to consumers.  This may be true, but it will also open up the market for retirement planning to smaller operations and registered financial advisors that are fiduciaries and always have been.  Accordingly, in a way, the 401(k) market will become more decentralized and customers will likely have more choices.  Remember, that Certified Financial Planners were not required to meet the fiduciary standard until 2007, and since that time the number of advisors has risen by one third.  This is proof positive that more protection of consumers leads to positive industry change and benefits all parties.  Furthermore, as larger institutions driven by broker sales and commissions will leave the market due to increased scrutiny, investors will have the opportunity to explore other investment options such as fee-based models or even “robo-advisors” that deliver investment advice with minimal cost basis.

Back to the unanswered questions though. even with this rule making, the issue of insurance has not been fully addressed.  Apart from situations where securities are used, such as the nefarious indexed annuity, insurance agents and brokers are not held to the fiduciary standard.  In Illinois for example, the Supreme Court in Kaperdas v. Country Casualty Insurance Co., 2015 IL 117021 last year held once and for all that in the statutory duty of acting with ordinary care and skill in procuring coverage, as set forth in Section 2-2201, applies to both insurance brokers and agents.  This is not to say that insurance agents and brokers do not intend to better their clients, but again, commission size can legally enter into the equation.  At the end of the day the question to ask is whether an person acting as a financial advisor or planner can give impartial advice if they are receiving a commission.  This is for the client to decide, but remember there is a wide variety of fee-based advice services and advisors that are only paid on a percentage of the portfolio and do not reap large commissions. Until there is total clarity on the standard of care, the door is open for fraud and commission “churning” and lawsuits will always be a possibility.

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