The Prudent Fiduciary

Scott Pritchard | Principal

A look at the major issues that are shaping fiduciary best practices today.

Whose Interests Come First?

March 2015

Here’s the scenario…

Patient: “Hi Doc, I came to see you today because I’m really not feeling well.”

Doc: “Tell me more about that.”

Patient: “I’m running a fever and coughing like crazy.”

Doc: “Okay, I know exactly what’s wrong. Here, rub this topical ointment on your feet and you’ll be fine. Just pay this invoice on your way out. Good to see you (with a firm handshake and a slap on the back).”

Patient: “But Doc, I’m not sure you heard me. I’m running a fever and coughing like crazy. What good is an ointment going to do?”

Doc: “Oh, I didn’t say this would cure the virus that you have, I just said I knew what was wrong. I gave you the ointment because the insurance company pays me $300 for prescribing that and they only pay me $200 for prescribing an antibiotic…”

No way this would ever happen, right? Of course not. It’s unrealistic. The physician would be sued for malpractice. Yes, he prescribed medicine, but it clearly wasn’t the right medicine.

But let’s consider a more realistic scenario in the world of investment advice…

Investor: “Hi Advisor, I came to see you today because I need some help saving for retirement.”

Advisor: “Sure, I know exactly what you need. Buy this mutual fund and you’ll be all set. Good to see you (with a firm handshake and a slap on the back).”
Realistic? Sure, this scenario plays out all the time.

But did the advisor follow the path of our imaginary physician and recommend the investment that paid the advisor the most commission, or did he recommend the one that was truly in the investor’s best interests?

Many investors in this situation today don’t know the answer to that question. And current rules and regulations say that’s okay. But that may be about to change.

For years, the Department of Labor has been pushing to change the rules governing the advice provided on 401(k) plans and IRAs. As it stands today, that advice is provided under two scenarios:

· The Suitability Standard – Is the investment merely appropriate for the client’s personal situation? This standard typically applies to advisors working for a brokerage firm or insurance company.

· The Fiduciary Standard – Is the investment in the client’s best interests? This standard applies to registered investment advisors (RIAs).

Under the Suitability Standard, an advisor could legally “prescribe” Mutual Fund A (the “ointment”, paying a commission of $300) over Mutual Fund B (the “antibiotic”, paying a commission of $200), even if Mutual Fund B was the best option for the investor.

Does this actually happen on a regular basis? There’s no way to know. But today’s current regulations do set the stage for conflicts of interest like this that allow some advisors to put their own interests ahead of their clients.

In contrast, an advisor under the Fiduciary Standard is legally required to put a client’s interests ahead of their own. Recommending a topical ointment when an antibiotic was clearly needed would not only be immoral, but would actually be illegal.

But yet many 401(k) plans and individual investors unknowingly continue to work with advisors who aren’t under the Fiduciary Standard.

That may finally be changing. The White House recently called for tougher consumer protections for investors:

“Right now, there are no uniform rules of the road that require advisors to act in the best interests of their clients…and that’s hurting millions of working and middle-class families.”

At the same press conference, Jo Ann Jenkins, CEO of AARP, echoed that sentiment:

“In today’s world it’s hard enough to save for retirement and achieve your financial goals. We don’t need to make it more difficult by allowing some in the financial industry to take advantage of hardworking Americans. All advice should be in the best interest of the consumer. Bad financial advice is just wrong –period.”

As an independent, fee-only, registered investment advisor, Capital Directions has always served under the Fiduciary Standard. We know that putting our clients’ interests ahead of our own is smart business.

We may not be in the minority much longer.

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