By Ron Florance, Senior Strategic Consultant, Robertson Stephens
The Department of Labor has created lots of chatter about the ethics of the investment industry. Their recent ruling on using the fiduciary standard for investment professionals has heated up a conversation that has been smoldering for some time. I would like to put this all in perspective.
What is ethics? It is actually a branch of philosophy that studies right and wrong conduct. Doing the “ethical” thing is about doing what is “right,” not what you can “get away with.” A good way to start an ethical analysis is by using The Golden Rule. Many in our society associate The Golden Rule with recent religious guidance, but it has been around far longer than that. As early as 2000 BC, Egyptian mythology included the concept of “do to the doer to cause that he thus to you.” In 1993, the Parliament of the World’s Religions issued a declaration towards global ethics stating that “we must treat others as we wish others to treat us.” That is a pretty good place to start.
The ethical struggle in the investment industry is between two standards: The Suitability Standard and the Fiduciary Standard. While these two standards are long and complex, let me try to simplify the differences. Suitability is based on the concept that an advisor must recommend investments that are “reasonably suitable for a client.” Fiduciary is based on the concept that an advisor must “act in the best interest of the client.” Why is there even an argument about this?
In Suitability, an advisor can recommend an investment, knowing that is “suitable” but maybe not in the client’s best interest. No wonder our industry is hated. Suitability standards apply to most broker-dealers that are regulated by FINRA. The Fiduciary Standard requires advisors to disclose all potential conflicts of interest and put the client’s interest in front of their own. The Fiduciary standard applies to RIAs (Registered Investment Advisors), Trust departments and fee based investment advisors.
The recent DOL ruling required all advisors working with retirement assets (401(k)s and IRAs) to use the Fiduciary Standard. This was a good idea for the $12 trillion in these accounts. And what about the other $55 trillion in financial assets held by US consumers? Unfortunately, by the time the ruling came out, the lobbyist had watered it down to the detriment of investors. Concessions included pushing back the implementation date for explicit disclosures on the costs of products and relaxed restrictions on annuities and proprietary products. That is too bad, but at least the main emphasis of client protections are in place.
As I talk to investors, most are not even aware of the two different ethical standards. They are unaware that by choosing one advisor over another, they may actually be choosing between different business ethics that can significantly impact their investment experience. Everyone in the industry, including professionals and regulators, needs to help educate investors about this reality.
There are professional designations that emphasize ethics for investment professionals. Both the CFA (Chartered Financial Analyst) and CTFA (Certified Trust and Financial Advisor) have ethics sections in their curriculum that go well beyond the required regulatory landscape. That is a great thing. Employers and investors should reward advisors that show this level of commitment to their profession. These industry groups should be more vocal about the benefits that these designations bring to investors.
Firms that follow the Fiduciary Standard need to be more vocal about their business approach of putting the needs of their clients above all else. Regulators need to stop being unduly influenced by self-interested lobbyists and start being influenced by the needs of investors they are hired to protect. The industry needs to promote higher ethical standards through professional designations that emphasize ethical behavior.
And finally, investors need to step up as well. When talking to potential advisor, they need to ask “do you follow the Fiduciary Standard by acting in my best interest?” If the answer is no, ask why.
Let’s all treat others as we wish to be treated.