Fiduciary: Answering to a Higher Standard

Posted on December 8, 2010
Filed Under Mutual Funds, Personal Investing, Revenue Sharing, The Economic Scene

As long-time clients know, I’m not a big fan of stock brokers. But even I was surprised by a sub-head for a Wall Street Journal article that ran on 12/6/10. It read, “Right now, securities firms don’t have to put investors’ interests first.  New regulations may change that – and Wall Street isn’t happy.”

Not happy indeed. The recent Dodd-Frank Act overhauls regulation of much of the financial world. Within its many pages it authorizes the SEC to conduct a study which potentially would result in a single standard of care for clients of both brokers and Registered Investment Advisors.  Currently, Weber Asset Management and our colleague RIAs are held to a higher standard, a “fiduciary” duty to put our clients’ interest ahead of our own. Brokers, however, need only put clients into “suitable” investments.

The differences can be stark – and expensive – because “suitable” doesn’t always mean “best.”  As Barbara Roper of the Consumer Federation of America said in the article, “The broker is free to recommend inferior options that compensate the broker more generously, rather than what’s best for the investor.”

“Inferior options” may be, for one common example, mutual funds with high fees or sales charges, or both, instead of similar low cost, no sales charge mutual funds. The broker may be paid a straight commission up front, or he may be paid a trailing 12b-1 commission for as long as you own the fund, or both.  And some firms still have contests in which brokers who sell the most of a particular product receive lavish rewards. It’s another example of “suitable” being good for the broker, but not being best for the client.

Typically, RIAs are paid strictly through fees which are a percentage of assets under management, with no commissions or other “revenue sharing” shenanigans taking place.

RIAs are regulated by the SEC, while stock brokers are watched over by FINRA, the Financial Industry Regulatory Authority, which is Wall Street’s self-policing organization.  After the market melt-down of 2008, as Sarah Palin might cynically ask, “so how’s that self-policing working out for ya?”

And remember that almost no one these days is a “stock broker.” Instead, they say they are “Financial Counselors” or “Investment Specialists” or even “Advisers.”  Despite the title, however, in most cases the person selling financial services at a large brokerage firm is a stock broker.

The SEC is far from perfect, but to my mind, its stringent oversight of investment advisors is far superior to the standards imposed by Wall Street on its own members.