Financial advisers come in an alphabet soup of designations -- CFPs, CPAs, CLUs, CFAs -- and they're all very happy to advise you. You can find advisers working for big brokerage companies, banks, insurance companies and small independent firms.

But there really are just two types of financial advisers: those who -- by law -- work for their clients, and those who really don't. The legal litmus test is called fiduciary duty, which means that the adviser is obligated to put the best interest of the client ahead of all else.

That distinction is at the heart of an important debate heating up in Congress over a set of financial services industry reforms proposed by the Obama Administration in response to the financial markets crash last year.

The Investor Protection Act of 2009 would affect everything from credit cards and mortgage regulation to derivatives trading, and it would create a new federal agency to protect consumers from the worst abuses. But an especially interesting provision of the bill would subject Wall Street brokers to fiduciary standards, and give the Securities and Exchange Commission the power to ban compensation practices that reward brokers for anything deemed not in the best interest of clients.

Here's the current landscape:

Stockbrokers and broker-dealer representatives don't have fiduciary duty; neither do the financial product salespeople working at banks or insurance companies. They are self-regulated by the Financial Industry Regulatory Authority (FINRA), an industry-sponsored group. FINRA regulations require its members and their representatives to recommend investments that are "suitable" for clients -- a definition with holes big enough to drive a truck through.

"I've tried to find a definition and the best I can find is 'reasonable,'" says Sheryl Garrett, founder of a network of fee-only advisers that bears her name. "But the investment only has to be reasonable at the moment it is made -- not next week or next year. And the definition doesn't cover where the money that's being invested came from. I've seen situations where advisers talked clients into taking money out of a safe, government-insured defined benefit pension and putting that into a risky variable annuity. That can fall within the definition of reasonable."

None of which is to say that you can't get perfectly sound advice from a non-fiduciary adviser. Brokers who bill themselves as investment advisers may well provide good counsel. But it's important to be mindful of the possibility of divided loyalty and conflict of interest.

Advisers who have fiduciary responsibility to you as a client are Registered Investment Advisers (RIA). The one exception to that is in California, where brokers also have legal fiduciary responsibility, although many advisers and consumers aren't aware of this.

These advisers usually are independent or work for small firms, and they're regulated by the Securities and Exchange Commission (SEC) or by state authorities. They're held to a fiduciary standard of care that says they must put the best interest of clients first -- not their own commissions and fees, and not the sales objectives of an employer.

Many investors don't understand -- or don't care -- about the difference. A study conducted last year for the SEC by the Rand Corporation found that most investors don't understand the meaning of the term fiduciary, and also couldn't describe the differences between brokers and investment advisers.

The current structure of the financial services industry has also tended to blur the lines, with the emergence of financial superstores that offer both advisory and portfolio management services through different divisions.

The House Financial Services Committee already has approved legislation containing the fiduciary duty reforms, and a companion bill in the Senate contains the provision, too. The securities industry has said it supports adopting a fiduciary standard, but wants a weaker standard. Industry lobbyists also are pushing provisions that would allow the SEC to empower FINRA to regulate advisers who are dually registered as a broker and an RIA.

This reform would have big implications for the way sales-driven advisory services are run, and -- if signed into law -- it will be good for consumers. Watching the proposal run the gamut through Congress should be fun.

 

 

 

Investor Protection Act Would Shake Up Financial Adviser Duties

(c) 2009 Mark Miller