Operational challenges come with offering advice.
The financial services profession is debating
whether or not a practitioner is acting as a fiduciary when he or she
delivers advice and services to clients. Let us address this issue
briefly and then move on to the bigger issue of how to deal with this
once you determine that you are, in fact, acting as a fiduciary. (And,
you probably are.)
Defining a fiduciary might be as simple as saying it is a person who has legal and/or moral responsibility for managing someone else's money. If we accept this broad definition, then most financial advisors would be considered fiduciaries, including wirehouse brokers.
A registered investment advisor (RIA) is always a fiduciary; for the dually registered broker/RIA, one would need to study the client services agreement to determine whether a fiduciary relationship exists. An investment consultant could be deemed a fiduciary:
When the consultant has discretion over a client's assets.
When the client is dependent upon the consultant's advice.
When the consultant is providing a client with comprehensive and continuous investment advice.
When the consultant is providing an ERISA client with investment advice and is receiving a fee.
When the consultant is an RIA.
A specific example related to advice might be in the preparation of a written financial plan. Do you:
Offer considerations (different choices for the client to choose from without specifically influencing the client's decision over which choice)?
Do you make specific recommendations related to the client's situation and needs (using words such as, "we recommend" or "invest in" or similar words)?
One caution is to avoid getting too caught up in the semantics of fiduciary status. You may be deemed to have a fiduciary relationship with a client regardless of how you word your financial plan if you are otherwise acting on behalf of the client in a fiduciary manner.
A wealth of regulations and case law support the definitions and determination of fiduciary status. For beginners, the Uniform Prudent Investor Act (1995) (UPIA), Management of Public Employee Retirement Systems Act (1997) (MPERS) and even the Employee Retirement Income Security Act of 1974 (ERISA) all contain provisions that support the definition and role of the fiduciary. Abundant case law further illustrates fiduciary status.
If you find yourself thinking that you are probably a fiduciary, do not despair. You are among more than five million men and women in this country who serve as such. The significance of being a fiduciary is that the practitioner first must acknowledge and disclose to the client that fiduciary relationship. This can and should be documented in a client services agreement (and/or engagement letter, if used). It should also be disclosed in the RIA ADV form. Further, it should be discussed with a client on an ongoing basis. If the language of fiduciary responsibility is incorporated into your communications with clients and prospects, and your required disclosures are followed diligently, rather than being a drawback to your practice it could become a marketable advantage.
Fiduciary standards of care also represent industry best practices, and provide a foundation and framework for a procedurally prudent investment process.
Defining your firm's fiduciary responsibilities will assist your firm in understanding the breadth and scope of your investment duties and help to improve communications with your clients and prospects. It also helps to improve long-term investment performance by imposing a disciplined operational process to the management of your client's investments. Moreover, operating as a fiduciary, following fiduciary principles and marketing yourself to clients as a fiduciary just might set you apart from the competition.
The Center for Fiduciary Studies (www.fi360.com), a nonprofit center associated with the University of Pittsburgh, has developed a Five-Step Investment Process that follows Uniform Fiduciary Standards of Care. The five-step process is:
1. Analyze Current Position. Analyze the client's current investment activities, strategies and policies; review short-, intermediate- and long-term cash flows (contributions and disbursements); review legal and legislative constraints.
2. Diversify: Allocate Portfolio. Create the investment mix best suited to the needs of the client.
3. Formalize Investment Policy. Write an investment policy statement (IPS) that reflects the investment mix, risk considerations and fiduciary standards applied. (This step and Step 5 are also an opportunity to reconfirm goals and objectives.)
4. Implement Policy. Reposition client assets, invest monies, etc.
5. Monitor and Supervise. Establish a specific schedule to oversee the accounts and provide feedback to the client.
The five-step process, shown above, probably does not look much different from what you may already be doing with your clients. The difference lies in how you document these steps to the client.
The fiduciary process also suggests that those practitioners who "bundle their fees" should consider developing an "unbundled" or a la carte pricing structure. This is where fees for each aspect of investment advice and management are delineated clearly for the benefit of client understanding.
The same would also apply to bundled investment opportunities. Breaking out the various costs of such investments offer the opportunity to investigate whether or not one or more components of the fees are unreasonable. With wrap-fee investments, variable annuities and separately managed accounts (SMA) and others, you may need to account for layers of management fees. Separating these for the benefit of clients can help them better understand what these fees are and why they are imposed. It also may assist in indemnifying the firm against the risks associated with not fully disclosing such fees.
Evaluating and/or choosing investments for your clients could enter a new dimension with the added issues of fiduciary standards of care. With the standards of care, the practitioner will need to look beyond just a strategic asset allocation based on client risk factors, investment performance or even Monte Carlo simulations and investigate such things as a range of expense ratios (with mutual funds), manager structures (with mutual funds, separate accounts, etc.) and performance differentials (published performance contrasted with individual client results).
Another fiduciary consideration in the investment selection and/or monitoring process is best execution. In seeking best execution, money managers should take into consideration commissions, strike price of the security and the quality and reliability of the trade.
The fiduciary is not required to seek the lowest commission, but he/she must justify paying more for a service. Having these additional considerations is an advantage, as it standardizes the investment selection process with the first consideration of protecting the client.
Positioning yourself as a fiduciary (and following fiduciary standards of care) also may result in cheaper errors and omissions insurance in the future. The Center for Fiduciary Studies has lobbied E&O providers to offer discounts to practitioners who follow and diligently document fiduciary standards of care. Once E&O providers recognize the reduced risks associated with such practitioners, embracing your role as a fiduciary may not only provide your clients with value, it could also result in lower costs, less risk and greater practice efficiency.
David Lawrence, AIF (Accredited
Investment Fiduciary), is a practice efficiency consultant and
president of David Lawrence and Associates, a practice-consulting firm
based in Lutz, Fla. (www.efficientpractice.com) David Lawrence and
Associates offers a variety of consulting services including technology
consulting related to the financial planning process and investment