Twenty-five years ago, when I first started writing and speaking about fiduciary responsibility, the vast majority of financial advisors were not familiar with the term, and those who were believed they were not subject to a fiduciary standard. Even the largest institutional investment consulting firms and family offices were not acknowledging fiduciary responsibility.
Significant progress was later made in advancing fiduciary standards-that is, until the Dodd-Frank act was signed into law. Now there is agreement that higher standards need to be adopted, but there is no consensus about how it will impact the industry, particularly on how it may affect wirehouses, broker-dealers and insurance companies. That uncertainty has come to shape the debate and the advancement of fiduciary standards has come to an abrupt stop, perhaps even started to backslide.
I think we're all in agreement that the myriad financial scandals of the past decade have bankrupted the public's trust in the financial services industry. We need to guarantee, not simply reassure, clients that their interests will come first. Where we differ is on whether a fiduciary standard is the appropriate, or only, answer. And we're not going to move forward with the standard until these questions are addressed.
So how can we mitigate the risks and remove the uncertainties? How can we make sure to insulate firms from unintended negative consequences of a standard that's trying to do good? One answer is to define a fiduciary "safe harbor."
Safe harbor procedures are widely used by federal regulators to help clarify the implementation of a particular regulation-and reassure those who are subject to it that if they follow prescribed procedures they will not run afoul of the regulations. Simply stated, if firms, financial advisors and other investment decision-makers can demonstrate they have followed fiduciary procedures prescribed by regulators, they will be insulated from liability associated with those procedures.
Safe harbor procedures all share two characteristics: 1) They are voluntary. 2) The responsibility to demonstrate compliance with prescribed procedures and industry best practices rests with the party seeking relief. For the retirement industry, a classic example is the Department of Labor's 404(c) regulations, which are procedures that insulate pension plan sponsors from liability when they offer their participants education.
Using existing safe-harbor procedures as a model, we could create a fiduciary safe harbor this way:
1. A firm must define the minimum qualifications (in terms of experience, licensing and training) for advisors who wish to serve in a fiduciary capacity;
2. The advisors must accept and acknowledge their fiduciary status in writing;
3. When serving in a fiduciary capacity, the advisors must agree to use only investment products, databases, software and technology approved by their firms;
4. The advisors must agree to maintain records that demonstrate their procedural prudence (the details of their decision-making process); and
5. The firms must monitor the advisors' activities on an ongoing basis.
Such procedures will enable firms to limit their liability to the conduct of the advisors and to their own oversight of those advisors. This way, a wirehouse, with its complex infrastructure of capital markets products and services, can fence off its fiduciary advisory services and reduce the potential that it will engage in prohibited transactions.
Naysayers will say that such safe harbor procedures can still be gamed-that client interests will not come first. This is true; however, firms and advisors who stretch the rules will be easy to spot and will be at risk of losing their safe harbor and facing litigation.
The safe-harbor procedures I have suggested are already similar to the ones being followed by Finra member firms and SEC-registered investment advisories. And they are business-neutral-no investment products or strategies are deemed to be imprudent. The test of prudence will depend on the advisor's decision-making process.