The Securities and Exchange Commission’s Regulation Best Interest is not only confusing to clients. It’s confusing to financial advisors as well. One advisor told me that he now adheres to a fiduciary standard because of this regulation.
My response: “Well, not really!”
While the regulation requires advisors to put clients’ interests ahead of their own at the time of a securities transaction, a true fiduciary standard asks you to put clients ahead at all times. It’s not limited to the time and date of a particular trade.
Take a group whose view on the matter is likely more orthodox: CFP mark holders. Those holding the designation have three core duties:
1. The duty of care. They must act with the care, skill, prudence and diligence that a prudent professional would exercise in light of a client’s goals, risk tolerance, objectives and personal circumstances.
2. The duty of loyalty. They place the interests of their clients above the interests of themselves and their firms, avoiding conflicts of interest, disclosing to the client any material conflicts that do emerge, obtaining the clients’ informed consent and properly managing conflicts.
3. The duty to follow client instructions. CFP mark holders are required to comply with the objectives, policy restrictions and other terms of engagement for dealing with clients and all the reasonable and lawful directions of the client.
These obligations don’t stop and end with a securities transaction. They stand at all times—unlike Reg BI, which only applies at the time a recommendation is made to a client. The CFP code of standards goes beyond, covering all financial assets—as well as other aspects of a client’s financial world, like tax strategies and insurance recommendations, that Reg BI has no interest in.
But whether the advisors are following a CFP standard or a Reg BI standard, there are conflicts that often fall through the cracks—things the advisors often miss. Here we’re going to examine four conflicts that are often overlooked: proprietary advisory platforms, forgivable transition notes, advisory administration fees and markups on third-party money managers’ management fees.
Proprietary Advisory Platforms
We see both broker-dealer RIAs and large producer groups (super OSJs) offering their own proprietary managed advisory programs. These are their primary profit centers. Yet if you give an advisor a 100% payout for a product that comes from your firm’s proprietary platform—while paying less for something from another advisory platform—that’s a conflict of interest. Broker-dealer RIAs do this. So do independent RIAs.
Michael Kitces, the creator of the Nerd’s Eye View blog, says, “To the extent that the RIA platform is giving different payouts to advisors for different investment solutions, that definitely raises conflict of interest concerns, as it’s literally a financial inducement to guide clients towards one solution over another.
“That doesn’t automatically make it wrong (not all conflicts of interest result in outright harm), but it’s certainly concerning, to say the least. Notably, the SEC’s fiduciary framework does generally allow such conflicts with some disclosures, although the Department of Labor’s original fiduciary rule back in 2016 would have outright banned such practices (as a ‘more stringent’ version of fiduciary where such conflict can’t be mitigated and disclosed, but would have had to be eliminated altogether).”
For fiduciary standard purists, anything with the word “proprietary” in front of it ought to invite skepticism.
More specifically, conflicted platforms do the following things:
• They offer payout advantage for proprietary advisory platforms over non-proprietary platforms (say, a 100% payout for something from the firm’s platform over 90% for a product from an outside platform).
• They limit the selection of competing advisory platforms.
• They promote proprietary platforms on their company website and at conferences while limiting the exposure from competing platforms.
• They put pressure on advisors to move client assets to proprietary platforms.
• They penalize advisors and clients for holding advisory assets away at turnkey asset managers or outside custodians like Schwab or Fidelity IWS. One way they do this is by imposing platform fees, usually paid by the advisor, costing 5 to 10 basis points on assets. They do this because they otherwise miss out on embedded profit they receive when those assets are in a brokerage account. The platform fee helps them make up the profit difference. Remember, a substantial percentage of broker-dealer RIAs won’t allow advisors to custody advisory assets outside of their clearing firms. For a fiduciary, the client advantages to using Fidelity IWS or Schwab for advisory assets are numerous, but the most obvious one is that the clients don’t pay ticket charges on stocks and ETFs. (Most B-D RIAs require clients to pay ticket charges, but not all.)