ABA Banking Journal Home

White Paper: How Do You Manage Different Standards of Fiduciary Care? You Don't. Manage to the Highest.

ICS Compliance
  • |
  • Written by  Gary Swiman
  • |
  • Comments:   DISQUS_COMMENTS
Currently there is a great amount of debate around reconciling the fiduciary standard among Trust Departments, Investment Advisers, and Broker-Dealers. Over the last few years, wealth management has evolved from a transaction-based business to an advisory business. Brokerage firms, which once solely provided transactional advice, now create more complete solutions for their clients. And there has been a tremendous increase in the number of Registered Investment Advisors (RIA’s) who are providing asset management recommendations without specific product sales to retail customers. Given the coalescence of these industries, it can be difficult for investors to distinguish between the Broker-Dealers, the RIA’s, and the Trust Companies, which creates a dangerous environment since the quality of the advice differs significantly between advisors. Not by virtue of their different regulatory frameworks, but because of the disparate fiduciary standards that they have implemented and adhered to. 

In 2008, as a consequence of the financial meltdown and front-page scandals, the SEC took interest. Regulators began examining the roles of different types of advisors, and the impact those roles have on the advice they give clients. In 2009 the President got involved. The Obama administration published the white paper “A New Foundation: Rebuilding Financial Supervision and Regulation,” which stated the government’s goal of establishing a fiduciary duty for broker-dealers that offer investment advice, and synchronizing the regulation of investment advisors and broker-dealers. Since then, the SEC has been developing a legal framework that better suits the trends and realities of today’s investment environment.

Meanwhile, the banking industry has also been in flux. Banks are having a difficult time driving enterprise value with zero percent interest rates so they have been acquiring Broker-Dealers and RIA’s in an effort to become more sophisticated in their product offerings and further grow revenue in this challenging environment. So what is the best practice for them to advise their investors ethically and in their best interest given the different fiduciary standards? The answer is they shouldn’t.

A bank’s duty is to serve the public’s best interests, and ultimately, an investor’s best interests are served by a well-designed, understandable, compliance-oriented, and repeatable process that offers the investor the likelihood of the best investment outcomes for their future objectives. Therefore, all firms would be best served by implementing one fiduciary process to the highest standard of care, because the primary goal should be to invest in the public’s best interest. Furthermore, given the SEC’s ongoing discussions about fiduciary duties, developing an enterprise-wide wealth management process to the highest standard would preempt the inevitable SEC regulation and give them first-mover advantage over any short-sighted competition.
Some History
A fiduciary is defined by Black’s Law Dictionary as, “one who puts their clients’ interests ahead of their own.” Fiduciaries owe two main duties to their clients, a duty of loyalty and a duty of care. The duty of loyalty requires that fiduciaries act solely in the interests of their clients, rather than in their own interest. The duty of care requires that fiduciaries perform their functions with a high level of competence and thoroughness in accordance with industry standards. Thus, fiduciaries must not derive any direct or indirect profit from their position and must avoid any conflicts of interest.

Trust companies are fiduciaries under common law and the Comptroller of the Currency has issued standards for fiduciary investment activities of national banks, known as Reg. 9. RIA’s are held to be fiduciaries ever since a 1963 Supreme Court ruling on the Investment Advisers Act of 1940 (Advisers Act), clarifying that investment advisors owe their clients a fiduciary duty. Conversely, Broker-Dealers and their registered representatives are currently not held to be fiduciaries, though they are required to recommend products based on the standards of “suitability.”

•    The definition of “investment advisor” under the Advisers Act excludes, “any broker or dealer whose performance of such investment advisory services is solely incidental to the conduct of his business as a broker or dealer, and who receives no special compensation therefore.” Under the Advisers Act, a full-service Broker-Dealer who charges a fee based on the size of the transaction or number of shares traded is not considered an advisor regardless of whether investment advice is also provided to the client. On the other hand, a broker who varies the commission charged based on the amount of advice and consultation given to the client, is considered to be an investment advisor under the Adviser’s Act. Registered representatives only have suitability requirements which require that broker’s sell investment products that are suitable to a client’s specific situation.

Making the Case for the Fiduciary Level of Care
There will always be risks involved in any type of investment product. However, following a consistent, structured, best practice product selection process allows advisors to limit risk and to justify the product choice in instances of underperformance, thus limiting litigation risk. Fiduciary standards help wealth management organizations measure their fiduciary responsibility and ascertain their compliance with such standards.

Much has been made by the RIA community of the superiority of the “fiduciary level” of care as opposed to the “suitability level” provided by brokers. Yet despite the boasting, many outside those communities believe that the lines have been blurred so much as to be indistinguishable. Many Broker-Dealers have parts of their business dual-registered as both an investment advisor and a Broker-Dealer, and then have done the same with many of their registered representatives because they know that if the legislation goes through, they will have to function at the RIA level. So while Broker-Dealers and affiliated Special Interest Groups are fighting to prevent legislation so they won’t have to fully change their model, retrain their people, etc., they have slowly been moving their model more towards the RIA model in the hope that self-legislation will prevent an official SEC rule change. So the solution to this problem for banks controlling investment advisors of every type is to adhere to a common, well-defined, highly compliant fiduciary level process because, whether formally or informally, the industry is headed that direction.

One argument that could be made in favor of banks maintaining the suitability level of care for their Broker-Dealers is that it would probably result in a lesser amount of legal monetary payouts to clients. Broker-Dealers win a lot of cases that RIA’s lose because they are held to lower standards, so conceivably, an institution could save a lot of money in litigation costs. But this strategy is not advisable. Bank culture already closely reflects the fiduciary level of care representative of RIA’s, rather than the Reasonable Man standard  Broker-Dealer. Not only is it safer for banks to maintain that the highest fiduciary standard enterprise-wide, but also it will create a faster, more cost-efficient integration for them due to the similarities in the thought processes between RIA’s and the Trust Departments of banks.

Considering the legal context, conflicts of interest, and current wealth management trends it becomes immediately clear that acting as a fiduciary without a defined fiduciary process fails to deliver for clients. A fiduciary process allows wealth managers to provide a logical, client-centric, and auditable investment advisory offering to their clients, thus distinguishing themselves from those who are not employing fiduciary standards. And since the primary benefit a client should gain from a fiduciary process is in knowing that the recommended solutions and products are in their best interests based on the client’s objectives and risk tolerance, by smartly deploying a fiduciary process, organizations can leverage the benefits of being both a Broker-Dealer and being an advisor while still offering their clients a best-in-class wealth management process.
The Five Keys to Implementing One Fiduciary Standard
Banks and Broker-Dealers have introduced business processes in their wealth management areas that adhere to some basic criteria:

1. Consistency - If a client would be advised twice, this client should receive the same treatment both times

2. Auditability - all processes , steps and advice outcomes need to be logged and filed  and be available for later review

3. Flexibility - all clients have slightly different needs and your standards need to be flexible and compliant at the same time

4. Advice - the fiduciary investment process should assist the advisor with planning, product selection and risk profiling

5. Segregation of Duties - make sure that there is a supervisory structure in place to keep advisory teams following the highest standards of competence

Best practices related to the role of a fiduciary in an investment advisory relationship emphasize the importance of: investor profiling, asset allocation, investment policy creation, product selection, disciplined rebalancing, and monitoring of the investment policy. The fiduciary level investment process is an implementation of these investment concepts given fiduciary standards. Once a firm has decided to implement a fiduciary level process to gain the best outcomes for their clients, they cannot go half way. The firm must develop the proper steps to ensure the desired outcome or they risk failing their clients, damaging their institution, and lagging behind the latest SEC rulings.

By Gary Swiman
President, Asset Management/Broker-Dealer Group
ICS Compliance
back to top


About Us

Connect With Us