“Courts have imposed on a fiduciary an affirmative duty of "utmost good faith, and full and fair disclosure of all material facts,"  - US Supreme Court decision: SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963)

From time to time, we are told that our commitment to eliminating financial conflicts is “overkill”.  Clients have also told us that our competitors have told them that the commissions don’t affect their judgment or that they will “use the commissions to offset their fee”, so it really doesn’t matter.  After all, the financial advisors are good, honest people.  They work for big, reputable Wall Street firms (or banks, or insurance companies, or fill-in-the-blank with whatever makes you feel warm and fuzzy), and besides, everyone has to get paid somehow – that’s just how it works in the financial industry.

Such talk brings to mind the scene in “The Wizard of Oz” when Dorothy and her friends are cowering before Oz one minute and the next minute Toto has pulled back the curtain and has the wizard by the leg of his trousers.  “Pay no attention to the man behind the curtain.” says the great and powerful Oz.  But once they realize that Oz is trying to manipulate them, they can’t ignore it.  The question isn’t “Is Oz a good person?”.  The question is, “If Oz has nothing to hide then why does the curtain exist in the first place?”  If other advisors have nothing to hide, why not fully disclose fees?  Why not stop accepting commissions in the first place?  Why not just charge the client a fair, fully disclosed price from the beginning? 

Traditional brokers (those regulated by FINRA) have no duty to disclose most facts about their compensation or conflicts and are not held to anything even approaching a Fiduciary Standard.  In fact, the broker and his client are frequently at cross purposes from a compensation point of view.  The broker works for the brokerage firm and owes them a duty to help them maximize profits for their shareholders, while he holds no such duty to the client.  The dirty little secret of the investment world is that brokers are held only to a much, much lower “suitability” standard.  This basically means that as long as an investment isn’t manifestly unsuitable for a particular investor’s situation, a broker can recommend it without fear.  This sounds more like caveat emptor than a fiduciary relationship.  Even if you love your broker, a wise course of action might be to “trust but verify”.  Ask about the commissions associated with the different recommendations.  Ask if your goals could be better achieved with a lower cost alternative.  Ask exactly how much he makes for the services he provides.  Then ask how much his firm makes.  Be sure to ask for the response in writing.  Be sure to sit down before reading the response (if you get one), because you’re probably going to be very surprised. 

What if your advisor nets the commissions from his fee?  That means he has no conflicts, right?  Not so fast.  Ask yourself; if your advisor wants to charge you X percent for his services might it make sense for him to focus on solutions that cluster around that price point, so that he can add value without adding cost.  How convenient that the solution to your problems is about the same as his fee!  He’s a hero.  At least as long as you don’t figure out that the goal could have been achieved more effectively with an investment 1/3  to ½ less expensive. 

Let’s assume for a moment that your advisor didn’t select your investments because of what they paid him, but that he does offset commission vs. fees.  Did he tell you that commissions are the least efficient way to pay him?  Today there is almost always an institutional or lower cost alternative to the regular retail version of an investment.  The differential amount that the investor is charged for the investment will almost always be more than the amount of the commissions that are paid to the advisor.  If the investment pays a 25 basis point commission, it is likely that it actually costs something on the order of 40 basis points more than the institutional version of the investment.  Ask yourself if this would be acceptable in any other transaction in your life.  Would you willingly pay $40,000 for a new car at one dealership if you knew you could go right next door and get the same car for $25,000?  Of course you wouldn’t, and a real fiduciary wouldn’t try to get you to pay $40,000 for the car, either.

Recent problems in financial markets, combined with sensational stories of greed, corruption, and incompetence have combined to produce a new outcry to hold those in the financial industry to a higher standard.  One of the most outspoken proponents of holding brokers and advisors accountable is the Committee for the Fiduciary Standard.  Their proposal outlines five principles that should be embodied in any Fiduciary Standard:

1. Put the client’s best interest first.
2. Act with prudence; that is, with the skill, care, diligence and good judgment of a professional.
3. Do not mislead clients; provide conspicuous, full and fair disclosure of all-important facts.
4. Avoid conflicts of interest.
5. Fully disclose and fairly manage, in the client’s favor, unavoidable conflicts.

To us, these principles seem basic.  The Fiduciary Standard should be about loyalty and trustworthiness.  It is about doing what is right, especially when no one is watching.  We support the Fiduciary Standard.  We believe in the Fiduciary Standard.  We practice the Fiduciary Standard.  We encourage you to learn more about the Fiduciary Standard and to make sure that it is the level of care that is being taken with your money. 

There are a number of excellent online resources where you can learn more about the Fiduciary Standard and see what is happening in the behind the scenes discussions of standards of care in the financial industry.  A few of those are listed below:

http://blog.fi360.com/fi360_blog/2009/08/defining-the-fiduciary-standard.html

http://www.bloomberg.com/apps/news?pid=20603037&sid=aDRJvkh6IQGk

http://www.brokeandbroker.com/index.php?a=blog&id=203