Stress the carrot and not the stick in formulating a rule that will get real results, says a fiduciary maven

February 26, 2015 — 5:54 PM UTC by Guest Columnist Don Trone

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Don’s Note: As a long-time advocate of fiduciary standards, it will probably surprise most people that I am strongly opposed to the fiduciary standard being proposed by the Department of Labor. My reason: What’s being proposed is not a fiduciary standard — it’s more rules that will have a negative impact on all financial advisors, not just brokers. The rules, which are now being reviewed by OMB, will very likely prohibit or restrict certain products and services, and result in increased compliance costs. The DOL is going to make it harder for good advisors to do what’s right, and make it easier for bad advisors to hide within the complexity of additional rules.

The president’s remarks on this Monday about the DOL’s fiduciary rules singled out great advisors who are doing the right thing for their clients. He then changed his tenor and talked about advisors who are “selling snake oil.”

As I considered the president’s remarks, it occurred to me that there are two faces to a fiduciary standard — positive and punitive — and it’s critical that the industry be able to distinguish between the two. See: Why I disagree with Don Tron’e characterization of Obama’s fiduciary stance as 'punitive’

The first face is positive. The presupposition is that advisors are honest and ethical and have the passion and discipline to protect the best interests of their clients. The purpose for defining a positive fiduciary standard is to provide the details on how advisors can improve their investment decision making processes. Let’s inspire advisors to do even better. An example is the handbook, Prudent Investment Practices, written by the Foundation for Fiduciary Studies and published in 2003. In the interest of full disclosure, I was the founder and president of the foundation. (View the handbook here.)

The second face is punitive. The presupposition is that there are advisors who are not honest and ethical, and who put their own interests first. The purpose for defining a punitive fiduciary standard is to define rules that will restrict or prohibit all advisors from certain activities. Let’s define rules in terms of negative motivation — follow the rules, or face the consequences. A good example is the direction the DOL wants to go with its “conflict-of-interest” rule, which has been sent to OMB. The DOL’s mood is reflected in the Phyllis Borzi’s remarks, which followed the president’s on Monday. See: Borzi: Exemptions from conflict of interest will be part of new fiduciary proposal.

DOL’s POV

In general I have significant concerns, informed by direct experience, about the negative attitude of the DOL being directed towards the industry. I was fortunate to have been appointed by the secretary of the Department of Labor in 2003 to the ERISA Advisory Council. It was an education, and this is what I learned:

- The DOL lacks expertise with the investment management industry — the DOL does not understand or appreciate the role of a financial advisor.

- The DOL views the retirement industry as the enemy — the industry is sucking the life out of pension assets. The DOL views itself as the last line of defense — only the DOL can save retirement plan participants and retirees. See: Proposed DOL regs expose more advisors to fiduciary liability.

- The DOL does not understand the purpose of fiduciary best practices, nor the value of education and training. If the DOL took even one-tenth of their enforcement budget and applied the amount towards education and training, we wouldn’t have the problems we’re experience today.

Too complex

Most of the fiduciary advocacy we have seen since the Dodd-Frank Act, signed in 2010, is punitive. Different groups have been formed, each declaring or implying that only their members have a true understanding of what it means to be a fiduciary. Their messaging is negative — join our church if you’re a true believer — sinners are not welcomed. See: As DOL contemplates stiff fiduciary-related penalties on advisors, NAPFA and FPA find rare concord with FSI.

Case in point: the DOL’s 408(b)(2) disclosure requirements for fees and expenses. The regulation was trumpeted by the DOL as being the solution to hidden fees and expenses, as a way to help plan sponsors determine who was being compensated by plan assets and to aid in the determination as to whether the compensation being paid to different parties was fair and reasonable for the level of services being rendered. See: Why 408(b)(2) is a flop for the 401(k) business and how RIAs can turn it around.

On the surface, a good thing; a tool to help fiduciaries with one of their critical tasks, which is to control and account for investment fees and expenses.

The result: a report that is too complex for the average lay fiduciary to interpret, and an increase in fees associated with the management of the plan.

Commonsense rules

The fiduciary movement started approximately 30 years ago. For the first 25 years, the objective of the movement was to define best practices associated with a positive fiduciary standard. The philosophy was simple and straightforward: A rising tide lifts all boats. If we can improve the investment decision-making process of investment fiduciaries, we can have a positive material impact on the fiscal health of our nation. See: Fiduciary leaders splinter into two advocacy groups over divergent views.

We’ve lost our way in defining a positive fiduciary standard. Fiduciary is no longer a point of inspiration for moral, ethical and prudent decision-making. If we don’t act now, we’re all going to suffer under a regime of negative motivation defined in terms of a punitive standard.

Consumers deserve to know that their advisor is working for them. Common-sense rules can protect investors and consumers, prevent abuse, and ensure that brokers and advisors provide advice that is in consumers’ best interests. See: TD throws its first client-best-interest summit, a micro-event, by 'candlelight’ in Palm Beach and ideas rise from the RIA deeps.

I foresee the same problems with what is being proposed — more complexity and cost, but no evidence that participants will be better off.

With that as a background, you can understand why I believe the DOL’s proposed fiduciary standard will be punitive — it will be designed to inflict pain. No one should be cheering.

Don Trone, GFS® is the founder and chief executive of 3ethos. He has been involved with the fiduciary movement for more than 28 years. He was the founder and former president of the Foundation for Fiduciary Studies, and was the principal founder and former chief executive of FI360. He has authored or co-authored twelve books on the subjects of fiduciary responsibility, portfolio management, and leadership.



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Barbara Roper said:

February 26, 2015 — 8:03 PM UTC

It is unfortunate that Mr. Trone has chosen to condemn the DOL’s rules without having had the benefit of actually reviewing them. He also fails to explain how requiring brokers to act in their customers’ best interests when they give advice, which is what DOL has said it plans to do, would be punitive, or negative, or bad for retirement savers. Unfortunately, while I have often admired Trone’s writing, this opinion piece is, in my opinion, “all wet.”

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Prof. Ron Rhoades said:

February 26, 2015 — 9:49 PM UTC

I concur with Barbara’s comment. I applaud Don’s earlier work, which emphasized following a process to adhere to the fiduciary duty of due care (which imposes largely “positive” obligations, in the sense that “you must do this”).

However, the fact of the matter is that the fiduciary duty of loyalty (which imposes “negative” obligations – in the sense that “you must not do this ….”) is the very core of the fiduciary principle. It is what differentiates, to a much larger degree, the fiduciary standard from the weak standard of suitability. It imposes a duty to avoid conflicts of interest. While the duty of due care (including due diligence) varies somewhat from the suitability to the fiduciary realm, it is the fiduciary duty of loyalty – in which the fiduciary finds herself or himself stepping into the shoes of the entrusted (client) – which clearly distinguishes the relationship of the parties. No longer are the parties dealing at arms-length, as in a sales relationship, but rather they are in a fiduciary-client relationship. The fiduciary duty of due care is enhanced from that of suitability, and the fiduciary duty of loyalty is imposed – the latter being the distinguishing characteristic of the relationship.

By way of further explanation, U.S. courts have in large part adopted the view of fiduciary obligations as resting upon “the triads of their fiduciary duty—good faith, loyalty or due care.” See In re Alh Holdings LLC, 675 F.Supp.2d 462, 477 (D. Del., 2009). The duty of loyalty, in turn, reflects several more specific duties (or principles), including those of “no conflict” and “no profit” (other than agreed-to-in-advance reasonable, expert-level compensation). Again, I would state that the fiduciary duty of loyalty, with its prohibitory attributes, is what makes the fiduciary relationship so distinctive from other commercial arms-length relationships.

The fiduciary standard is a principles-based standard, whose broad prescriptions apply in a variety of contexts. It must be free to adapt, as fraud is infinite and business practices change over time. However, it is possible to derive from established authorities more specific standards of conduct applicable to those who provide personalized investment advice. These are often not “rules,” but rather a further elicitation of fiduciary principles. These standards can serve to inform and guide the fiduciary provider of personalized investment advice to a plan sponsor, plan participant, or IRA account holder.

As to Don’s criticism of the work undertaken by many different organizations over the past decade or so, in advancing further understanding of the fiduciary duties (including the fiduciary duty of loyalty), I believe such criticism is unfounded and is a disservice to the dozens, if not hundreds, of individuals who have labored to advance the profession. Moreover, Don’s view reflects a misunderstanding of the breadth of the fiduciary principle, and a refusal to acknowledge the fact that adherence to the fiduciary duty of loyalty is what makes a fiduciary expert possess the singular characteristic clients desire so greatly – trustworthiness.

We do not know the language of the DOL’s proposed rule, at this time. Hence, characterization by Don Trone of their pronouncements as “rules” and not “principles” seems rather bright-line, and premature. We will have to wait and see.

Again, while I applaud Don’s work in the area of defining a process for adherence to the duty of due care, there are many aspects of the fiduciary principle which were under-emphasized in his prior publication, in my opinion. While Don may desire that we all seek to adhere to lofty, positive prescriptions, the law serves to impose not just positive duties but also negative proscriptions. For, as James Madison wrote in Federalist Paper No. 51, “If men were angels, no government would be necessary.”

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Grant Barger said:

February 27, 2015 — 12:13 AM UTC

—-Calling All Advisors!—-
The day is coming! All advisors will be considered “fiduciaries” and the watered-down context of the actual content of the fiduciary oath will drag all authentic fiduciaries down to the lowest common denominator. (Q)How will the serious steward of wealth overcome being defined by an industry which continues to cannibalize itself through paradoxical mandates? (A)The serious financial professional realizes that he or she is in complete control of the perception of his or her value and authenticity.
As well-intended as the fiduciary standard is, it cannot survive this industry that has proven itself devoid of trust (about every 8 years or so). So it will be incumbent upon the serious advisor, who considers him/herself as a fiduciary, to go beyond the industry standards and mandates handed down from any institution or administration. It is time to go beyond fiduciary…Why in the world would a serious advisor want to be defined by his or her industry when he/she can define his or her authenticity and back it up with execution that is definable detectable and desirable? In fact, it will be critical for all serious advisors to take action and define their unique value and integrity model if they are going to thrive in the age of digital advice. So fiduciary has served a purpose… to get us here… what will come next is entirely up to each individual advisor.
—-Punitive Actions—- I agree with Don that the main concerns of the current authentic fiduciary should genuinely be – the punitive actions that will follow this watershed juncture, because there is no upside for the authentic steward… only more bureaucratic red tape. I feel some genuine empathy for Don because he is seeing the writing on the wall… he has dedicated a majority of his life to trying to make sure the actions of a few do not sully the reputations of many. I am grateful that he has shared the genuine concern he has about the state of the industry, which has been delivered in a relatively reticent fashion… compared to the absolute rage that most authentic fiduciaries will be feeling when this actually hits home…the realization of this regulatory defiling of their long standing badge of honor. Thank you, Don for sharing your insight in such a timely fashion and thank you for your service.

-Grant

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Larry Elford said:

February 27, 2015 — 1:11 AM UTC

As a longtime follower and supporter of Don Trone’s good work surrounding fiduciary duties, I have to say I am less than convinced by his current writing. Without going into great detail, I side with Barbara Roper and Prof. Ron Rhoades. @RecoveredBroker

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Stephen Winks said:

February 27, 2015 — 3:19 PM UTC

We should have learned from our fight for Brokers to acknowledge their ongoing fiduciary responsibilities. Until fiduciary duty is codified and executed by advisors, the transactions industry and its advocates are very resourceful and will be doing everything in its power to minimize the codification of fiduciary duty. Products do not add value, it is what the advisor does with products (or prudent process) that adds vale. A more modern approach to portfolio construction is required where cost is an important consideration to rendering individualized advice based on all a clients holdings.

Don is just wisely saying, keep vigilant. We may go through a period of refinement if not from regulators, then the industry or brokers in the execution of fiduciary duty . The free market is important here in getting it right in according professional standing. Just as there is a difference between being an accountant and a CPA, given the brokerage industry’s misunderstanding of fiduciary duty, our trade associations must gear up their credentialing—to determine the ultimate achievement of, not the aspiration of, fiduciary standing.

This will mean many (especially independent brokers) who think they are acting in a fiduciary capacity, are going to require a much different type of support. It is not business as usual. Broker/dealer advice products that give the broker no control over their value proposition, cost structure, margins and professional standing will give way to an expert authenticated prudent investment process that advisors manage (the literal definition of financial services) which is materially different from the selling of brokerage advice products.

A new era of innovation in the consumer’s best interest is emerging. It may be seem incongruent but our largest broker/dealers, with massive resources and scale, may emerge as our most astute supporters of fiduciary duty.

SCW


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