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One-Man Think Tank: Yes, advisors, there is a way to cope with fiduciary liability

Ron Rhoades recipe includes one surprising ingredient

Tuesday, December 21, 2010 – 2:21 PM by Ron Rhoades, Columnist
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Ron Rhoades crafted this response to two advisors' question about turning RIA

Several advisors (including two registered representatives about to leave their wirehouse) contacted me over the past several months, after reading my columns on RIABiz.com, to express to me their great concerns about the increased liability resulting from fiduciary status. A fiduciary advisor, however, has much less to fear than a registered representative, as long as the fiduciary understands and respects the nature of trust, and the four components of it.

First, the client trusts today’s RIA as an expert advisor with respect to both financial planning and investments. Education, and a commitment to lifelong learning, is required of every professional.

Attaining CFP certification is a first step to achieving the requisite base set of knowledge a financial planner should possess. I would then encourage advisors to attend NAPFA conferences, which provide a the “NAPFA University” course of study, picking up where the CFP exam study leaves off and enabling the transition from book knowledge to real-world delivery of financial advice.

For the requisite base education (and then some) in investment theory and portfolio management, the conferences put on by Dimensional Funds Advisors are superb. If you choose instead to select actively managed funds, consider fi360’s training and tools, and the AIF designation they offer. However, since a fiduciary should possess an investment strategy which withstands academic scutiny, don’t overly rely on instruction from just a few sources, regardless of how good the instruction may be. In this regard, I suggest to you the Financial Economics Network at ssrn.com – an excellent resource for academic white papers on investment theories.

In sum, as to this aspect of trust, commit to become an expert. Or, better yet, work within an ensemble firm – surrounding yourself with expert advisors from multiple disciplines.

The second component of trust is the client’s reasonable expectation that you will advance the client’s interest before your own.

This does not mean that you are not entitled to be compensated; in fact, a trusted advisor should, in a rational world, be compensated more than a non-fiduciary registered rep or life insurance agent. What is required is that your compensation be reasonable, given your level of expertise, the value you add, and many other factors. And, as a best practice, your compensation (and that of your firm) should be agreed to at the inception of the fiduciary-client relationship, and your compensation should be level (i.e., not varying depending upon products recommended).

To keep the client’s interest paramount, it is best to avoid conflicts of interest. Many wise sages over the millennia, in many different contexts, have conveyed the simple truth that a person cannot serve two masters. Don’t try to wear two hats. And NEVER try to take off your fiduciary fedora, once it rests upon your head.

Those conflicts of interest which cannot be avoided must be fully disclosed – and properly managed. Treat the client as if you were a member of your own family. Clients must provide their informed consent – after achieving full understanding of the proposed action, any conflict of interest which may exist, and the ramifications of that conflict. No client would ever consent to a course of action which would be harmful to that client.

To emphasize this point – do not rely on disclosures to “cure” a conflict – because they don’t. Disclosures are ineffective for a variety of reasons, including numerous behavioral biases possessed by clients. Biased advice, even with disclosure of the bias, is usually poor advice, even when the advisor intends to be “good.” For a greater understanding of the inherent problems of conflicts of interest and the ineffectiveness of disclosures, read Professor Daylian Cain’s research on the problems of biased advice, some of which is available at ssrn.com. What we all feared: 'Better’ disclosure yields worse results, according to Yale professor’s study.


The third element of trust is honesty. Scrupulous honesty. Candor. Because a misrepresentation, or a failure to convey essential material facts the client should know, destroys trust. And once trust is destroyed, it is nearly impossible to restore.

Moreover, once trust is betrayed by any “financial advisor,” the client becomes increasingly skeptical of ALL financial advisors. If you operate as a true fiduciary, you’ll need to convey how you are different, to overcome the deep skepticism of financial and investment advisors which has built up among the public, and which is often reflected in articles written by well-intentioned, but not always fully informed, journalists.

If the foregoing three elements of trust sound familiar to you, that’s good. Because expert advice, in the client’s best interest, honestly delivered, combine to roughly translate into the broad fiduciary duties of due care, utmost good faith, and loyalty. These broad and generally non-waivable fiduciary duties must be adhered to by every RIA and financial planner.

In my view, however, there is a fourth component of trust. Compassion. Clients place trust in their advisors if they believe the advisor will seek to understand the client’s concerns and then endeavor to alleviate them. Compassion, and caring for others, although perhaps not legally required of a fiduciary, is an essential aspect of leading a professional life.

Despite its importance, compassion is rarely taught in financial planning curricula, or at secular colleges generally. For some self-study in this area, I would recommend The Lost Art of Compassion, a book by Lorne Ladner, Ph.D. It is possible to learn how to become more compassionate, and this will help you in serving your clients and in their perceptions of you. In essence, the more compassionate you become, the greater likelihood that your clients will refer their family and friends to you.

Entering into relationships built upon such an extraordinary level of trust, in which you, the advisor, are engaged as steward of your client’s life savings (and of their hopes and dreams), is not an activity to be engaged in lightly. For this reason, not all registered representatives should seek to become fiduciaries. (However, many of them already are, under state common law, which applies fiduciary status upon those in relationships of trust and confidence, regardless of licensure or the terms of any written agreement with the customer. The use of the title “financial consultant” greatly increases the likelihood of finding that fiduciary status exists, de facto.)

Care for your clients

In summary, any fear of heightened liability arising from fiduciary status can be circumscribed by the advisor following the dictates found in another timeless phrase: “Say what you do, and do what you say.” If you aspire to be a fiduciary, be an expert. Be fully, not partially, committed to the client’s interest. Practice with the highest degree of honesty and candor. And, as a professional, care for your clients.

Follow these precepts and substantial worries about potential liability fade away. In fact, as reported by one insurance brokerage firm several years ago in a 1995 comment letter to the SEC (see the excerpt below), fee-only fiduciary advisors have far fewer claims, and less substantial claims in terms of severity, asserted by their clients, when contrasted with the average registered representative.

I’ve never said being an RIA and fiduciary advisor was easy. It requires a strong level of commitment. It is a professional calling.

But being a fiduciary advisor, with proper attention to fulfilling the trust reposed in the advisor by the client, will always yield tremendous professional and personal satisfaction for both the advisor and the client. It’s a true “win-win” proposition.

Practicing correctly as a fiduciary results in little concern about potential liability. In fact, those who practice under the bona fide high standards of conduct required of true fiduciaries can focus on assisting their clients. They know that simply by doing what is right they can practice with peace of mind, and with little to fear.

Ron A. Rhoades, JD, CFP® serves as Chief Compliance Officer and Director of Research for Joseph Capital Management, LLC, a registered investment adviser with offices in New York, North Carolina, Georgia and Florida. This article represents his views only, and not necessarily the views of any organization to which he may be affiliated.

Excerpt from the Cambridge Alliance’s comment letter: https://sec.gov/rules/proposed/s72599/s72599-1515.pdf which states: “by virtue of years of experience, we are a repository of knowledge about the liability issues which both Broker Dealers and investment advisers face … Beginning in 1993 we began to examine the differences in claims arising from Broker Dealers and those from Registered lnvestment Advisers. Our predisposition was, because of their heightened legal duty, that Registered lnvestment Advisers would present claims with both greater frequency and severity than Broker Dealers. To our surprise, just the opposite was the case -claims against Broker Dealers dominated and were, on average, twice as frequent and twice as severe as those made against Registered lnvestment Advisers. Upon further examination, the differences became even more apparent -while Registered lnvestment Advisers had the heightened duty of a fiduciary, the evidence unequivocally suggested that they also, at the risk of regulatory censure or sanctions, did a demonstrably more effective job in meeting the needs of the investing public. As another leading indicator of the effectiveness of the advisors in meeting the needs of the investing public, we also examined the claims files in greater depth. Claims presented by Broker Dealers, which were typically brought against the Registered Representative as well as the Broker Dealer, would contain documentation about the actual trades but little supporting information. A Registered lnvestment Adviser’s file, by contrast, would typically contain documentation of the client’s investment objectives and tolerance for risk, an investment policy statement, and continuous files notes as the relationship progressed.”

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