The Problem with the Fiduciary Standard


Question: In a recent column you wrote about the evolution of financial advisors, the relatively new breed of independent financial advisors, and how different advisors are paid.  Some work only for fees, some work for commissions, and some work for both fees and commissions.  How does the fiduciary standard fit in to this?  It seems logical to me that my advisor should sign a fiduciary contract.

Answer: Your question has been the subject of much discussion in recent years, precipitated primarily by the Dodd-Frank Wall Street Reform Act of 2010.  The Act gave the Securities and Exchange Commission (S.E.C) authority to require advisors who sell securities for commission to act as fiduciaries.  They haven’t done it. Is it even possible? 

There are two different standards at play here: the fiduciary standard and the suitability standard.  Fee-only Registered Investment Advisors (RIAs) are required to follow the fiduciary standard, which, in simplest terms, says that the fee-only advisor must put the client’s best interest first – ahead of the fee-only advisor’s own best interest. 

Commission-based advisors, aka stockbrokers and registered representatives of securities firms, have a somewhat lessor standard.  They are required to recommend investment products that are suitable for a client, but not necessarily in the client’s best interest. 

The sale of mutual funds is a good example.  Say the broker/advisor recommends a U.S. large-cap stock fund.  The suitability rule states that broker/advisors “must have a reasonable basis to believe” that a transaction or investment strategy involving securities that they recommend is suitable for the customer.  This reasonable belief must be based the customer’s age, other investments, financial situation, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, and risk tolerance.

Now assume that the broker/advisor can choose from several different U.S. large-cap stock funds that meet these suitability criteria.  One pays a 5% commission, one pays a 4% commission, and one pays no commission. Because they are all suitable, the broker/advisor can sell his customer the fund that pays him the most, even though the higher commission is not in the customer’s best interest. And that’s the problem. It’s like trying to mix oil and water. How can you apply a fiduciary standard to a transaction like that without changing and diluting the fiduciary standard's meaning and worth?   

What about advisors paid with both fees and commission, sometimes referred to as fee-based advisors? They wear two hats.  They can manage a client’s portfolio for a fee under the fiduciary standard and sell the client an investment and earn a commission under the suitability standard.  Again, oil and water.

Your idea of a fiduciary contract is worthwhile, especially if there is any doubt in your mind as to which standard your advisor is governed by in his relationship with you.  My guess is that many investors don’t know. Tara Siegel Bernard wrote an article in last Sunday’s New York Times in which she quoted Arthur Laby, a Rutgers School of Law professor and former assistant general counsel at the S.E.C., as saying:

“Brokerage customers are, in a certain sense, deceived. If brokers continue to call themselves advisors and advertise advisory services, customers believe they are receiving objective advice that is in their best interest.  In many cases, however, they are not.”

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey, CA.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to