The Challenge of Complying with Multiple and Differing Fiduciary Rules
For nearly eight decades, financial advisors have been subject to federal and state securities laws, regulations and SRO rules regulating the type of service they provide to clients – investment advice, brokerage transactions, the sale of insurance products, and other services. The most recently enacted federal regulation – the Department of Labor fiduciary rule — expands and, in some respects, creates new regulations that apply to advisors who provide investment advice relating to 401(k) plans, other tax-qualified plans, and IRAs. The challenge for firms and advisors is that the DOL fiduciary rule applies in circumstances when the fiduciary standard under the Investment Advisers Act of 1940 (the “Advisers Act”) may not. In addition, advisors who hold certain financial services designations, such as the CFA® and CFP® designations, are required to abide by ethical standards that may differ from the requirements of both the DOL and Advisers Act.
When the DOL fiduciary rule becomes fully effective on January 1, 2018, firms and advisors will be expected to know the circumstances in which a fiduciary standard applies, as well as the differences between multiple fiduciary rules and standards. For instance, the fiduciary standard under the Advisers Act applies when a registered investment adviser (“RIA”) or investment adviser representative (“IAR”) provides investment advice to a client for compensation. However, once the RIA/IAR delivers his/her recommendations to a client (e.g., in the form of a written financial plan), the fiduciary relationship ends if the recommendation the adviser implements includes only brokerage transactions and/or the sale of insurance products. In this instance, the adviser’s obligation to the client under the Advisers Act switches from a fiduciary standard to a suitability standard of conduct.
The new DOL fiduciary rule impacts a financial advisor’s duty to a client in the following ways:
- The DOL fiduciary rule no longer allows an adviser to switch (as is permitted under the Advisers Act as described above) from the higher fiduciary standard that applies during the planning, analysis and presentation of recommendations to the lower suitability standard when the recommendations being implemented are limited to brokerage and/or insurance transactions if those recommendations involve a 401(k) plan, other tax-qualified plan, or an IRA.
- The DOL fiduciary rule also raises the standard of conduct from suitability to fiduciary for an advisor who holds the CFP® designation and is implementing recommendations involving a 401(k) plan, other tax-qualified plan, or an IRA if the advisor is deemed under CFP Board’s ethical standards to be in an other-than-financial planning engagement (CFP Board’s fiduciary standard applies only when an advisor is in a financial planning engagement).
The following example further illustrates the challenge posed by these differing fiduciary rules:
|Develops and Presents Recommendations Considered Investment Advice||Develops and Presents Recommendations Limited to Brokerage Transactions and/or Insurance Products||Implements Recommendations Considered Investment Advice||Implements Recommendations Limited to Brokerage Transactions and/or Insurance Products|
|Advisers Act, Sec. 206||Fiduciary duty||N/A||Fiduciary duty||Standard switches from fiduciary to suitability if the advice is incidental to transaction and no special compensation is received.|
|FINRA Rule 2111||N/A||Suitability standard||N/A||Suitability standard|
|DOL Fiduciary Rule||Fiduciary duty applies if the advice relates to a 401(k) plan, other tax-qualified plan, or an IRA.||Fiduciary duty applies if the advice relates to a 401(k) plan, other tax-qualified plan, or an IRA.||Fiduciary duty applies if the advice relates to a 401(k) plan, other tax-qualified plan, or an IRA.||Fiduciary duty applies if the advice relates to a 401(k) plan, other tax-qualified plan, or an IRA.|
|CFP® Ethical Standards||Fiduciary duty applies if advisor is deemed to be in “financial planning” engagement with client.||Fiduciary duty applies if advisor is deemed to be in “financial planning” engagement with client.||Fiduciary duty applies if advisor is deemed to be in “financial planning” engagement with client.||Fiduciary duty applies if advisor is deemed to be in “financial planning” engagement with client.|
|CFA® Ethical Standards||Duty of loyalty, prudence and care regardless of whether legal fiduciary duty applies.||Duty of loyalty, prudence and care regardless of whether legal fiduciary duty applies.||Duty of loyalty, prudence and care regardless of whether legal fiduciary duty applies.||Duty of loyalty, prudence and care regardless of whether legal fiduciary duty applies.|
An Advisor who holds the CFA® and CFP® designations delivers a financial plan to a Client that addresses the Client’s goals and objectives, and contains the Advisor’s recommendations. One of the Advisor’s recommendations is for the Client to rollover her 401(k) funds to a non-discretionary IRA account with a diversified portfolio of stock, bond and cash investments. The Advisor also recommends that the Client open a discretionary non-tax-qualified brokerage account for the Client to take advantage of anticipated market swings.
Under the DOL fiduciary rule, the Advisor in the above example must abide by a fiduciary standard of conduct with regard to the 401(k) rollover to the IRA account. Under the Advisers Act, however, the lower suitability standard rather than the fiduciary standard would apply if the Advisor’s implementation activities are limited to brokerage and/or insurance transactions for the client so long as any advice given to the client is in the context of these transactions and considered incidental to these transactions. CFP Board’s fiduciary standard would apply to this Advisor only if the Advisor is deemed to be in a “financial planning” engagement, as that term is defined in the organization’s ethical standards. In other words, CFP Board’s fiduciary standard would not apply if the Advisor is deemed to be in a brokerage-only or in an insurance-only engagement with the Client. (See chart following this article for further details on these differing fiduciary rules.)
Returning to the above example, for the non-tax-qualified discretionary account, the DOL fiduciary rule does not apply. The Advisers Act fiduciary standard, however, would apply to this account if the Advisor is providing advice that goes beyond being merely incidental to the transaction. The CFA Institute’s ethical standards do not contain a fiduciary standard per se, however, they do require the Advisor to “act with loyalty, prudence and care even in the absence of a legal fiduciary duty.” CFP Board’s fiduciary standard would apply to the implementation of a non-tax-qualified account, but again, only if the client engagement is deemed to be “financial planning.”
Today, and even more so when the DOL fiduciary rule becomes fully effective, firms and advisors are faced with the daunting task of determining the appropriate standard of conduct that applies – suitability vs fiduciary –, and if fiduciary, which of the fiduciary rules. This imposes an increased obligation on firms to have clear policies and procedures in place, and to provide ongoing training to its advisors on those policies and procedures. A robust compliance program is the best solution to mitigate the risk of litigation, regulatory fines and potential damage to a firm’s reputation resulting from an advisor who fails to comply with the applicable rules.
 For purposes of this article, “financial advisor” and “advisor” refer to a representative of an RIA, BD, insurance company, bank or similar financial institution.
Michael P. Shaw, CRCP is Managing Director of Oyster Consulting. He previously served as CFP Board’s Managing Director, Professional Standards & Legal, and Corporate Secretary; and as Director of FINRA.