Don’t buy stocks at the butcher
Early vague concepts of “fiduciary” appear in Hammurabi’s Code and the Bible. The Romans were the first to coin the word fiduciary derived from the root fide meaning trustworthy or faithful (e.g., confidence, federal).
In modern English, a fiduciary (both noun and adjective) is expected to put the interests of their clients or beneficiaries before their own or the company’s. It’s is a very high standard of care with well-articulated duties and responsibilities. Fiduciary standards contrast with marketplace transactions at your local butcher, for example, which have more modest ethical expectations: caveat emptor.
Fiduciaries are everywhere. Your real estate broker is a fiduciary. You are a fiduciary to your spouse. An estate executor and the trustee to a 401(k) is a fiduciary. In 1942, the supreme court found the federal government breached its fiduciary duty to indigenous peoples for paying off tribal leaders rather than ensuring aid was distributed to the population.
Many popular consumer financial advice websites (1,2) imply that you need only ask your advisor to confirm they are a fiduciary verbally as if it’s a magic spell of protection. Without enforcement, “fiduciary” is just a word.
These days, if you are seeking financial advice, you’d be hard pressed to find someone who doesn’t describe themselves as a fiduciary somewhere in their materials. At the risk of sounding sanctimonious, which I assure you I am not, there are too many ersatz, weakly-enforced fiduciaries out there. It’s just too hard for consumers to know what level of protection they are truly getting.
The best fiduciary standard on Wall Street comes from the incredibly important Investment Company Act of 1940. This Act, along with its sibling the 1933 Securities Act was written in the aftermath of the stock market plunge and form the basis of our capital market regulatory structure. Those Acts remain the strongest restraints on Wall Street power over the American public.
Clarified by the Supreme Court in 1963, the 1940 Act created a special professional license with fiduciary responsibility “to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment advisers against the stigma of the activities of these individuals…”
It’s called a Registered Investment Advisor or RIA. Lifetime Financial is an RIA. If you are working with an RIA, fiduciary status applies to all financial advice given at the company and is always in effect. It has the best regulatory enforcement and U.S. court remediation. It’s the best standard you can get.
Except when it’s not. There is a huge loophole.
The 1940 Act doesn’t require that all investment advice be given by fiduciary RIAs. It explicitly exempts minimally registered Wall Street salespeople like insurance agents and stockbrokers from whom you bought your stocks until the 1990s when they were disintermediated by discount brokers. These salespeople are still around and are legally held to a lower standard*. Worse, they can freely represent themselves as financial advisors and fiduciaries.
The weak rationale for this is that “consumers deserve a choice” between a salesperson and a professional when it comes to investments. I suppose it would be acceptable enough to offer a choice if consumers could tell the difference between a stockbroker and a fiduciary advisor at an RIA. It’s not so easy. They all look the same. They all use “financial advisor” (or wealth manager or similar), and many will claim they are fiduciaries.
The SEC is making this issue even worse. In 2005, they made a decent attempt to deal with it, but it was overturned by courts on a technical flaw. Since then, they have pursued a controversial strategy to encourage former stockbrokers (employed at “Broker-Dealers“ or B/Ds) to also register as fiduciary RIA’s. These are called hybrid RIAs and are, as the name implies, part RIA and part Broker-Dealer (stockbroker). Hybrid RIAs are where (60%) of financial advisors work.
I guess the SEC regulatory argument is that the RIA fiduciary standard is better, so let’s get the stockbrokers and insurance agents registered as fiduciary RIAs. That would work if they transferred licenses, but they get to keep both! As a hybrid RIA employee, they can represent themselves to clients as a fiduciary professional investment advisor and then switch hats to the non-fiduciary stockbroker role without acknowledging the change in fiduciary status to the client (except in the fine print). Unscrupulous ones can even double dip and bill both sides. This is clearly a loophole!
Many hybrid RIAs are good, but it’s also where the old culture of Wall Street lives on, under the pretense of being a fiduciary financial advisor. An often cited research paper found that industry mechanisms for (hybrid RIA) advisor self-regulation are badly failing. Unsurprisingly, hybrid RIAs also have the highest fees.
The SEC says they are working to limit these bad practices at hybrids, but they wouldn’t have to if it were clear to consumers whether they were with a stock salesperson or getting fiduciary financial advice. Even better, just make everyone a fiduciary already. After all, who buys stocks at the butcher?
*For years their standard was called suitability and in 2019 it was upgraded to something slightly better called best interest. Best Interest may be better than a used car salesman-level of marketplace ethics, but the law is making it very clear that it isn’t fiduciary advice.
