CKBlog: Standards

Friday, October 06, 2017

The Dark Side of the Fiduciary Rule

Earlier this month, our VP of Investments, Lauren Quesada, was contacted by someone she has known for many years asking Lauren to review her investment portfolio. For the purpose of this post, we will call this person Annie. After a comprehensive review, Annie asked CastleKeep to manage her accounts and within days the account assets were transferred to Charles Schwab to be managed by our team.

Lauren played a huge role in Annie trusting us to manage her nest egg. But the reality is, I am not sure we would have had the opportunity to welcome Annie to CastleKeep had it not been for the Department of Labor’s (DOL) plans to implement the Fiduciary Rule.

Fiduciary Standard

The Fiduciary Standard is our version of the medical profession’s Hippocratic Oath. It requires an Investment Advisor to put their clients’ interest ahead of their own. SEC Registered Investment Advisors (RIAs) like CastleKeep operate under this standard. Most wire-house brokers (think Merrill Lynch, Morgan Stanley, UBS, Wells Fargo etc) do not, enabling them to sell high commission products to clients when more transparent, inexpensive, and efficient solutions may make more sense. And the Department of Labor wants to change that.

(For more info on the Fiduciary Standard, please read my previous post on the topic: “Rental Golf Clubs are Suitable”)

To be clear, the DOL has not finalized its framework, and the Fiduciary Rule hasn’t been signed into law. But one of the main objectives of the DOL is to reduce or eliminate the sale of high commission products such as annuities, fee loaded mutual funds, and non-traded REITS inside Individual Retirement Accounts (IRAs). Not surprisingly, in anticipation of this, many banks and wire-houses, including Merrill Lynch, Edward Jones, and LPL Financial, have begun to prohibit its brokers from selling such products inside client IRAs: “Bank of America Merrill Lynch tells advisers to stop selling mutual funds in brokerage IRAs now.”

The Pitch

Annie’s IRA had been managed by a broker at a large, well-known wire-house for many years. We will call him Jim. Annie never thought too much about the portfolio as it seemed to grow steadily over the years. But recently, something changed.

Jim started to call Annie, asking her to come in for a meeting. Eventually, she agreed. In the meeting, Jim advised Annie that while her mix of bond funds had served her well over the years, it was time to make some portfolio changes. He described an investment which, among other things, provided a death benefit to her heirs and offered guaranteed monthly payments for life. Despite the fact that he would not supply her with a prospectus or paperwork describing this investment, it’s clear to me he was pitching an annuity.

“What changed? Why now?” Annie wondered. She had been pleased with the portfolio to date and she had no current need for guaranteed income. Jim was steadfast, insisting this investment was the perfect vehicle for her. Annie refused to sign any paperwork in that meeting. Her next move was to seek out Lauren’s counsel.

The $20,000.00 Commission

What Annie didn’t know is had she signed the paperwork and purchased the annuity, Jim likely stood to “earn” a commission somewhere between $15,000.00 and $20,000.00. How do I know that? I used to sell annuities while employed at a wire-house and 5% to 7% up-front commissions are pretty standard. To be fair, maybe Jim was well-intentioned. Indeed, Annie tells us that Jim did describe the fees associated with the annuity and that he would stand to earn a commission but it was difficult for Annie to follow the details.

But what made Jim decide to attempt the annuity sale when he had a client who was comfortable and happy with his services?

DOL’s Intended Result

Clearly, the DOL has the right intentions. How could anyone argue with the premise of “always acting in your clients’ best interest”? But humans act in strange ways, especially when paychecks are involved. A well respected CEO once said to me, “you tell me how someone gets paid, and I will tell you how they will act.”  While I believe this is a universal truth in business, nowhere is it more accurate than in the investment management business.

So did Jim’s boss walk into his office recently and say, “Quick heads up. I’m hearing that the higher ups are going cut us off from selling annuities in IRAs soon. You may want to get some of those sales in now while you can”?  Did that cause Jim to scan through his client list for candidates then pick up the phone and call Annie? We will probably never know for sure. But having previously worked at a wire-house I can tell you conversations like these happen all the time.

So while I love the ideals behind DOL’s Fiduciary Rule, and I believe it will have huge positive impacts for clients in the long-run, I’m concerned that in the short term, we may just witness the opposite. The pending legislation may spur the underbelly of our industry to rush to juice their commissions while they still can. What would you do if your boss dangled $20,000.00 in front of your desk telling you if that you don’t act soon the opportunity would be lost? Would you pick up the phone?

The Challenge

So my challenge to you is to challenge your broker. When they recommend a new “strategy” or “solution,” ask them if their compensation will change if you agree to go along with their recommendation. If the thought of asking these questions gives you anxiety, copy, paste and send the following to your advisor:

I’ve been reading a lot about the Dept. of Labor’s plans to implement the “Fiduciary Rule.” Can you explain what that means? Do you operate under the Fiduciary Standard?

Worst case, you uncover a conflict of interest. Best case, you confirm that you are working with an honest, transparent professional.

Kudos to Annie for having the courage to seek a second opinion. She told us she feels more at ease now that she has a partner to guide her through the financial planning process. My concern is far too many unsuspecting investors may not have someone like Lauren in their life. Or perhaps they lack the courage to second-guess their broker, undeniably falling for the pitch.

Contact us if you don’t have someone like Lauren in your life as Annie did. My colleagues and I will shed light on how the Fiduciary Standard can be applied to enhance your financial picture.