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Is Your Investment Advisor Subject to the Fiduciary Standard?

by Kelli E. Madigan, Shareholder

Department of Labor proposed new more stringent rules on persons giving investment advice, including retirement account advisors, broker-dealers, and insurance agents.  Specifically, the new rules are an expansion of the definition of “fiduciary” and a modification of the existing “fiduciary standard” under the Employee Retirement Income Security Act.  The expanded definition of fiduciary would now include many investment advisors, such as 401K plan advisors, IRA investment advisors, broker-dealers and insurance agents, to whom the fiduciary standard did not previously apply.

These advisors will now be held to a standard which is in the “best interest” of their client rather than simply advice that is “suitable” for that client.  Public hearings were held at the end of August and it is anticipated that the new standards will be finalized in early 2016. 

The current standard by which these advisers operate requires that any investment is “suitable for a client at the time of the investment”.  Under the suitability standard, investments must fit a client’s investing objective, time line and experience, at the time the investment is made.  But there is no continuing obligation to monitor changes in the client’s objective, time line or experience, and thus no obligation to provide on-going advice about changes in the investment strategy.  In addition, there is no obligation to disclose conflicts of interest between the advisor and the client.  Thus, nothing to prevent an advisor from suggesting that the client invest in something that produces the highest compensation to the advisor so long as the investment is suitable to the client. 

Because the suitability standard is a lower standard, giving advisors more discretion in what investment strategies and products are suggested to a client, the suitability standard leaves plenty of room for advisors to suggest investments that fall within the suitability standard but produce the highest compensation to the advisor.  Furthermore, in the absence of any requirement to disclose conflicts of interest, a client may never know whether the advisor’s compensation or the client’s best interest is the driving force behind the recommendation.

For these reasons, the proposed new regulations would impose a “fiduciary standard” on a broader class of advisors which standard requires an investment advisor to have in mind the best interest of the investor, rather than the advisor, at the forefront of the investment advice.  When looking at the array of investment options for a client, a fiduciary would be required under the fiduciary standard to recommend the one that is in the best interests of the client, even if it meant reduced compensation to the advisor.  A failure to do so could result in the advisor or the advisor’s firm being held liable for a breach of its duties. 

In short, under the new proposed rule anyone providing individualized investment advice would be a fiduciary and obligated to put their clients interest ahead of their own, which would mean providing impartial advice in the client’s best interest and not accepting payments which create conflicts of interest unless they qualify for exemption.  New exemptions include the “best interest contract” and

the “principles-based exemption,” along with the previously existing “prohibited transaction exemption”.  The exemptions are intended to allow the continuation of certain revenue sharing and fee arrangements among investment advisors

While these proposed changes are not the same as the financial reforms proposed in 2010, they are intended to address the same concern - the protection of a middle-class American’s retirement plan from unknown and undisclosed investment fees.

Kelli Madigan is a shareholder with Mathis, Marifian & Richter’s (MM&R) Belleville, Illinois office, who focuses her practice in business law, estate planning, taxation, real estate and banking.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.

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