The Price We Pay for Keeping Our Promises

Recent studies show that most Americans cannot tell the difference between various investment products available for retirement accounts. That, and most Americans don’t know whom to ask for advice and how much to pay for that advice. Whether it’s stocks, bonds, variable annuities, mutual funds or any number of ‘alternative investments,’ that confusion translates into poor investment returns and billions of dollars of extra fees and expenses that is wasted by retirees every year.

The fifth Circuit Court recently struck down the proposed Department of Labor Fiduciary Rule, which was intended to make advice more accessible and cost effective for retirees.  According to the now defunct rule, all advisors were expected to act as fiduciaries, where previously only Registered Investment Advisors (RIAs) were. Americans are still in the dark in terms of retirement plan choices and costs, and there is no alternative plan to provide guidance in the future.

As the investment advisory business has evolved over the last 50 years, the providers of advice and products – and the way that each is compensated – have evolved as well. As the costs of trading individual securities have come down and access to markets has opened up to individual investors, the securities industry has developed a dizzying array of investment products – many with hidden fees and high commissions. Today, there are two distinct types of advisors – RIAs and brokers – who are compensated – and ethically constrained – by the advisory business model under which they operate.  The DOL’s new rule aims to bridge the gap between them, and create uniformity.

One advisory model is that of the Registered Investment Advisor (RIA).

RIAs are generally compensated via a set percentage of the value of the assets that they oversee. Northstar is such an advisor. Under this model, the interests of the client and the advisor are aligned in a way that is mutually beneficial. As the clients’ assets grow, the fees earned to manage those assets grow as well. The Securities and Exchange Commission (SEC) already holds RIAs to a fiduciary standard. The traditional fiduciary standard states that an advisor has a duty of loyalty to the client and must put clients’ interests ahead of their own.  For example, under the fiduciary standard, an advisor cannot buy securities for his or her personal account prior to buying them for a client and is expected to adhere to certain standards of best execution when choosing a broker to execute trades for clients.

Another advisory model is the broker model. Generally, brokers are paid via sales commissions that accrue from transactions that are executed on behalf of the client. Advisors who earn commissions are usually associated with a broker-dealer, which is a firm that provide products and a platform for advisors to sell to clients. Such advisors are subject to a “suitability standard.” The Suitability Standard requires that a broker make suitable recommendations based on a client’s personal situation. Thus, a broker can choose a higher fee investment from among several ‘suitable’ choices.  Absent from the broker model is the imperative to demonstrate loyalty to the clients’ best interests.  A key distinction is that a broker’s duty is to the broker-dealer he or she works for, not necessarily the client served.

The conflicts of interest that have been indulged under the brokerage business’ suitability standard are estimated to cost individual investors about $17 billion a year in fees and commissions that are paid to brokers and agents. The now-defunct DOL fiduciary rule would have lowered that by a substantial amount. As a result, reasonably priced Investment advice would have been available to a broader range of retirees.  Of course, Northstar clients have known all along that they’re getting the better deal. Too bad the rest of the market won’t be as well served.

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