Carnegie Investment Counsel Blog

Understanding Best Interest Rule: A Wolf in Sheep's Clothing?

Posted by Gary Wagner on Jul 30, 2019 9:45:00 AM

Best Interest Rule A Wolf in Sheep Clothing

Just a few years ago, the terms “fiduciary” and “fiduciary advisor” had little meaning to the general public.

But knowledge of these words spread when the Department of Labor (DOL) issued the fiduciary rule and proposed all ERISA investment accounts be managed as a fiduciary.

The fiduciary rule would have required any advisors who offer retirement advice to act in their clients’ best interest. It had widespread ramifications for brokers and insurance agents who traditionally push self-serving, high-commission products, with little or no regard for the clients' best interest.

Broker-Dealers Do Not Follow the Fiduciary Standard

Let’s break this concept down a little: In general, at a very high level, the financial services world is made up of two categories:

  • Firms that sell products (the broker-dealer model) and
  • Firms that engage in financial planning and investment advice (the advisor model)

From a high-level perspective, SEC Registered Investment Advisers have been held to a fiduciary standard of care when providing investment advice, while broker-dealers have been held to a “suitability” standard of care.

Ultimately, the fiduciary rule was challenged, so the status quo could remain for Big Wall Street. Then, in June 2019, the SEC issued “Regulation Best Interest.” This allows brokers to tell clients that they provide advice that is in the clients’ “best interest” without registering as fiduciary advisors.


Why You Need a Fiduciary Advisor

Even with the demise of the fiduciary rule, the proverbial cat is out of the bag. Public awareness around the fiduciary standard continues to grow. Investors are becoming more aware of the importance of hiring a fiduciary advisor to manage their investments.

More and better information continues to flood the market. This helps educate investors on the differences between advisors and empowers them to make more educated decisions when hiring one.


Is an RIA a Fiduciary?

Many investors are moving towards Registered Investment Advisors (RIAs), who abide by the fiduciary standard under the Investment Advisers Act of 1940.

The act requires RIAs to place the best interest of the client first, always seeking to avoid conflicts of interest.

In other words, RIAs are required to act as a fiduciary. Registered Investment Adviser firms, like Carnegie Investment Counsel, receive compensation in the form of fees for providing financial advice and investment management. This arrangement helps to avoid conflicts of interest.


Regulation Best Interest: A Win for Brokers?

The DOL rule also seemed to offer an opportunity for regulators, who serve the investing public, to clarify confusion around the differing standards of broker-dealers and registered investment advisers.

However, requiring brokers to adhere to the fiduciary standard was just not feasible. That’s because brokers gain rewards and incentives for offering various types of services and products to their clients, in other words, creating conflicts of interest.

“Regulation Best Interest” consists of a whopping 771 pages, so we won't attempt to explain the fine details here. Though this SEC ruling may have the guise of a step forward for consumers, it has genuinely just added confusion. And, it’s been called a "big win for brokers and large financial services” (Forbes: SEC Brings Increased Confusion For Investors With New 'Best Interest' Rule).

An excerpt from the final rule follows: "For example, an investment adviser's fiduciary duty generally includes a duty to provide ongoing advice and monitoring, while Regulation Best Interest imposes no such duty and instead requires that a broker-dealer act in the retail customer's best interest at the time a recommendation is made." (SEC Regulation Best Interest).

The key phrase to note is "at the time a recommendation is made." After that immediate time, will the account be monitored for continuous improvement? Are the investment choices being weighed as to when to sell or make changes to remain aligned with client needs? What if client circumstances change and the investments no longer support their goals? Applying discipline to answer these questions is where an RIA earns his or her fee. (In the spirit of full disclosure, a broker may agree in writing to provide ongoing advice, but this is rare.)


The Benefits of Working with an RIA

Regardless of changing regulations, we believe that the core nature of a relationship with a broker versus an RIA remains mostly unchanged. While broker relationships are typically transaction-oriented and temporary, a relationship with an RIA is constant and ongoing.

A fiduciary advisor does not receive incentives or rewards for selling or trading particular products or services. When selecting advisors, it's crucial for you to ask them how they get paid. Be aware if the answer is vague or confusing. Fee-only is the most straightforward form of advisor compensation. It's a transparent model that promotes trust and helps remove conflicts of interest.

So, in our opinion, we urge caution when seeking financial help. The advice you receive may come in the form of a "sheep" that seems harmless and unassuming. It's the wolf lurking around the corner that should cause you concern.


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Topics: Investment Management

Gary Wagner

Written by Gary Wagner

Gary Wagner is Principal and Chief Operations Officer. He also works directly with clients to provide investment and strategic wealth advice. Gary sits on Carnegie’s Investment Committee and also manages the firm’s strategic initiatives and operations.

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