The Four Different Types of Fiduciary Financial Advisors

SEPTEMBER OCTOBER FEATURE 2017

By Michael E. Kitces, MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL

he Department of Labor (DOL) disclosure- and transparency-oriented the Center for Financial Excellence fiduciary rule has heightened approach to fiduciary duty, but only for (CEFEX) certification.1 Tconsumer awareness of the investment advice and investment concept of fiduciary duty, but the reality management. The DOL fiduciary rule The bottom line is that there are many is that being a fiduciary (or not) isn’t impacts anyone giving advice on retire- different definitions of fiduciary duties, a singular concept. Conceptually, it’s ment accounts (not taxable investment and two advisors who are both “fiducia- about acting in the interests of the accounts), but it is more stringent in ries” might have very different fiduciary client, and honoring the fiduciary duties its limitations on conflict of interest. obligations. And unfortunately, given of loyalty and care, but not all regulators And the CFP Board requires that certifi- research showing that consumers strug- define (nor enforce) those terms cants adhere to a fiduciary duty, but the gle to understand even the difference consistently. requirement depends on specifically between fiduciary and suitability stan- whether the certificant is doing “financial dards, it’s unlikely that many grasp the This article explores four different types planning or material elements of finan- nuances of the different types of fidu- of financial advisor fiduciaries, includ- cial planning” for a client. ciary duty. ing registered investment advisors (RIAs) that are Securities and Exchange Meanwhile, organizations with a volun- Which means the fact that several differ- Commission (SEC) fiduciaries, DOL tary fiduciary standard for their advisor ent fiduciary rules can apply to financial fiduciaries serving retirement investors, members—such as the National advisors is leading to a new form of con- CFP® fiduciaries providing financial Association of Personal Financial sumer confusion. planning, and voluntary fiduciaries who Advisors (NAPFA) and the XY Planning decide to step up to honor private or Network (XYPN)—have their own defini- REQUIREMENTS TO CALL third-party fiduciary standards (see tions of when fiduciary duty applies, YOURSELF A FIDUCIARY table 1). and which conflicts are and aren’t per- FINANCIAL ADVISOR mitted. In addition, RIAs who are An RIA under the SEC and a broker One reason for varying fiduciary stan- struggling to differentiate as fiduciaries under DOL can both be fiduciaries, but dards is the fact that different industry —now that DOL fiduciary will apply the they’re not quite the same kind of fidu- channels are regulated by different over- rule to more advisors in the future—can ciary. In addition, advisors can be seers—each of which defines fiduciary look to pursue and opt in to even more subject to different regulators within dif- obligations in its own way. RIAs are stringent versions of voluntary fiduciary ferent channels, each with its own rules. overseen by the SEC and state regula- rules such as the new registry of the The variability in the fiduciary rules tors, which both have adopted a Institute for the Fiduciary Standard or ranges across the requirements to be a

Table FOUR TYPES OF FIDUCIARY FINANCIAL ADVISORS 1 Fiduciary Type Fiduciary Scope Fiduciary Limitations/Requirements SEC Investment Advice Disclose conflicts of interest DOL Retirement Advice Eliminate many conflicts of interest CFP Financial Planning Disclose conflicts of interest Membership Associations and Varies by Organization Varies by organization Voluntary Organizations

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fiduciary, the consequences if you fail to they simply require that all of them be fiduciary standard with application lim- live up to being a fiduciary, and even the disclosed and communicated transpar- ited to the conflicts of interest around scope of the activities that the fiduciary ently so that it’s not deceptive, fraudulent, the investment advice. requirement covers. or manipulative. This means you can have RIAs that have related businesses A DOL FIDUCIARY FOR In general, however, we’ll see basically offering insurance, real estate transac- RETIREMENT INVESTORS four different types of fiduciary financial tions, etc. Now we will contrast the SEC fiduciary advisors in the coming years, as dis- with a DOL fiduciary, governed by the cussed below. I highlighted this on my blog Nerd’s DOL fiduciary rule, which is different.7 Eye View in 2015 when CNBC featured AN SEC FIDUCIARY UNDER THE a list of the top fee-only RIAs, and nine First and foremost, the scope is differ- INVESTMENT ADVISERS ACT OF 1940 of the top 10 had related businesses ent. SEC fiduciary rules apply only to The first type of fiduciary is an invest- receiving insurance commissions.5 investment advice delivered as an RIA— ment adviser who is registered with the Those businesses and commissions had either SEC registered or state registered. SEC or as a state-registered investment to be disclosed, and we identified those DOL fiduciary rules apply any time adviser. For an RIA, fiduciary duty “fee-only” firms actually still getting investment advice is given in an advice comes about under Section 206 of the commissions precisely because every- relationship to a retirement investor. Investment Advisers Act of 1940 thing was explained in their ADVs. (Advisers Act).2 From the SEC’s perspective, the advi- A “retirement investor” could be a sors disclosed those activities, so it was 401(k) plan administrator, a plan partici- Technically, though, the Advisers Act okay. But it revealed that the firms pant (someone investing in the 401(k) doesn’t state that an RIA must be a fidu- weren’t actually fee-only fiduciaries— plan), or an individual retirement ciary. Instead, it states that advisors they were fiduciaries that also had account (IRA) owner—but the advice cannot engage in any acts that would be related non-fiduciary (and commission- given must be tied to a retirement fraudulent, deceptive, or manipulative based) businesses. account. For example, if someone works when they hold out to consumers. But in as a financial advisor with a client who SEC v. Capital Gains Research Bureau, Technically, it’s even possible for an RIA has a taxable brokerage account and an a famous 1963 U.S. Supreme Court case, to get commissions as an RIA.6 It’s not IRA, the advisor is only a DOL fiduciary it was determined that the requirement common, but there’s nothing that out- for the IRA and not for the other that advisors can’t be fraudulent, decep- right forbids SEC fiduciaries from account. The brokerage account might tive, or manipulative when they hold out getting commissions. It’s just that the be subject to the SEC fiduciary rule if to consumers effectively means that they most common form of investment- the advisor is an independent advisor have a fiduciary duty to their clients.3 related commission results from selling rep of an RIA, or it might not if the advi- a securities product, which goes through sor works for a broker–dealer. In other words, Section 206 of the a broker–dealer and isn’t under SEC Advisers Act specifies how advisors can standards. But nothing in the SEC rules This highlights the limitations around hold themselves out to the public—it’s for fiduciaries explicitly states that an the DOL fiduciary rule regarding scope. the handbook for how advisors can RIA can’t have commissions. However, the manner in which DOL advertise their services, and a fiduciary applies its fiduciary rule shows it to be duty is attached to it.4 Therefore, the Notably, though, the scope of the more stringent than that of the SEC in fiduciary nature of being an investment Advisers Act covers just investment actual application. advisor focuses on being clear and trans- advice, investment management, and parent with clients about what you’re the compensation advisors receive for SEC fiduciaries can have a relatively doing, what you’re charging, and any providing investment advice and invest- wide swath of conflicts, as long as potential conflicts of interest. Anyone ment management. It doesn’t cover the they’re disclosed in the ADV. But DOL who’s gone through the RIA registration sale of securities products, insurance fiduciaries are prohibited from many of FOUR TYPES OF FIDUCIARY FINANCIAL ADVISORS process has disclosed all outside busi- products, financial planning, tax advice, those conflicts. DOL fiduciary rules limit ness activities and potential conflicts of estate planning advice, or retirement advisor compensation if it would create Fiduciary Type Fiduciary Scope Fiduciary Limitations/Requirements interest in Form ADV to comply with advice. Thus, the SEC’s version of fidu- undue influence. DOL fiduciary rules SEC Investment Advice Disclose conflicts of interest these fiduciary requirements. ciary duty is fairly limited in scope and raise fiduciary concerns any time there’s DOL Retirement Advice Eliminate many conflicts of interest focus, at least for the typical comprehen- variable compensation. DOL fiduciary CFP Financial Planning Disclose conflicts of interest Note, however, that the SEC rules don’t sive financial planner. Its focus is on not rules consider the quality of the advice Membership Associations and prevent or stop advisors from engaging being misleading in advertising, making and whether it meets a best-interest Varies by Organization Varies by organization Voluntary Organizations in a lot of those conflicts of interest; it a transparency disclosure-oriented standard as well as the reasonableness of

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the compensation—in addition to an you are doing for the client.10 For conduct the way they can sue for a fidu- SEC-style requirement not to make instance, you can be a CFP non- ciary breach under the SEC or DOL, misleading statements. fiduciary order-taker just executing because the CFP certificant doesn’t sign client orders. That’s different from the a separate fiduciary contract with the Thus, the DOL fiduciary rule is much SEC’s version (where just being an RIA client. All the CFP Board can do is pri- more limiting to advisors (and arguably makes you a fiduciary), but similar to vately admonish you, publicly admonish more protective to consumers). For DOL (because once you’re giving you, suspend your marks, or revoke your instance, an advisor who has discretion advice, the fiduciary rule will apply). marks. This means that, at the end of the cannot have variable compensation day, even CFPs who commit drastic across a portfolio under DOL fiduciary, breaches of the CFP fiduciary standard which is a big difference from SEC can keep going as financial advisors— requirements, which require only that The key point to recognize just without “CFP” after their names. the variable compensation be dis- is that the DOL fiduciary closed.8 Likewise, RIAs who have VOLUNTARY FIDUCIARY discretion for managing stocks and rules prohibit some types STANDARDS—INVESTMENTS bonds are allowed to charge more for of transactions presumed & WEALTH INSTITUTE, NAPFA, the stocks than the bonds under the to be “too conflicted,” and CEFEX, AND THE INSTITUTE FOR SEC fiduciary rules, but forbidden to do THE FIDUCIARY STANDARD so by the DOL fiduciary rules when the the SEC allows many of A fourth type of fiduciary standard is advisor has discretion. them while simply one that applies to those who voluntarily requiring that they be state that they’re going to act as one and The key point to recognize is that the comply with a particular voluntary set of DOL fiduciary rules prohibit some types disclosed in Form ADV. standards. of transactions presumed to be “too conflicted,” and the SEC allows many of For example, those who take the fidu- them while simply requiring that they be The CFP fiduciary standard is also ciary pledge under NAPFA11 or groups disclosed in Form ADV. But these fidu- much broader in scope and coverage. such as XY Planning Network,12 organi- ciary rules apply in different situations. To be a CFP fiduciary, you must be zations that require members to pledge DOL pertains to retirement accounts doing financial planning, but once you to operate as a fiduciary with clients, (not taxable investment accounts), but it are, it applies to all financial planning commit to be voluntary fiduciaries. also applies to other types of invest- activities, including subsequent recom- Similarly, Investments & Wealth ments in retirement accounts including mendations. Thus, the CFP fiduciary rule Institute members commit to the annuities, which the SEC fiduciary rule is arguably the broadest fiduciary rule in Investments & Wealth Institute Code doesn’t cover at all. scope, because it applies to your retire- of Professional Responsibility, which ment advice, tax advice, insurance includes in its core values objectivity DOING FINANCIAL PLANNING advice, investment advice, and every- and the expectation that an Institute AS A CFP FIDUCIARY thing else under that financial planning professional will provide advice in the A third type of fiduciary rule can apply umbrella, whereas the DOL fiduciary client’s best interests.13 to someone who is serving as a fidu- rules are limited to retirement accounts ciary under the CFP Board’s Practice and the SEC fiduciary rules are limited to Note that some of these organizations Standards.9 investment advice and investment may have their own definitions of appro- management. priate fiduciary behavior and their own This fiduciary rule is different yet again. limitations on conflicts of interest. For First, it applies only to CFP certificants, On the flip side, although the scope of instance, NAPFA and XYPN are both not to anyone else who holds out as a the CFP fiduciary rule is the broadest, fee-only organizations, and their version financial advisor. More significantly, it it’s also the least enforceable. Because of fiduciary requires advisors to accept applies only within the scope of financial the CFP Board is not a regulator, it no commissions, whereas the SEC does planning: The CFP certificant must be doesn’t have the legal right to investi- not bar commissions (they are rare but providing financial planning or “material gate, compel witnesses, and subpoena not forbidden), the DOL fiduciary rule elements of financial planning” to be documents. It can ask you for informa- allows commissions (they are scrutinized deemed a CFP fiduciary. tion about a client complaint, and if you but not banned), and the CFP fiduciary don’t comply it can take away your marks, standard allows commissions as well. In other words, being a CFP doesn’t but that’s it. Consumers generally can’t Investments & Wealth Institute’s Code make you a fiduciary, it’s about what sue a financial advisor for breach of CFP of Professional Responsibility similarly

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2. 15 U.S. Code § 80b–6, Prohibited Transac- requires that all compensation—including Unfortunately, we know from the con- tions by Investment Advisers, https://www. commissions—be disclosed, but does not sumer research that most consumers law.cornell.edu/uscode/text/15/80b-6. 3. See https://www.sec.gov/divisions/invest- necessarily limit such conflicts of interest. don’t even understand the difference ment/ capitalgains1963.pdf. between fiduciary and suitability stan- 4. See https://www.law.cornell.edu/uscode/ text/15/80b-6. Another example of a self-imposed fidu- dards, much less SEC versus DOL 5. michael Kitces, 9 Out of Top 10 CNBC ciary standard is the Institute for the versus CFP versus voluntary standards. ‘Fee-Only’ Advisory Firms Not Actually Fee-Only? (June 3, 2015), https://www. Fiduciary Standard’s new registry, which So there is still room for fiduciary advi- kitces.com/blog/9-out-of-top-10-cnbc-fee- is being positioned as the most stringent sors to differentiate themselves, but it’s only-advisory-firms-not-actually-fee-only- 14 17 according-to-cfp-board-compensation- of fiduciary standards. This means that also a struggle to do so. disclosure-rules/. it imposes the most consumer- 6. michael Kitces, Can A Fiduciary Duty for Investment Advisers Co-Exist with protectionary requirements that advisors Accordingly, this is why lobbying Commissions? (January 27, 2015), https:// completely avoid conflicts of interest, around the fiduciary standard, and how www.kitces.com/blog/can-a-fiduciary-duty- for-investment-advisers-co-exist- with- rather than merely disclosing them and these rules are defined, really matters. commissions/. then moving on. Similarly, some advi- Because these standards are not all the 7. michael Kitces, Advisor’s Guide to DOL Fiduciary and the New Best Interests sors are getting voluntarily certified as a same in terms of consequences for advi- Contract (BIC) Requirement (April 11, CEFEX fiduciary, which also boasts one sors and protections for consumers. 2016), https://www.kitces.com/blog/ best-interests-contract-exemption-bice- of the more stringent self-imposed fidu- Perhaps someday we’ll adjust to a more and-dol-fiduciary-bic-requirements/. ciary standards and requires an annual uniform fiduciary standard that applies 8. This is even an issue for proprietary products in the portfolio (i.e., where they 15 fiduciary audit. evenly across all advisors and all circum- make more if they shift the client into their stances, although that has its challenges proprietary product); see Michael Kitces, How DOL Fiduciary Will Disrupt the Notably these are still purely voluntary as well.18 BlackRock and Schwab Robo-Advisors standards. You declare you will follow (May 12, 2016), https://www.kitces.com/ blog/schwab-intelligent-portfolio-and- them, and if you fail to do so, the worst- The fundamental point is that not all blackrock-futureadvisor-under-dol-level- case scenario most likely is just that types of fiduciary financial advisors are fee-fiduciary-rules/#disqus_thread. 9. CFP Board, Financial Planning Practice you get kicked out of the organization. the same, and this is likely going to be Standards, http://www.cfp.net/for-cfp- A few require that you, as a member an issue of contention and confusion in professionals/professional-standards- enforcement/standards-of-profession- voluntarily committed to fiduciary stan- the coming years. al-conductfinancial-planning-practice- standards. dards, must sign fiduciary contracts with 10. Michael Kitces, CFP Certification, Financial your clients, which opens you to being Michael Kitces, MSFS, MTAX, CFP®, CLU, Planning, and Fiduciary: Doing Versus ChFC, RHU, REBC, CASL, is a partner and the Being (December 10, 2012), https://www. sued by a client for a fiduciary breach, director of wealth management for Pinnacle kitces.com/blog/cfp-certification-financial- because you opted yourself into a fidu- Advisory Group, co-founder of the XY Planning planning-and-fiduciary-doing-versus-being/. ciary contract with them. This is a big Network, and publisher of the financial 11. nAPFA, https://www.napfa.org/. planning industry blog Nerd’s Eye View. 12. XY Planning Network (XYPN), http://www. difference from CFP fiduciary rules, Follow him on Twitter at @MichaelKitces. xyplanningnetwork.com/?__hstc=22091 7575.0e5a4887f1fa5b3d5e0a63c92efa which don’t require CFP certificants to 0d03.1497451273680.1497451273680.14981 explicitly create fiduciary contracts with The original version of this article first appeared onNerd’s Eye 65283709.2&__hssc=220917575.1.1498165 View, https://www.kitces.com/blog/the-4-different-types-of- 283709&__hsfp=3871031694. every client. That may change, however, 13. See http://www.imca.org/pages/Code- pending the CFP Board’s update of its financial-advisor-fiduciaries/. Professional-Responsibility and page 63 of 16 this issue. own Standards of Conduct. 14. Institute for the Fiduciary Standard, Best ENDNOTES Practices Affirmation Program, http://www. 1. Founded in 2011, the Institute for the thefiduciaryinstitute.org/best-practices/ SUMMARY Fiduciary Standard is a research and affirmation-program/. The bottom line is simply to recognize education institution—a think tank—whose 15. Center for Fiduciary Excellence (CEFEX), single purpose is to promote the vital https://www.cefex.org/. that there are different types of fiduciary importance of the fiduciary standard in 16. Michael Kitces, CFP Board Begins the financial advisors out there. Just saying investment and financial advice. http:// Process of Updating Its Fiduciary Standards www.thefiduciaryinstitute.org/. CEFEX is of Professional Conduct” (February 8, 2016), you’re a fiduciary doesn’t clarify for the Center for Financial Excellence; CEFEX https://www.kitces.com/blog/cfp-board- clients what your obligations are or are certified firms adhere to a standard repre- commission-on-standards-to-revise-cfp- senting the best practices in their industry. standards-of-professional-conduct/. not, nor does it clarify what you’re The standards include specific criteria that 17. Michael Kitces, If the Fiduciary Fight Wins, allowed to do or not. Fiduciary obliga- have been substantiated by regulation or Does Your Marketing Plan Lose? (April 29, written in consultation with leading firms. 2011), https://www.kitces.com/blog/if- tions can vary. Even the scope of what A successfully completed standards-based the-fiduciary-fight-wins-does-your- advice is subject to fiduciary duty (or assessment results in certification. This marketing-plan-lose/. is written assurance that the firm meets 18. Michael Kitces, Why I Do Not Believe the not) may vary. Simply saying you’re a the requirements of the standard. CEFEX SEC Should Create a Uniform Fiduciary fiduciary financial advisor does not nec- certified firms voluntarily undertake annual Standard for All Brokers and Investment audits by independent expert analysts. This Advisers (March 30, 2015), https://www. essarily mean you’re a fiduciary continually verifies their adherence to the kitces.com/blog/why-i-do-not-believe-the- applicable standard and is supplemental to sec-should-create-a-uniform-fiduciary- regarding all the ways you may engage oversight performed by regulators or finan- standard-for-all-brokers-and-investment- with clients. cial auditors; see https://www.cefex.org/. advisers/.

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