The Economist posed an interesting question recently: What would the world be like if advisers had to act in their clients’ best interests?
Just as it was a surprise to consumers in Australia that financial planners didn’t already have to act in their clients’ best interests, and a specific provision had to be inserted into the Future of Financial Advice (FoFA) laws to that effect, it was a surprise to consumers in the US that retirement advisers didn’t already have to act as fiduciaries.
This came to light after the Department of Labour (DoL) proposed its so-called fiduciary rule, by expanding the definition of “investment advice fiduciary” under the Employee Retirement Income Security Act (ERISA) to make sure retirement advisers always act in their clients’ best interests. Until then, there was no such requirement.
It might have been surprising to consumers that in two developed economies with sophisticated markets, advisers were perfectly legally allowed to put their own interests first. But it’s not unusual. In the UK, too, in an example of where advisers’ interests have been put first, “payment-protection insurance” mis-selling has resulted in £27 billion ($45 billion!) being paid back to consumers.
The Economist ponders what the world would look like if everyone who works in finance had to follow something like the DoL rule or FoFA laws. “Putting clients first ought to be the principle underlying the provision of investment advice,” it says.
Incidentally, the DoL rule is again under threat as the US Congress weighs having another crack at getting rid of it. Interestingly, the adoption of fiduciary responsibility is being pursued regardless, not by legislators but by advisers themselves.
A broader definition
Since the DoL rule applies only to advice on retirement products, the CFP Board – the body that administers the Certified Financial Planner designation in the US – is pushing to have a broader definition of fiduciary duty incorporated into its code of ethics and standards of conduct. Its aim is to extend a CFP’s responsibility to act in the best interests of the client at all times when providing financial advice.
“Since the definition of financial advice is broader than the definition of financial planning, the draft revised Standards expands the commitment that all CFP professionals make to acting in their client’s best interest,” the CFP Board says. It goes on to provide a definition of what financial advice is (see box).
The Economist says it is important that advisers act as fiduciaries. Resistance to the idea, it says, comes mainly from those who argue that consumers should be able to make their own informed judgements about the cost and value of advice. But that overlooks a fundamental issue: most consumers can’t tell good advice from bad, as the Australian Securities and Investments Commission (ASIC) has found in shadow shopping projects in years past; assessing the price of services is often far more difficult than assessing the price of goods.
It doesn’t help that in the first place many advisers can’t adequately articulate the value of the service they provide. They often struggle with it for a simple reason: they don’t actually get paid for the service they provide. It’s difficult for a consumer to place a value on one thing if they’re paying for something else. If you only get paid for managing a client’s money then the implied value of all your other services is zero.
Goods versus services
The Economist observes that it’s easier to tell if a TV is any good or if you like the taste of a particular brand of baked beans than it is to make a judgement about a how good a financial planner’s service is.
In addition, a consumer can look at the price of, say, a washing machine at several retailers, and choose the best price, on a like-for-like basis. It’s considerably more difficult to make meaningful comparisons between services.
Goods carry a warranty under Australian consumer law that they are fit for purpose. But it can sometimes take years before a client knows if financial advice is good, bad or indifferent – and so consumers of financial planning services have to be treated differently from the buyers of washing machines.
The industry can’t hide behind caveat emptor, because consumers aren’t necessarily sophisticated enough to make good decisions, even on matters that potentially affect them significantly. A survey in the US, for example, found that about a third of consumers do not know that Obamacare and the Affordable Care Act are the same thing – so they can simultaneously support repealing Obamacare even as they support retaining the ACA.
If individuals can’t be assumed to operate as informed consumers, then someone must represent their interests. In financial planning, that someone is the professional financial planner, which is why best interests and fiduciary duties are being inexorably introduced in financial planning markets around the world.
In the US it’s the CFP Board, not lawmakers, pushing a fiduciary standard, which provides an insight into a self-regulatory mindset that Australian financial planners should note.
What is financial advice?
A. A communication that, based on its content, context and presentation, would reasonably be viewed as a suggestion that the client take or refrain from taking a particular course of action with respect to:
1. The development or implementation of a financial plan addressing goals, budgeting, risk, health considerations, educational needs, financial security, wealth, taxes, retirement, philanthropy, estate, legacy, or other relevant elements of a client’s personal or financial circumstances.
2. The value of or the advisability of investing in, purchasing, holding or selling financial assets.
3. Investment policies or strategies, portfolio composition, the management of financial assets or other financial matters.
4. The selection and retention of other persons to provide financial or professional services to the client.
B. The exercise of discretionary authority over the financial assets of a client.
Source: CFP Board Proposed Code of Ethics and Standards of Conduct, annotated.
TOPICS: best interests, code of ethics, Conflict of interest, Fiduciary duty, Financial advice defined, FoFA
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