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Choosing a Financial Advisor in Light of the New Fiduciary Regulations

It is revealing that Prof. Kent Smetters, a faculty member at Wharton, one of the country's best business schools for studying finance, is a strong proponent of "Fee-Only", fiduciary financial advisors.  You can read his recommended criteria for choosing a financial advisor here.

Among those criteria, he includes the following explanation:

"Note: the term "fiduciary" is now being reinterpreted by the commission-based broker-dealer industry to mean something less than its original meaning, thereby allowing the industry to continue with hidden commissions.  As a result, we only take advisors who refuse commissions."

This sidebar is a reference to the recent Dept. of Labor regulations that impose a form of fiduciary obligation on advisors who provide advice on retirement accounts. These new rules do not, however, prohibit commissions or other revenue-sharing arrangements.

Nevertheless, it's striking that these new regulations are already causing major upheavals in the financial industry:

1.  Apparently Morgan Stanley has formed an internal "Fiduciary Standard Help Desk", designed to help its brokers comply with the new rules.  Presumably, some of their brokers are so unaccustomed to putting clients' interests ahead of their own that they need guidance on how to do it.

2.  The nation's largest independent broker-dealer, LPL Financial, recently reported that its commission revenues last quarter dropped 13% from a year ago.  Sales of commissioned mutual funds and variable annuities both contributed to this fall, but the biggest culprit was a 72% drop in commissions from sales of alternative investments, mostly non-traded REITs.  It's revealing to see how difficult it is for a broker to make a sales pitch for a non-traded REIT when a client's best interests actually have to be considered.

3.  An insurance industry trade group predicts that sales of fixed-index annuities will fall by 30-35% next year because of the new regulations on financial advice.

Like non-traded REITs, fixed-index annuities offer outsized commissions to the salesmen who hawk them.  And similarly, in a fiduciary environment it's becoming much more difficult for brokers and insurance agents to make a case for investing in these pricey, complex, and illiquid products.

In years past, it was easy for many conflicted brokers and insurance salesmen to cynically claim they were acting in the best interests of their clients.  But now that rules, as well as the threat of penalties and financial liability, are in place to impose a fiduciary obligation (albeit in a somewhat limited and diluted form) on these "advisors", it is becoming increasingly clear which firms and products prospered the most when it was easier to take advantage of unwitting consumers.