ingraining fiduciary principles into your financial planning practice duane r. thompson, aifa®...

Ingraining Fiduciary Principles into Your Financial Planning Practice

Duane R. Thompson, AIFA®Senior Policy Analyst, fi360

Session Overview

• The fiduciary standard exists for the benefit of society, professionals, and, most importantly, the individuals who rely upon fiduciaries.

• The core fiduciary duties of loyalty and care are the ethical foundation underlying laws, regulations, and professional standards governing planning practitioners.

• Regulatory developments in particular shape the fiduciary standard and affect your planning activities.

• This session is based upon FPA’s “Fiduciary Implications of Financial Planning” program.

Learning Objectives

• Understand fiduciary roles, responsibilities, and regulations as applied to financial planners.

• Recognize the benefits to client and planner that can be achieved by properly embedding fiduciary processes in a financial planning practice.

…[W]e cannot do everything ourselves; different people are more capable in different matters.

…[I]n cases where we ourselves cannot be present, the vicarious faith of friends is substituted; and he who impairs that confidence, attacks the common bulwark of all men, and as far as depends on him, disturbs the bonds of society…

–Cicero, 106-43 BC, Oration for Sextus Roscius of Ameria

Historical Perspective

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Professional Expectations of Fiduciaries Remain High Today

“A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor most sensitive, is then the standard of behavior [for fiduciaries].… Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the ‘disintegrating erosion’ of particular exceptions. … [The fiduciary standard] will not consciously be lowered by any judgment of this court.”

- Judge Benjamin CardozoMeinhard v. Salmon, 1928

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Common Law and Statutes Define Fiduciary Obligation

© 2013 fi360 Inc. All Rights Reserved

Anglo-American

common law

Common law of trusts

State trust laws

Congress ERISAAdvisers Act

Fiduciary Standard

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The Fiduciary Standard Continues to Evolve


Property

Dispute

Case Law Precedent

Court Interpretation

Congress Passes Statute

AgencyRule

Enforcement or Lawsuit

Court Interpretation

19th Century 20th Century

Fundamental Fiduciary Duties – Loyalty and Care

•Loyalty – Obligation to serve the client’s best interests

• Care – Obligation to act with the skill, care, and good judgment of a professional

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Fiduciary Standard

Duty of Loyalty

Avoid / Manage Conflicts

Disclosur

e

Proxy

Policy

Principal Trades

Duties of Loyalty and Care

Best Execut

ion

Reasonable

Fees & Expen

ses

Suitability

Duty of Care

Safeguard Client

Assets, Privacy

Procedural Prudence

Due Diligence

Monitoring

Record-Keeping

Duties Associated With the Fiduciary Standard

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Duty of Loyalty – Financial Planning Applications

• Focus on the client’s best interests when researching client’s situation and financial goals.

• Develop recommendations based solely on the client’s goals and objectives.

• Identify and disclose direct and indirect sources of compensation.

• Document how conflicts are resolved in favor of the client.


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Duty of Care – Financial Planning Applications

• Understand basic requirements of the law and regulations.• Act consistently in accordance with fiduciary principles when

laws or rules do not specifically address appropriate conduct.• Apply a consistent data-gathering process to address all

subject areas in the scope of engagement.• Employ a prudent due diligence process to select third-party

service providers. • Suitability of investment advice -- focus upon a prudent

investment due diligence process as opposed to chasing performance.


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How Does Fiduciary Status Typically Arise?

1. “Named fiduciary” in trust or ERISA plan documents

2. Provide investment advice in a professional context3. Exercise discretion over client property4. Have the authority to delegate duties to a co-

fiduciary


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Fiduciary Roles

• Stewards – manage the overall decision-making process

• Advisers – provide advice that is material to decision-making in a professional context (with compensation, based upon superior skill).

• Investment Managers – make investment decisions and select the individual securities to implement a specific investment mandate


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Functional Fiduciaries

• It’s not what you call yourself that’s decisive, it’s what you do.

• If you exercise discretion or give personalized advice for compensation, you are a fiduciary.

• You are a fiduciary to the extent you perform fiduciary functions.


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GAO Report on Financial Planning

• Dodd-Frank Wall Street Reform Act called for GAO Study.* • Conclusions of the GAO Report:

– No direct regulation of financial planners exists per se and no additional layer of regulation over financial planners is warranted at this time.

– Financial planners are primarily regulated by federal and state investment adviser laws.

– Financial planners are subject to broker-dealer and insurance laws when “acting in those capacities.”

*Government Accountability Office Report submitted to Congress in January 2011


SEC, State Definition of RIA includes Planners

Financial planners are RIAs – therefore you are an investment fiduciary.

• SEC Interpretive Release 1092 (1987): planners give investment advice; must register as IAs.

• State “holding out” provisions capture planners for their investment advisory activities

• Planners receive asset management fees• Most complaints focus on investment losses• Regulator inspections focus on investment activity

IN Definition of an Insurance Consultant

‘Consultant’ means a person who:(A) holds himself or herself out to the public as being engaged in the business of offering; or(B) for a fee, offers;any advice, counsel, opinion, or service with respect to the benefits, advantages, or disadvantages promised under any policy of insurance that could be issued in Indiana.

Exemptions:– Attorneys– Insurance producers– Trust officers– Actuaries and CPAs

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Fiduciary Duties Defined in Case Law

Investment advisers are fiduciariesSEC v. Capital Gains Research Bureau (1963, U.S. Supreme Court) –

Investment advisers are fiduciaries to their clients. Unlawful for adviser to engage in fraudulent, deceptive, or misleading conduct.

Disclosure of conflicts/best executionIn the Matter of Arleen Hughes (1948, D.C. App. Ct.). Acting as fiduciary,

dually registered adviser failed to disclose adverse interests, including securities sold out of inventory, and best price execution.


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Fiduciary Obligations of CFP Certificants

“A certificant shall at all times place the interest of the client ahead of his or her own. When the certificant provides financial planning or material elements of financial planning, the certificant owes to the client the duty of care of a fiduciary as defined by CFP Board.”

-- CFP Board Standards of Professional Conduct, Rule 1.4


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OK, so I’m a fiduciary. Now what?

• Responsibilities can come from contractual obligation, statutes , regulations or common law court decisions.

• Determining that you are a fiduciary leads to other key questions:*

– To whom am I a fiduciary?– What are my guiding principles (duties) and responsibilities

(scope of engagement)?– What are the consequences of failure to exercise fiduciary

obligations?

* SEC v. Chenery, 318 U.S. 80, 85-86 (1943)


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Fiduciary Standard Varies by Law and Regulation

Federal

ERISA Fiduciaries Advisers Brokers

Federal

State

Organizational

Individual

State

Organizational

Individual

* Source: Mercer Bullard, fi360 2010 Annual Conference Presentation

Fiduciary Responsibility under ERISA and the Advisers Act

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Factor ERISA Fiduciary Investment Adviser

Conflicts of interest Prohibition and disclosure Disclosure and client consent

Self-dealing Generally prohibited Disclosure and client consent

Private right of action

Participants may sue fiduciaries for violating ERISA; tax and

financial loss penalties

No private right of action for violation of the Act;

restitution of advisory feesDuty to diversify Plan must generally offer

diversified investment optionsBroad discretion

Compensation Must be reasonable Negotiable

Fidelity bond Required Not required


Registered Representatives – Beefed-up Suitability Rule

Revised FINRA suitability rule (July 2012) adds fiduciary elements:

• Time horizon, liquidity added as factors• Enhanced due diligence on customer profile

o ageo investment experience o risk tolerance

• Recommendation to hold a security (not just buy or sell)• Includes investment strategies in addition to individual securities• Recommendations consistent with ‘customer’s best interests’

Financial Planner Oversight

Securities and Exchange Act of 1934

Investment Advisers Act of 1940

ERISA

Bank and State Trust Laws

State Insurance Consultant Laws

Federal and State Common Law

FPA Standard of Care

• Put client’s best interests first• Act with due care and utmost good faith• Do not mislead clients• Provide full and fair disclosure of all material

facts• Disclose and fairly manage all material conflicts

of interest

Loyalty

Care

Core Fiduciary Duties

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CFP Board Definition of a Fiduciary

“One who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client.”

-- Standards of Professional Conduct, Terminology section


CFP Board Definition of a Conflict of Interest

“A conflict of interest exists when a [CFP®] certificant’s financial, business, property and/or personal interests, relationships or circumstances reasonably may impair his/her ability to offer objective advice, recommendations or services.”

-- Standards of Professional Conduct, Terminology Section

CFP® Rules of Conduct Related to Conflicts

Rule 1.4 – At all times place the interest of the client ahead of his or her own (baseline standard of care). When providing financial planning services, act in a manner the planner reasonably believes is in the best interest of the client (CFP Board’s fiduciary definition).

Rule 2.2 – Requires timely disclosure of all conflicts having potential to materially affect a relationship when CFP® professional knows, or should have known, of a conflict.

Rule 4.1 – Requires the CFP® professional to treat clients fairly and services with integrity and objectivity

Best Practices* – acknowledgement and consent from a client should be obtained– conflicts may not all be handled through disclosure

*Source CFP Webinar on Managing Conflicts of Interest , February 2013

Benefits of Achieving Fiduciary Excellence

• Consumer expectations– all financial services agents act in best interest of clients

• Client benefits– superior knowledge, skill, and/or management of a professional

• Professional benefits– client satisfaction– competitive advantage over non-fiduciaries– personal satisfaction as a true professional

Benefits of Integrating Fiduciary Principles into Your Practice

• Enhance client satisfaction: Clients seek trustworthy and competent advice above all else.

• Mitigate risk: Reduce regulatory, litigation, business, and PR risks.

• Increase practice efficiency: Well-defined fiduciary processes aligned to generally accepted investment theories are efficient and effective.

Questions?

Duane Thompson, AIFA®Senior Policy Analyst, fi360

www.fi360.com

ingraining fiduciary principles into your financial planning practice duane r. thompson, aifa®...

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