“Are you legally required do what’s best for me?” Most people don’t ask the person giving them investment advice this key question, but they should. The answer is: it depends. There are a lot of different ways investment advisors can be structured, and that affects their legal obligation to you.
So why do we at LNWM say we always act in our clients’ best interest? LNWM’s Rob Hille, General Counsel and Chief Compliance Officer, explains.
Rob, what are investment advisors legally required to do for their clients?
Rob: It depends on how they’re set up. Currently, the thousands of US stock brokers, many of whom work at big Wall Street firms, are regulated by the Financial Industry Regulatory Authority (FINRA). They’re legally obligated to recommend products that are “suitable” for the client. “Suitable,” however, doesn’t necessary mean “in the best interest of.”
For instance, let’s say a broker recommends a fund that’s 60% stocks/40% bonds, since you’re near retirement. What if that fund has a 5% sales fee plus a 2.5% annual management fee? These high fees would put you at a great disadvantage relative to a lower-cost fund with a similar structure and track record. But that would be OK. The pricey fund can still be deemed suitable even though it’s probably not in your best interest.
So what types of advisors are legally required to act on their clients’ best interest?
Rob: Two types of financial entities have what’s known as “fiduciary duty,” meaning they’re legally required to act in the client’s best interest:
#1. Trust companies; and
#2. Registered Investment Advisors (RIAs), which are regulated by the Securities & Exchange Commission if they have client assets of more than $100 million.
RIAs typically charge a fee for their services (hourly, fixed, percentage of assets). Some also make a commission on products they sell to clients, if they’re what’s known as a “hybrid,” a combination of RIA and broker/dealer. Either way, RIAs must disclose how they’re compensated. Another thing that distinguishes RIAs is that their assets are held by a third-party custodian. This means that client money at an RIA is actually placed with a large financial institution that is independent of the RIA, creating another layer of oversight.
In the U.S., it’s estimated that 450,000 people are in the business of giving financial advice in some form. About 10% of them are RIAs, according to Boston-based Aite Group.
What is LNWM’s structure?
Rob: Laird Norton Wealth Management is a trust company and an RIA. So on both sides of our operations we are legally required to act in our clients’ best interests.
The majority of LNWM’s assets (around 67%) are in the Laird Norton Trust Company, which manages trust and investment accounts of various types. The rest of our client assets are in our Registered Investment Advisor (RIA), called Laird Norton Tyee Asset Strategies. Everyone here is paid to work for the best interest of the client, regardless of whether the client assets are in trust accounts or in RIA accounts. We are never paid based on product commissions or other incentives.
In 2014, the Financial Times ranked LNWM as one of the Top 300 RIA firms in the United States.
Any chance we’ll see the fiduciary standard applied to all investment advice?
Rob: Actually, the US Dept. of Labor has been trying to expand fiduciary duty so that it applies to anyone who manages IRA retirement accounts, in which Americans have a lot of money invested — around $8 trillion. This would require managers of IRA money to act in the client’s best interest. So the example of the high-fee fund I gave earlier could be legally challenged as not in the client’s best interest.
Studies show that advisors working on commission are much more likely to advise clients to switch from low-cost funds to higher-cost ones that pay advisors more. Poor advice like this costs Americans $17 billion a year, according to U.S. government estimates.
How do you define “in the client’s best interest”?
Rob: Keeping investment costs low is just one part of the equation. At LNWM, acting in the client’s best interest also means things like:
- Managing risk so it accurately reflects the client’s temperament, lifestyle and goals;
- Minimizing investment taxes;
- Making sure investments are aligned with estate planning; and
- Making ongoing adjustments as plans change.