By Ryan Bradley
Your company's broker may not have to have your best interest in mind. This may come as a shock to some, but under the current rules, a broker only has to ensure suitability when they are selling insurance products or securities. If you are an entrepreneur or business owner, this fact can impact your employees and members of your team in a very profound way.
The stock market swings up and down so arbitrarily that unless you happen to have a supercomputer and the ability to participate in so-called “flash trading,” finding a return in the market is nearly impossible. Furthermore, traditional forms of investments such as CDs and highly-rated bonds are not currently providing a return necessary to ensure a comfortable retirement for most people despite the fact that the Federal Reserve is steadily increasing interest rates. Yet this backdrop provides an amazing opportunity for entrepreneurs to make a lasting impact on the financial future of their employees.
Founders wishing to help employees prepare for retirement by participating in company-sponsored plans, while achieving any level of comfort with their choices, are well-advised to seek the advice of a financial advisor or lawyer — but maybe not a broker. While the proposition is simple, choosing an advisor is anything but. Business owners are bombarded with a menagerie of individuals selling various products, usually from insurance companies and securities brokers. The individuals selling these products often represent themselves as “advisors” when in fact they are brokers with a very different standard of care.
The dichotomy of standards of care is commonplace in the world of attorneys, but not so much for entrepreneurs. Last year, the Department of Labor undertook a rulemaking process to raise the duty level of brokers and make them Fiduciaries. President Trump has ordered the DOL to re-examine this rule, but the intent was to “level the playing field” for investors saving for their retirement by allowing the peace of mind that comes from knowing that an adviser and now brokers have the best interest of the client in mind by creating a fiduciary standard.
The term "fiduciary" is defined generally as an individual in whom another has placed the utmost trust and confidence to manage and protect property or money. No doubt this is a high standard. Based on this definition, a fiduciary has the obligation to put the interest of the other (client) before his or her own. In brokerage terms, this means that the fiduciary must put the client, whether it be a business or an individual, before the commission. One would hope that any individual offering financial advice, services or products would abide by this standard anyway, but this is not the case. Therefore, while a registered financial advisor owes a fiduciary duty, insurance brokers and agents do not, and neither do securities brokers. This is the problem that the Department of Labor is trying to solve. But why is it even a problem at all?
Imagine a situation where a dispute arises between a securities broker and a well-intentioned entrepreneur who has instituted a company investment plan. The investments recommended must be suitable for investors, but they are not required by law to act in their clients’ best interests. Thus, any disputes between brokers and their clients are settled through an arbitration process. This deprives the client a right to access the court system. Further, in a world where insurance and securities and brokers are driven by larger and larger commissions, the tendency for the broker would be to maximize commission so long as the investment is “suitable” rather than do what is best for the client.
The proposed rule would be keyed off of the definition of fiduciary in ERISA and is primarily targeted at broker-dealers who manage retirement plans and advise individual clients. Since American investors have approximately $12 trillion invested for their retirements, the Department of Labor is the applicable rule-making body. To accomplish this end, the rule would likely focus on the Best Interest Contract, which essentially allows the broker to disclose fees and commissions to the client and receive an exemption from the fiduciary standard. Still, given that brokers are, at the end of the day, salespeople, simply disclosing the potential conflict of a high commission may not provide enough protection from a seasoned broker trained the art of sales.
Not surprisingly the broker dealer industry was outraged, arguing that the new systems required to monitor advisors and produce better disclosures for clients will cost a lot of money — some of which will almost certainly be passed along to consumers. Furthermore, as larger institutions driven by broker sales and commissions will leave the market due to increased scrutiny, investors will have the opportunity to explore other investment options such as fee-based models or even “robo-advisors” that deliver investment advice with minimal cost basis. The movement to alternative models to accomplish an established end is something that rings true for founders and entrepreneurs who have essentially built their careers on developing innovative solutions. This innovation, along with the Fiduciary Rule, will decentralize the retirement planning market resulting in more choice — and for entrepreneurs in the tech and data space, more choice means opportunity. This, of course, is all hypothetical in that the rule has not yet taken effect.
At the end of the day, the question to ask is whether a person acting as a financial advisor or planner for your company can give impartial advice if they are receiving a commission. No matter what the future holds for the Fiduciary Rule, founders and entrepreneurs are in many cases the gatekeepers for the financial security of their employees, and this function should not be taken lightly.
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Ryan Bradley is a lawyer, founder and consultant. Many hats, one goal-deliver value. Koester & Bradley, LLP, Bacaro.io, Profectus Health, White River Consulting.