Executive Summary
With the flurry of activity and attention surrounding the Department of Labor's fiduciary rule and whether it will be delayed or not, there has been a dramatic increase in media coverage around what it means to be a fiduciary, and a push for consumers to seek out RIAs over those who work at broker-dealers. Despite the fact that most advisors, at both RIAs and broker-dealers, are trying to do the right thing for their clients.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss why being a fiduciary matters, and why Series 7 licensees technically CAN'T be full fiduciaries to their clients without the DoL fiduciary rule.
The key issue is that the Series 7 exam is technically the "General Securities Representative Examination". This name is important, because it indicates that ultimately, the licensee is acting as a representative of the broker-dealer. In other words, a Series 7 license allows an individual to represent the broker-dealer in the sale of securities products to clients. This is why Series 7 licensees are referred to as "Registered Representatives" of a particular broker-dealer.
And as a representative of the broker-dealer, the broker technically has an obligation to serve the broker-dealer, not the client. This is why a broker-dealer can terminate a broker for outside business activity, or for soliciting a client to move with them to a new broker-dealer. In fact, technically the client isn't even a client of the broker's; it's a client of the broker-dealer's, and the broker is just the sales representative. That's why it's illegal for the broker to take any client information when changing broker-dealers!
Of course, in today's environment, the overwhelming majority of those working at a broker-dealer are dual-registered as a sales rep under the broker-dealer and working under a corporate RIA. Nonetheless, anytime the broker sells a product and earns a commission (i.e., using the Series 7 license), the broker is not a fiduciary, but a sales representative! Notably, these advisors are fiduciaries when they give under the RIA and are paid an advisory fee. But they are still effectively wearing two hats, and cannot be full fiduciaries while the Series 7 hat is on!
And the reason all this matters is because, if someone wants to take money from their clients by selling high-commission products to anyone they can, the suitability standard that applies to brokers is a relatively low caveat-emptor bar. But a fiduciary standard doesn't legally permit such behavior. That's why it matters - it's not about the already-good advisors who are doing the right thing, but about raising the bar to reduce the risk of bad brokers who try to do the worst they (legally) can. Which is why the focus on fiduciaries vs non-fiduciaries has morphed into a discussion of RIAs vs broker-dealers. Because the "easiest" way for the media to recommend avoiding a bad non-fiduciary (broker) is simply to recommend avoiding all of them.
The bottom line, though, is to recognize that Series 7 licensees are legally sales representatives. And if you don't like being treated as a salesperson, (re-)consider how your business is structured! Although ironically, if the DoL fiduciary rule does not get delayed, it may all soon be a moot point - as everyone working with retirement investors will be subject to the same fiduciary duty, regardless of their current business model! Ultimately, though, until brokers either voluntarily move to a new business model or are held to new DoL fiduciary standards, the reality will remain that you can't be a full fiduciary with a Series 7 license!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces!
With the flurry of activity surrounding Department of Labor's fiduciary rule and whether it will be delayed or not, there's been a huge increase in media coverage around what it means to be a fiduciary in the first place and why it matters for consumers. And as a result, more and more consumers seem to actually be asking questions about whether the person they work with is a fiduciary or not, which in today's market, favors the RIA channel, and puts growing pressure on those who work in insurance companies and broker-dealers.
In that context, I want to kick off this week's "Office Hours" with a recent question that came to me from an advisor friend who built his practice under...let's just say, a "well-known independent broker-dealer". We'll call him "Jim". So Jim sent me this message recently, and it said:
"Michael, I built my practice by doing the right things for my client from day one, and I've always acted as a fiduciary to my clients. It's just good business. Why do we have to make this about RIAs versus broker-dealers, instead of just talking about who's doing the right thing for their clients?"
Amen, Jim. Great question. I'm seeing this discussion come up more and more lately, particularly from those who work under a broker-dealer and really do try to give advice in the best interests of their clients, and maybe only use commission-based products when it's genuinely prudent to do so because it's actually what the client needs.
But here is the challenge and why it matters... because from the legal perspective, the nature of the relationship with a client really is different when you're under a broker-dealer versus an RIA. I know we like to all call ourselves "advisors", regardless of which channel we work in, but the reality is that, technically, you can't actually be a fiduciary to a client based on a Series 7 license.
Why A Series 7 Licensee Can’t Be A Fiduciary [Time - 1:46]
I realize that's a strong statement to make – that you can't be a fiduciary to a client based on a Series 7 license – so let me explain further.
The Series 7 exam, which is what almost everyone in today's world takes when they're going to work under a broker-dealer, is actually just a shortened label. The full name for the Series 7 exam is the "General Securities Representative Examination".
Now, the "general securities" part means the licensing exam pertains to any and all "general" types of investment securities. By contrast, the Series 6 exam is a "mutual funds and variable products securities representative". But the Series 7 is a General Securities Representative exam. Thus, the Series 7 licenses you to sell mutual funds and variable annuities, but also stocks and corporate bonds, annuities, direct participation programs, etc.
But it's the second part of the Series 7 exam title that matters here. It's the General Securities Representative Exam. Representative of what? Representative of the broker-dealer. In other words, when you take the Series 7 exam, quite literally, it's a license to allow you to represent the broker-dealer in the sale of its products.
That's why you have to be sponsored by a broker-dealer to take the exam, because you can't, working directly as an independent advisor with a client, sit for the Series 7 exam. You're a representative of the broker-dealer. They have to sponsor you to take the exam so you can become their rep!
Similarly, that's why you have to put on your business card, the footnote of your website, and any piece of paper you ever hand to the client, that disclaimer: "So-and-so is a registered representative of the Such-and-such broker-dealer". Because legally, you're not there to give advice to the client. In fact, it's not even actually your client. It's the broker's dealer's client, and you are a sales representative of the broker-dealer.
Now, I know that sounds harsh for some of you that are working in a broker-dealer. You may even be angry with me right now for calling you a sales rep. But please don't shoot the messenger. It's just the actual legal reality of how the laws are written.
In fact, the whole reason you're not subject to a fiduciary duty now as a Series 7 rep under the Investment Adviser's Act of 1940 is that the Adviser's Act has an exclusion that says if you work for a broker-dealer and your advice is solely incidental to the sale of brokerage products, you don't have to become an RIA.
So literally, the only way you avoid being an RIA under current law is that you have to not be in the business of giving advice and primarily be in the business of selling the products of your broker-dealer!
Brokers Are Obligated To Their Broker-Dealer Over Their Clients [Time - 4:30]
Here's why that matters from the perspective of this question being a fiduciary to your client... because when it's not your client – it's the broker dealer's client and you work as a sales rep for your broker dealer's products – legally, your duty is not to the client. It actually can't be. Your duty is to the broker-dealer that you represent.
That's why when you leave a broker-dealer, you can't take your client information with you. You can't take your client files. You can't take the financial plans. You can't even take a list of their account numbers. At best, the broker protocol only allows you to take basic names and contact information. And really, that's just because you can look it up online anyway at this point! It's barely private information!
Similarly, that's why even if you mention to your clients that you're planning to change broker-dealers, your broker-dealer can terminate you immediately with a U-5. It's not just because they're afraid you're going to leave and want to preemptively fire you. It's because soliciting clients for your new business while you're still a representative of their business is a breach of your employment contract with your broker-dealer. Because it's the broker dealer's client, and legally, you are a sales rep of the broker-dealer.
And that's why even under the Department of Labor's fiduciary proposal, as the broker, you would not actually be signing the Best Interest Contract with your client. The contract gets signed with the broker-dealer. Because, technically, the broker-dealer is the one with the client relationship, and the broker-dealer is the one that is going to be held to a fiduciary duty. Now, obviously if you work under a broker-dealer as their rep, if the BD has a fiduciary obligation, they will impose that expectation on you to also act as a fiduciary. But it's still subject to their oversight, because technically, you're still not the fiduciary. The broker-dealer is the fiduciary. You're the fiduciary's fiduciary rep!
Dual-Registered And Hybrid RIA Fiduciaries [Time - 6:15]
It's worth nothing that in today's environment, the overwhelming majority of those who work in a broker-dealer actually are dual-registered as a sales representative of their broker-dealer and work either under their corporate RIA or maybe a hybrid advisor with their own outside RIA.
In that case, you're effectively wearing two hats. One truly is a fiduciary under the RIA, and the other is as a sales rep for the broker-dealer. When you sell a product and generate an order commission, you're not an advisor or a fiduciary, you're a sales representative. When you separately give actual advice under the RIA and get paid an advisory fee, then you're actually operating as a fiduciary.
Although notably, even in the latter scenario, you're actually technically still a rep. You're an investment advisor representative, or IAR, of the corporate RIA, but that actually still means it's not your client. You must honor your employment contract with your RIA, first and foremost. But since the RIA is held to a fiduciary duty and they want you as their rep to honor that, they'll be held accountable, so you're held accountable as a fiduciary under their supervision.
Why Being A Fiduciary Is Different Than Just Acting Like One [Time - 7:11]
But here is the key point, in the context of the earlier conversation about why trying to do the right thing for your client and acting as a fiduciary is different than whether you legally are one...
It's pretty universal that trying to do the right thing for your client is good for business in the long run. And I know most advisors do this. I meet thousands of advisors at broker-dealers when I speak at their national conferences, and I know that most of us in the industry - regardless of RIA or broker-dealer channel - are really trying to do the right thing for our clients. And not because we're legally obligated to, but simply because we took this job to help people, and it's good for business to truly try to help them and serve their interests.
But the legal reality is still that you're not a fiduciary, and you can't be a fiduciary that puts your clients' interests first in all situations, because you still have a primary legal obligation to represent your broker-dealer and their interests instead. And the very fact that you're operating under a Series 6 or Series 7 license, which again, literally are sales representative examinations - it has "rep" in the title - precludes your ability to fully act as a fiduciary for clients.
You may still be doing the right thing for your clients, regardless of all of this legal stuff, and say it's a moot point. But the problem is still that you're not obligated to, or maybe it's more accurate to say, "The other brokers in your firm are not obligated to," and this is why the media picks on it. Because the only thing the other reps in your firm are obligated to do is provide their disclosure information to every client, and affirm basic suitability before they sell the highest-commission product they possibly can. And it's legal because it was a product sale, not advice, so it's caveat emptor and not subject to the fiduciary duty.
Think of it from the other perspective. Imagine you're a bad advisor...or you're not even an advisor. You're an evil sales dude whose goal is to get as many clients as possible to part with as much of their money as you can.
Basically, you have three choices: number one, steal their money; number two, sell products that pay giant commissions; number three, get paid a 1% advisory fee. Now, number one, stealing, it is outright illegal in any world, so not a very appealing option to risk jail time. Number three, getting paid a 1% advisory fee, is a really slow way to take your client's money, and not really helpful if you're trying to do bad things. But number two... overwhelm people with disclosures, make your complex sales pitch, get them to say yes once in a moment of weakness and then they can't take it back because there are surrender charges, and you can take 10% of the net worth of everyone you meet! That's a pretty sweet opportunity.
And that's why the fiduciary duty matters. It's not about trying to force you, the broker who is already trying to do the right thing, to do the right thing. It's to screen out the people who might be posing as advisors but truly are just trying to sell the crappiest high-commission product they legally can.
In other words, fiduciary is about raising the minimum bar on what the worst person in your organization might do if they wanted to be nefarious. Because again, as a Series 7 rep, you have no obligation to be a fiduciary. It might be good long-term business to do the right thing. But unfortunately, it's also a pretty good short-term business to sell the crap out of the highest-commission product you can find, and cash out, and move on later to another business if you have to.
So as long as that tension exists - as long as there are sales reps at broker-dealers who are only required to fulfill their minimal obligations to their broker-dealer as a sale rep and have no obligations to the client and are subject to lower standards - the fiduciary standard will continue to be an issue. And especially as long as sales reps continue to hold out to the public as advisors, because now the public can't actually tell who's a sales rep and who's a fiduciary.
Except, the public actually can identify the difference between a sale rep and a fiduciary, which the media now has picked up on... because sales reps, by definition, work at broker-dealers, and fiduciaries work under an RIA. That's why you're seeing this dynamic emerge where what started out as fiduciary versus suitability is now morphing into advisors versus sales people and RIAs versus broker-dealers.
How DoL Fiduciary Equalizes Broker-Dealers And RIAs [Time - 7:11]
But the bottom line, getting back to Jim's question, is that if you don't like this environment and being called a sales person and dealing with the scrutiny on you, frankly, I'd ask you to consider how you're structured and whether you want to change it. Because as long as you choose to operate under a Series 7 license as a sales rep of a broker-dealer, you are legally a sales rep. That's the job and its legal status. That's why you have a duty to your broker-dealer. That's why they can fire you for breaching it. That's why you can't take your clients when you leave. That's certainly why you can't sell the business and the clients in it the way that you can with an RIA.
Which means if you actually want to operate as an advisor and hold out that way and not be a sales rep, you need to be affiliated with an RIA. That's just the legal reality of how the rules are structured.
Now, ironically, if the fiduciary rule does not get delayed and actually goes through, then suddenly everyone, regardless of whether they're at a broker-dealer or an RIA, actually becomes subject to the same fiduciary duty. It doesn't matter whether the client engages through a BD or an RIA. And then this whole fiduciary discussion, and even much of the discussion about RIAs versus broker-dealers will become a moot point.
So if you're frustrated with the current fiduciary discussion, and you're in a broker-dealer environment, you should actually be hoping the fiduciary rule goes through from the Department of Labor! Because it levels the playing field. It takes the fiduciary question off the plate as a potential objection or concern, because now broker-dealers can be held to a similar fiduciary duty as the RIA, and so fiduciary would no longer be a differentiating discussion. At least pertaining to retirement investors, as that's the limited scope of the DOL's rule.
In the meantime, I hope that provides some food for thought around fiduciary versus suitability, and why we're seeing this morph into an RIA versus broker-dealer discussion. This is "Office Hours" with Michael Kitces, 1 p.m. East Coast time on Tuesdays. Thanks for joining us and have a great day everyone!
So what do you think? Can someone with a Series 7 be a fiduciary? Have you noticed the dialogue around fiduciary versus suitability shifting? Does actually being a fiduciary matter more than just acting like one? Please share your thoughts in the comments below!
