Fiduciary advice - what is it and why is this an often-discussed concern regarding investment advisers and financial planners?

The term "fiduciary" basically means that the person or practice identified as such places the interests of the client at all times above his or her personal interests. At the present time, the only types of investment advisers and financial planners that potentially meet this standard are "fee-only" (NOT "fee-based") financial planners and registered investment advisers. I contend that the adherence to objective, non-conflicted advice can significantly improve your ability to meet your financial goals over the course of a lifetime.

It's a hot topic because of the recent market decline, excesses revealed in recent years and the increasing public awareness of inherent conflicts within the industry. These conflicts were well-hidden for many years as financial advice was provided by firms that also sold financial products that compensated the salesperson. Consequently, the advice often led to the purchase of the company's main product.

If we walk into a Lexus automobile dealership, we expect the salesperson to show us the benefits of owning a Lexus: take us for a test drive, review the neat gadgets and point out how it's different from competitors. That's a suitable approach when shopping for a product. We don't expect the salesperson to be an "automotive adviser" or to offer a spreadsheet of various makes and models with an unbiased recommendation at the end of our visit.

One of the problems in the financial services industry is that providers can hide behind the veneer of a title, such as financial adviser, financial consultant, wealth manager or even financial planner. When we talk to someone who represents themselves in such a manner, we want to believe the advice is unbiased and objective. If the advice is guided by compensation from a product vendor or its firm, then a fiduciary duty may have been violated.

Financial planning as a profession is a relatively recent phenomenon. We are just now getting to a point where the public accepts paying a fee directly to advisers for objective advice. In the past, a client typically went to his or her stockbroker, banker or insurance agent for advice. No fee was discussed, and the adviser normally was compensated through commissions, asset management fees, or both. This created many opportunities for conflicts of interest.

When you factor in the relationship between advisers and their employers, the scenario gets more cloudy and frightening. In a paper written by Ingo Walter of New York University titled "Conflicts of Interest and Market Discipline Among Financial Services Firms," he identifies two types of conflicts of interest confronting firms in the financial services industry:

1. Conflicts between a firm's own economic interests and the interests of its clients; and
2. Conflicts of interest between a firm's clients or between types of clients, which place the firm in a position of favoring one at the expense of another.

We all understand type 1, and experienced investors are increasingly capable of identifying these situations. But what about type 2?

Type 2 conflicts have become exposed in recent years as demonstrated by brokerage firms with institutional research and underwriting departments. When a significant portion of a firm's revenue comes from IPOs and consulting arrangements with client companies, the individual client can take a back seat.

Probably one of the most creative examples of this took place in 2003, when a large New York brokerage firm assisted Enron Corp. with a series of sham transactions involving Nigerian oil barges that effectively defrauded the common stock investors in favor of the corporate insiders. That firm exists now only as a division of a large national bank.

This column easily could be a book, as examples provided by history are practically endless. The moral of the story is all investors should become familiar with best practices and ask the hard questions of their adviser prior to accepting advice. Here are some examples of things to look for:

1. The investment adviser is a registered investment adviser (RIA) with the SEC or state authority where they practic They sell no other products.
2. The adviser is "fee-only" and is a member of the National Association of Personal Financial Advisors (NAPFA). There are two major fee-only practice networks in the United States - The Garrett Planning Network, and the Alliance of Cambridge Advisors (ACA). In full disclosure, the author of this article is a member of the Alliance of Cambridge Advisors and NAPFA. To learn more, NAPFA maintains a website to educate the public on fiduciary issues: www.focusonfiduciary.com.
3. The adviser cannot earn revenue by recommending products that provide commission income, 12 (b) 1 fees, or any "back-end" compensation.
4. Does the adviser recommend products produced by his or her firm? This can be a red flag that other factors are influencing the recommendation, such as compensation or career advancement.
5. The adviser pledges "undivided loyalty" to the client.

Seems pretty simple, doesn't it? Be aware that brokers licensed by the NASD are not required to act as fiduciaries for their clients, only that their recommendations are "suitable." There have also been instances of fiduciary misconduct by banks, trust departments, financial planning firms, and investment advisers. To help you evaluate the practices of any adviser you are considering, download the Fiduciary Questionnaire at www.focusonfiduciary.com. You may also want to become familiar with The Garrett Planning Network at www.garrettplanningnetwork.com, the Alliance of Cambridge Advisors at www.acaplanners.org and NAPFA at www.napfa.org.