Last year, the Department of Labor issued a new ruling requiring that most financial professionals who provide advice on retirement investments must act as fiduciaries, meaning that they are legally and ethically required to act in the best interest of their clients. Prior to this, most advisers acted under something called a suitability standard, which tended to give advisers more wiggle room.

When a person accepts a fiduciary duty on behalf of another party, it creates an ethical relationship of trust with specific duties. Two such duties are to act in good faith and trust (the term fiduciary comes from “fiducia,” the Latin word for “trust”). 

Duties owed to another party are not always financial in nature—lawyers, for example, have fiduciary duties toward their clients—but in the context of investment, fiduciaries are expected to manage their clients’ assets for the investors’ benefit, not their own.

When the new ruling was first announced, many consumers were surprised to learn that all financial advisers didn’t already have a fiduciary duty, but in fact the existing industry standard often was merely one of “suitability.” 

Under the suitability standard, advisers are required to recommend products and services that are suitable to meet investors’ needs and objectives, but those choices might or might not necessarily be the best or most cost-effective ones. 

It’s a bit like, say, shopping for a new mountain bike: You walk into your local bike shop and tell the salesperson what features you’re looking for, what kind of riding you like to do, and what your budget is, and he recommends a bike that meets those criteria.

If he steers you toward a certain model, you don’t necessarily know if it’s because that’s really the best bike for you or if the retailer simply stands to make more money off that particular sale. As long as the bike meets your specifications, it’s “suitable,” even if there might be other more appropriate options that the salesperson didn’t mention. 

No one expects a salesperson at a bike shop to act as a fiduciary, but with investment advice, the stakes are much higher. The sensitive nature of the material under discussion creates an expectation of trust, and the consumer is generally at a significant disadvantage in terms of knowledge and understanding of the myriad options. 

If a financial adviser receives a commission for selling certain products, that individual might steer clients toward those products with higher commissions. And, in fact, consumers continue to be sold overpriced mutual funds and annuities that come at a real cost to their retirement security. 

Thanks to the magic of compounding, over decades even very small differences in costs can make a dramatic difference in the size of an investor’s nest egg when retirement time comes. In 2015, the White House Council of Economic Advisers estimated that biased advice costs investors $17 billion annually. 

Under the DOL ruling, investment advisers must put clients’ interests above their own, and they must disclose any potential conflicts of interest. Such conflicts might include selling mutual funds managed by their employer or securities underwritten by their employer, or accepting what are called 12b-1 distribution and marketing fees from mutual funds. 

They must clearly communicate all commissions and fees, including fees embedded in the investments or mutual funds. Notably, the fiduciary rule doesn’t apply to those engaged in retirement education, such as employers providing general advice when rolling out a new retirement plan, or to what is considered order taking, when customers ask brokers to buy or sell specific stocks.

The ruling was scheduled to take effect on April 10, 2017, but the DOL has announced a 60-day delay in implementing these policies while it reviews the regulations, with a view to modifying or overturning the ruling entirely. The review is based on concerns about onerous compliance costs and restricted choice. 

For many financial advisers who already adhere to the higher standard of care, nothing will change either way. Bank wealth managers and trust departments, for example, act under state or federally issued trust powers requiring them to act in a fiduciary capacity.

Washington Trust Bank’s Wealth Management & Advisory Services operates on a noncommissioned, fee-for-service basis, with portfolios designed with no proprietary mutual funds and no securities “from inventory.” Also, we don’t underwrite securities, so our advisers are unbiased in relation to the investments in a client’s portfolio. Transparency and communication regarding compensation are key.

Whether the DOL ruling is implemented, changed, or struck down, investors should understand what fiduciaries are and how they must act. 

Of course, if the ruling stands, the new regulations won’t be a cure-all. There will always be a few individuals who act dishonestly regardless of the rules, and investors will still need to do their homework. However, a broader application of the fiduciary standard would provide significant protection for investors, and the new regulations also would make it easier for investors to sue advisers who don’t act in their best interest. 

Even if the ruling is overturned, though, the discussion surrounding the legislation has already been beneficial in terms of raising both awareness and expectations, and an increasing number of investors will now demand greater transparency from their financial advisers.

Rob Blume is managing director and senior vice president of Wealth Management and Advisory Services at Spokane-based Washington Trust Bank. He can be reached at [email protected].