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If Advisers Are Fiduciaries, Fund Managers Might Be Next

The mutual fund industry's trade group, the Investment Company Institute, rarely surprises. Dismays, yes. Disappoints, certainly. But surprises? Not so much. Which is why it was so noteworthy last week when ICI president and CEO Paul Schott Stevens made a statement that did surprise, saying he supported the idea of requiring all financial advisers to act as fiduciaries.

Of course, it's only common sense that a financial adviser should be bound by a fiduciary duty -- a requirement to put clients' interests ahead of their own. After all, who would want to take investment advice from someone driven by their own financial interests rather than their client's? You might expect that sort of adversarial relationship when you buy a car, but not when you're investing your life savings.

Not-so-common sense
But the ICI has long had a strange relationship with common sense. On most matters of importance to investors, they're usually either hopelessly behind the curve (their then-president announced, just months before the mutual fund timing scandal broke, that "the interests of those who manage mutual funds are well aligned with the interests of those who invest in mutual funds") or producing self-serving research. (A wonderful example of the latter: In a congressional hearing on retirement security last month, the ICI's testimony included a "poll" which asked participants questions such as whether they agreed or disagreed that "the government should replace all retirement accounts with a government bond." In a testament to how frightening the markets are these days, a quarter of all households agreed.)

That's one reason why so many were surprised when Stevens said he supported holding advisers to a standard of fiduciary duty. The second reason is that many of the ICI's members don't agree with that standard, preferring instead the watered-down suitability standard.

What's the difference? An adviser held to a suitability standard must only prove that an investment they recommend is suitable for a client. Thus an index fund with a 1.5 percent expense ratio and a 5 percent sales load would, under the suitability standard, be an appropriate recommendation for a client seeking equity exposure. A standard of fiduciary duty, on the other hand, would require that the adviser recommend a no-load index fund with a much lower expense ratio. Recommending the latter fund, of course, would not compensate an adviser who's paid by commissions, but it would indisputably be in the best interests of the client.

Focusing on fiduciary duty
Stevens' position, while likely borne more of a need to rebuild investor trust in a grinding bear market, is nonetheless commendable. What he might not have realized, however, is that he's placed himself on a slippery slope. Once the idea that a fiduciary duty applies to all individual advisers takes hold -- as it should -- it seems logical to then consider how well mutual fund management companies are meeting the fiduciary duty that they owe mutual fund owners.

Are mutual fund managers serving as fiduciaries when they churn out new funds focused on the sector of the moment? Are mutual fund directors acting solely in their shareholders' best interests when they fail to negotiate lower management fees on the funds they oversee? Whose interests, exactly, are being served when a money market fund has a one percent expense ratio?

Are the ICI and its member firms ready to have these sorts of conversation with regulators? It remains to be seen. Perhaps one of the silver linings of this interminably stormy period is that we'll emerge with little patience for self-serving arguments and a newfound respect for common sense.

Image via Flickr user phauly, CC 2.0

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