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DOL Fiduciary Rule
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How the Fiduciary Rule Can Make You Money

Accessing independent, fundamental research in support of your investment decisions meets a fiduciary “duty of care” standard, yes, but it also impresses clients and prospects.

The Post-DOL world is here. Despite delays, certain elements of the fiduciary rule are already in place.  

Full implementation is scheduled for July 2019, and figuring out how to deal with the fiduciary rule has been a priority for many firms and advisors. Here’s how you turn this regulatory bombshell to your advantage.

Don’t Fight the Inevitable

Many of the largest investment managers have already made changes to comply with the fiduciary rule. For example, Bank of America Merrill Lynch moved clients from commission-based accounts to fee-based ones. Fidelity has been aggressive in positioning itself as a fiduciary to retirement plan participants. The industry is moving towards a fiduciary standard, and soon a fiduciary level of service will be required to acquire and retain clients.

Win More Assets and Keep Them Longer

Most everyone is familiar with the “Duty of Loyalty” portion of the fiduciary rule, but few understand it also encompasses a Duty of Care. In other words, it may not be enough to put business practices at the service of clients first, it’s also incumbent on advisors to know why they’ve made certain investment recommendations, and have the ability to justify those recommendations. Show clients that, despite the ambiguity surrounding the Duty of Care,  you understand how to meet their needs when it comes to investment advice.

Avoid Regulators’ Scrutiny

In our meetings with wealth management executives and advisors across the country, the biggest concern we hear is “when we get pulled in front of an arbitration panel, how will we justify our recommendations?”

This concern is understandable given the conflicts endemic to sell-side research, and the lack of rigor in technical research. When it comes to showing clients, or regulators, why certain investments were made over others, we believe it’s important to leverage independent research that can stand up to scrutiny, and impress them with your diligence.

Despite the lack of regulatory guidance for fulfillment of the Duty of Care, there is guidance from thought leaders. We’ve written about it in this publication and others, as has Michael Kitces and Kim O’Brien, CEO of Americans for Annuity Protection. Research that fulfills the Duty of Care should be:

  1. Comprehensive: Incorporate all relevant publicly available data from 10-Ks and 10-Qs, including the footnotes and MD&A.
  2. Un-Conflicted: Provide unbiased research.
  3. Transparent: Show how the analysis was performed and the data behind it.
  4. Relevant: Show a tangible, quantifiable connection to fundamentals.

It’s hard to find fault in providing clients with the research that underlies your recommendations meeting these standards. In fact, most average investors probably think most of today’s investment research already meets these standards, but it does not.

Not long ago, research like this did not exist with scale and consistency. Frankly, it’s not been in the best interest of most Wall Street firms to make this kind of research available.

Fortunately, recent advances in technology make it possible to deliver independent research that meets the four standards in a cost-effective manner and at scale. Advisors now have access to the research they need to fulfill the Duty of Care without raising costs for their clients.

Accordingly, the advisors who delay embracing fulfilment of the fiduciary Duty of Care risk losing market share to those that do.

Here’s Why Regulators Like This Approach to the Duty of Care

For those that remain skeptical, we provide further explanation of each of the standards to underscore the self-evident nature of their importance to fulfillment of the Duty of Care.

  1. Comprehensive

It’s no secret that corporate managers often exploit a large number of accounting loopholes to manipulate earnings per share (EPS). As a result, advisors have a fiduciary responsibility to analyze more than EPS. Only by reading through the financial footnotes and management discussion and analysis (MD&A) can advisors close accounting loopholes and assess the true profitability of a company.

Despite the importance of reading 10-K’s and 10-Q’s, many traditional research providers don’t do this work. One sell-side analyst even recently admitted he hadn’t realized that a bank he covered stopped filing reports with the SEC two months before. This lack of diligence is how you end up with 21 out of 23 sell-side analysts telling investors to buy or hold Valeant Pharmaceuticals (VRX) the day before it drops by 50 percent.

Don't clients deserve research that accounts for the entire financial picture of a company, not just a portion of it? Why settle for anything less than analysis of all financial information?

Warren Buffett says he reads 500 pages of 10-K’s every day. Jim Chanos was able to spot the Enron fraud by looking at its 10-K’s and 10-Q’s. The most successful investors know that diligence matters.

  1. Un-Conflicted

Not all sell-side research is conflicted, but how does one know given all the disclaimers warning of a multitude of potential conflicts in every report.

The same concerns apply to fund research, where the research providers are often paid largely by the funds they cover.

Investors deserve truly unbiased research that is not influenced by relationships with the companies and funds under coverage.

  1. Transparent

Advisors need to prove to clients and regulators that they’re fulfilling fiduciary duties. Clients are in need of convincing since roughly two-thirds of investors don’t trust the financial services industry to act in their best interest.

Client education is the key for advisors to overcome this mistrust. Advisors who help clients understand their decision-making process and are open about the data and analysis behind their recommendations can reap long-term rewards. By getting clients more engaged in the process, advisors increase the probability of keeping clients committed to their investment plan through good times and bad.

Fiduciaries need to be transparent enough to back up their investment research and recommendations with key details and the assumptions that drive them in real-time, not just when a regulator asks about them.

  1. Relevant

Take a hypothetical advisor that reads every 10-K and 10-Q and then only buys stock in the companies with the highest proportion of the letter “e” in their filings. This process would be comprehensive, objective, and transparent, but it would not be relevant to long or short-term performance of the investment.

Without a tangible, relevant link to long and short-term performance, an investment process is incomplete. With all the focus on sentiment, technical research, macro themes and other pure trading strategies, fundamentals can be overlooked. Advisors and investors that ignore fundamental research are doing themselves a disservice, as research has found that even technical-based strategies can improve with the use of fundamental analysis.

Though fundamentals need not represent 100% of the driver for investment decisions, they should not be 0%. Fundamentals matter, and investing without proper fundamental analysis puts clients at undue risk. Advisors that can back up their recommendations with relevant fundamental research will take clients from those that don’t.

This article originally published on December 14, 2017.

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, style, or theme.

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