On both sides of the Atlantic moves are afoot to require all financial services firms, from broker-dealers to old fashioned private banks, to have a fiduciary duty of care to their clients. Like so many ideas that sound good at first, the issue is not as simple as it sounds.

On both sides of the Atlantic moves are afoot to require all financial services firms, from broker-dealers to old fashioned private banks, to have a fiduciary duty of care to their clients. Like so many ideas that sound good at first, the issue is not as simple as it sounds.

Considering some of the problems and financial scandals of recent years, it is certainly understandable that policymakers, even the more thoughtful, pro-market ones, are in the mood to impose a blanket fiduciary standard, not to mention other rules. For example, some private clients might not realise that some of the institutions they deal with are not required to have a fiduciary responsibility at all, and clients may have an unpleasant surprise if their money gets lost or if their advisor has a serious conflict of interest. (Given the current woes of clients of bankrupt US business MF Global, this is hardly a remote problem).

It should be pointed out, a senior figure in the stock-broking and investment industry recently told me, that stockbrokers in the UK, for example, have an "agency" status in which they are required, for example, to keep client monies in a segregated account. This might not go the full distance of achieving the fiduciary requirement that some UK regulators are thinking about, but it is nevertheless an important, existing feature of the financial ecosystem. And to some extent, of course, the UK’s Retail Distribution Review program of reforms, which outlaw use of commissions, are supposed to go a long way to make wealth management more impartial and professional.

In the US, it is expected that some general fiduciary requirement will be imposed across the board sometime this year, although the exact starting date as of the time of writing is uncertain.

For the non-US audience, I should explain that the present system, which dates back to 72-year-old legislation, leaves states within the US free to develop their own, often varied, definitions of what “fiduciary duty” might mean. This is, as the US Securities Industry and Financial Markets Association has argued on its website, highly confusing. And in a litigious country such as the US, confusion is costly. Because of the Advisers Act of 1940, investment advisors must adhere to the fiduciary duties but stockbrokers and broker-dealers instead must observe a less rigorous standard of “suitability”. In the latter case, it only requires recommendations that are consistent with the interests of customers – potentially quite a vague definition.

So as SIFMA explains, the current Obama administration has proposed to standardize fiduciary care, whether it involves financial advisors or broker-dealers at the federal level. As I found out from Morgan Stanley Smith Barney, one of the biggest broker dealers in the world, some in that side of the business are unhappy. For example, one problem with a fee-based advisory model, in contrast to the much-maligned brokerage one, is that a person who has a portfolio where not much ever happens still must pay an annual fee even if nothing changes within a portfolio for years. “Commission” has become almost a dirty word in our industry – but is this fair?

Much of the impetus for reform now comes from the Dodd-Frank Act, which told the powerful Securities and Exchange Commission to draw up a new federal fiduciary standard of care. And meanwhile, in 2010, the US Department of Labor proposed what SIFMA called a “wholesale revision to its regulation that redefines what it means to be a fiduciary under the Employee Retirement Income Security Act and the Internal Revenue Code”. In this case, SIFMA explained, this proposed definition “would have affected whether retail brokers, prime brokers, institutional trading desks, swap dealers, and others who work with pension and 401(k) plans and IRAs will be deemed fiduciaries under certain circumstances”. The new proposed rule is expected to be issued early this year.

An obvious question that arises straightaway is cost. Broker-dealers are hardly going to enjoy switching to a fee model since if it made no difference to their costs, they might have done this years ago anyway without any prodding from lawmakers. Commission charging is not, in of itself, a bad thing so long as it is transparent.

And as the UK market reforms of the RDR demonstrate, costs of even the most innocuous change can be heavy. Some people in the industry reckon at least 15 per cent of the country’s independent financial advisors will be forced to quit the business, either by selling up or retiring.

As ComPeer, the research firm, pointed out from a poll of UK wealth advisors recently, some firms are spending at least 50 per cent of their net profits on compliance. And it is hard to see how this is going to get any better if the entire industry, regardless of its business model and level of service, has to provide the same fiduciary duty of care. The concept sounds very admirable, and not perhaps as controversial as some other big changes being imposed. But policymakers need to realize that the regulatory burden cannot rise indefinitely before serious damage is done.