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The Logical Inconsistency of a Broker Fiduciary Standard

Serving two masters in the realm of financial services is impossible, argues W. Scott Simon of Prudent Investor Advisors.

W. Scott Simon, 03/01/2012

W. Scott Simon is a principal at Prudent Investor Advisors, a registered investment advisory firm. He also provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. Simon is the recipient of the 2012 Tamar Frankel Fiduciary of the Year Award. 

I'm generally sympathetic to the weak, the old, and the infirm, whether they be humans or animals (even including cats--well, most cats). More particularly, I feel a special compassion for those personally close to me who are somehow wronged by forces more powerful than they or who need someone to stand up for them because they cannot do so themselves. In such cases, I usually work up a feeling of indignation that can be expressed as "It's just not right!" Most people would probably have similar feelings.

However, sometimes I get really incensed. That happened back when I practiced law and was called on to argue a case in court. We represented an old woman who had so clearly been wronged by an individual that I was ready to personally hang him up by his thumbs. My indignation was so great that I was visibly contemptuous of the defendant in open court. My victory was so complete that even the defendant--an attorney--congratulated me afterward and offered me a job to boot.

But whatever personal feelings I may have had about that defendant's conduct really didn't mean diddlysquat. In fact, I had to show that his conduct was subject to some legal standard of care--in his case the fiduciary standard--and then prove that he violated it.

The personal feelings of, say, a stockbroker who is subject to the suitability standard are similarly irrelevant when she says that she cares for her clients so much she feels like a fiduciary to them. She can say that, and even believe it, but her feelings are of no legal import because ordinarily she isn't subject to the fiduciary standard.

Reported attempts by federal regulatory authorities to devise a broker fiduciary standard, if enacted as the result of a successful political beat-down by the brokerage and insurance industries, would change that. But it wouldn't change the logical inconsistency of attempting to fit the square peg of brokers into the round hole of a fiduciary standard. Here's why.

(The discussion in this month's column isn't limited to stockbrokers; it can also apply to benefits brokers, insurance agents, or any other entity following a sales model in the financial-services arena. In addition, distinct from commissioned stockbrokers emphasized in the column are brokers who provide great value to their customers by serving as order-takers but are not permitted to provide any advice at all. Such brokers don't muddle up transactions with advice.)

No One Can Serve Two Masters
The Biblical admonition that a person cannot serve two masters is, at base, really all you need to know about the logical inconsistency of a broker fiduciary standard and the resultant impossibility of devising such a standard. Serving two masters in the realm of financial services is impossible because there will always be the perception--if not the reality--that a broker will at times be disloyal to its customers and favor its broker/dealer. This is an inherently fatal flaw in brokerage sales models because the duty of loyalty is the fundamental duty that underlies all other fiduciary duties. To be disloyal is the very antithesis of being a fiduciary. Disloyalty negates the very meaning of what it means to be a fiduciary.

W. Scott Simon is an expert on the Uniform Prudent Investor Act and the Restatement 3rd of Trusts (Prudent Investor Rule). He is the author of two books, one of which, The Prudent Investor Act: A Guide to Understanding is the definitive work on modern prudent fiduciary investing.

Simon provides services as a consultant and expert witness on fiduciary issues in litigation and arbitrations. He is a member of the State Bar of California, a Certified Financial Planner, and an Accredited Investment Fiduciary Analyst. Simon's certification as an AIFA qualifies him to conduct independent fiduciary reviews for those concerned about their responsibilities investing the assets of endowments and foundations, ERISA retirement plans, private family trusts, public employee retirement plans as well as high net worth individuals.

For more information about Simon, please visitPrudent Investor Advisors, or you can e-mail him at wssimon@prudentllc.com

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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