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Financial Advisors Have Fiduciary Duty to Prospective Clients, Too

July 24, 2015
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By Sheryl Garrett

Learn more about Sheryl on NerdWallet’s Ask an Advisor

During a discussion with a group of financial planners, mostly fee-only “solo-preneurs,” I suggested that many of us would be extremely challenged to serve all clients as their fiduciary and provide all their needed services.

One advisor shared that she had recommended outsourcing the ongoing management of a client’s portfolio to a highly regarded, low-cost money management firm. All things being equal, she said, she couldn’t provide the services for anything close to the price of the outsource firm.

This advisor recognized that her highest and greatest good for her clients was in her financial planning skills and in serving as a catalyst to help them do what was in their best interests. She felt that their portfolio needed ongoing oversight and recommended someone other than herself to provide that service. The advisor acted in her clients’ best interests — just as all fiduciaries are required to do.

The client appreciated the thoughtfulness of the recommendation but elected to keep everything with the planner. With full disclosure and informed consent, the advisor had fulfilled her fiduciary duty.

But what is our fiduciary obligation to prospective clients, as opposed to existing clients? Investment advisors are fiduciaries under the Investment Advisers Act of 1940, not only for our clients, but also in recommendations given to prospective clients, including the recommendation that they work with us and how that arrangement will be structured.

In other words, our fiduciary duty applies at the point where we propose how we enter into the equation. Are we the best choice of advisor to meet a prospective client’s needs? Could we be a great help in most areas and provide outsourcing options for everything else? Are there similar services available for less money?

Some states require disclosures of this type, and many professionals argue that it’s their ethical duty to provide them. Most registered investment advisors have standard disclosure language regarding the fact that “like services may be obtained at a lower cost elsewhere,” but many may not be aware of our responsibilities at the point where we make a pitch to a prospective client.

Consider the common scenario of a holistic solo practitioner with multiple service offerings — for example, a retainer for long-term planning engagements, an assets-under-management fee structure for the portfolio, and hourly or project fees for everything else. We have to be equipped to offer these services as promised, yet I’ve found that most solo practitioners and small planning firms are better off if they focus on one, or possibly two, pricing or service-offering options.

Let’s consider an advisor who does primarily project work and charges an hourly or flat fee. The work is limited in scope, and the engagement is complete upon delivery of that work product. But the advisor may also work with a few clients on retainer, who are welcome and encouraged to contact the advisor anytime, day or night, if they have questions or concerns. On top of that, the advisor provides ongoing portfolio management, comprehensive planning and tax return preparation services for clients.

Imagine that this advisor has a presentation scheduled with an hourly client and something urgent comes up with one of the retainer clients in the middle of tax season. Something’s got to give, and it’s likely going to be the “limited scope” engagement client — or possibly the advisor’s sanity or business reputation.

If you have the professional talent in your firm to back you up, that’s an entirely different story. But those working solo or in a small firm must consider our array of service offerings and how it may affect our ability to fulfill our fiduciary obligations to all clients before we offer these options to prospective clients.

Being all things to all people is a recipe for disaster. It takes time, energy, competence and coordination to offer such a broad array of service and pricing options. Do we have the bench strength in our firm or company to support each of these services and pricing structures for a variety of clients? If not, we must focus our service offering and pricing to meet the needs of the types of clients and planning issues in which we specialize.

I held myself out as a general practitioner focusing on middle-income and do-it-yourself clients. Those who came to me were not looking for someone to whom they could delegate most or all their money-management responsibilities. I didn’t work best for delegators. I recognized that limitation and changed my business model to best meet the needs of the clients I felt I could serve best.

For my type of clientele, I favor tailoring the fee and services to the urgent and immediate needs of the client. I believe charging for our time, or our estimate of the time and complexity involved, is a very fitting way to deliver project-oriented or periodic advice. A fixed fee, possibly paid monthly over the span of the engagement period, would fit other clients’ needs better. I personally find the concept of charging for our time to be the most appropriate compensation method for a financial planning client. However, it may not be the least expensive. Fairness and reasonableness of compensation for work provided is essential in fulfilling our fiduciary duty.

Although fee and commission is the most common compensation method employed today, it’s tough to provide prospective clients with a clear picture of their total costs for the services to be rendered before determining whether there will be recommendations involving additional compensation. How can a prospective client make an informed decision without having this information? It’s tough, but we must do our best to be fair and transparent.

Next time you visit with a prospective client, remember the duties of a fiduciary. Clients rely on you to provide recommendations in their best interests — including that first recommendation on whether and how you should work together.

This post first appeared on Nasdaq.

Image via iStock.

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