Part One: A Deadly Cocktail? The “Extreme Makeover” of Annuity Agents into Registered Investment Advisors
Earlier this year I published an essay on the burgeoning effort to recruit annuity agents into the ranks of Registered Investment Advisors. While I haven’t written about this issue since that time I’ve thought about it a great deal. So have a lot of other people including some who see an opportunity to create lucrative new businesses by disrupting independent agent distribution. I’m all for free enterprise. But I’m opposed to initiatives that may seek to exploit agents who are frustrated by challenges they didn’t’ ask for or expect.
Today’s article is the first in a series devoted to the agent-to-RIA conversion “pitch.” The more I delve into this the more concerned I become. One of my goals with this series is to help protect annuity agents by providing them a balanced perspective on the RIA option. It’s my hope that a thorough understanding of the risks and potential rewards will lead to good decision-making.
Back in April I expressed caution about the pitch to annuity agents that urges them to become registered investment advisors. My early caution has crystallized into a strong belief that for most annuity agents the RIA option is, well, unsuitable.
Opting to become an RIA may be a viable course of action for annuity agents willing to submit to a truly extreme makeover in terms of their stated allegiance and compensation model. How many agents will be willing to drink the fiduciary cocktail and take on the related responsibilities that come with observing a fiduciary duty once they understand all of its ingredients?
What’s in the Fiduciary Cocktail?
Ahh, fiduciary duty! That’s the key issue, isn’t it? I checked Wikipedia’s definition of fiduciary duty and this is what I found:
“A fiduciary duty is the highest standard of care imposed at either equity or law. A fiduciary is expected to be extremely loyal to the person (the principal) to whom they owe the duty. They must not put their personal interests before the duty, and must not profit from their position as a fiduciary, unless the principal consents. The fiduciary relationship is highlighted by good faith, loyalty and trust.”
“When a fiduciary duty is imposed, equity requires a stricter standard of behavior. It is said the fiduciary has a duty not to be in a situation where personal interests and fiduciary duty conflict, a duty not to be in a situation where their fiduciary duty conflicts with another fiduciary duty, and a duty not to profit from their fiduciary position without express knowledge and consent. A fiduciary cannot have a conflict of interest.”
The very last sentence, “A fiduciary cannot have a conflict of interest” would seem to crystallize the key challenge: how can an individual simultaneously act as a fiduciary and an agent for an insurance company within the framework of a single client relationship?
It’s not possible in the opinion of Rick Miller, a Certified Financial Planner from Cambridge Massachusetts and a member of the National Association of Personal Financial Advisors. According to Miller, “An annuity agent who is simultaneously a fiduciary sounds like a contradiction in terms at the most basic level. As a fiduciary the advisor must act in the best interest of the client. As an agent, the advisor must act in the best interest of the insurance company. I wouldn’t want to be the advisor who has to attempt to resolve that conflict.”
The website for Miller’s firm, Sensible Financial Planning, states: “We accept no commissions or any other payments from any financial product or service provider. We work only for you.” That description stands in stark contrast to the way annuity agents typically operate.
The August 2007 edition of Investment Advisor Magazine contains an article written by Bob Clark that stated, “The inescapable conclusion for anyone looking at the financial services industry and its marketing machine is that financial consumers—middle class and affluent—are completely ignorant of the fact that their stockbrokers or insurance agents are not fiduciaries, and have no legal obligation to put their clients’ interests ahead of their own or their firm’s.”
Some annuity agents may not fully understand the legal structure of the “principal-agent relationship” that governs their obligations to the insurance companies they represent. In the same manner that stockholders of a corporation (the principals) hire managers (the agents) to act in their best interests, the insurance company (principal) hires agents to act in its best interests. The fact is, under this relationship framework the primary duty an annuity agent undertakes is to represent the insurer’s interests, not the client’s.
There’s No Escaping Regulation
I sought the opinion of Joan Boros, who is a friend and a well-known expert in securities law. Joan, an attorney with the prestigious Washington, D.C. law firm, JordenBurt LLP, had this to say about agents contemplating registration as investment advisors:
“Agents should be aware that registration as an investment adviser carries its own set of burdens and vulnerabilities; there are always trade-offs. At a minimum, agents are subject to a whole new regime of regulation in each state where they operate. On a more challenging level, plaintiff’s lawyers and regulators have asserted the view that as an adviser the agent owes a fiduciary duty to the prospect or customer. While that may not be the outcome, threading through fiduciary duty obligations makes suitability determinations seem like a walk in the park.”
Yet the advertising coming at annuity agents sounds like the RIA makeover is a walk in the park. “End broker-dealer harassment and haircuts” goes the RIA pitch. To annuity agents who have seen their businesses impacted in ways they view negatively since the issuance of NASD NTM 05-50, it’s a powerful message. Is “harassment” a code word for rigorous broker-dealer compliance when used in the context of the RIA pitch? I suspect it is. And what annuity producer doesn’t want to earn more money by eliminating broker-dealers’ commission “haircuts?”
Annuity agents who have seen broker-dealers disapprove their relied-upon annuity advertising and sales presentation materials including letters, seminar presentations and display ads, will surely be attracted to the notion of becoming their own compliance officers. But how many annuity agents possess the knowledge and experience to develop compliant advertising in the context of a registered advisory practice? And what of the longer-term consequences following biennial audits of registered investment advisors’ practices including their advertising? Could annuity agents be setting themselves up for an unpleasant future shock?
Possible Unfulfilled Financial Expectations
One shocking change annuity agents who become RIAs may encounter in the future is reduced income. Agents who are accustomed to making larger commissions as their sales volumes increase may find that new approaches to annuity compensation may alter their expectations. According to Paula Hogan, Principal of Hogan Financial Management, a Milwaukee-based, fee only firm providing comprehensive financial planning services, “When people wear two hats it’s very confusing to the consumer. Consumers have a right to know who the advisor is working for.”
Hogan also believes that the transition to income-generation will lead to new ways to compensate advisors: “The issue you raise (compensation) is also an important one because it speaks to changes taking place in the financial services industry as people shift from accumulation to retirement income distribution. Annuities will play an increasingly important role as more and more people seek to insure their standards of living in retirement. I believe that advisors have real value to offer their clients and they deserve to be paid for it. However, agents’ traditional commission-based compensation models may prove as unworkable as advisors’ AUM-based models. It may be that new approaches to compensation will be needed including flat-fee arrangements.”
Fewer Advisors, Greater Responsibility
Boomer retirement is certainly likely to propel increases in annuity sales. But according to Harold Evensky, Chairman of Evensky & Katz, a wealth management firm headquartered in Coral Gables, Florida, annuities fit in a larger context of retirement planning which must prioritize the best interests of consumers. Says Evensky, “There’s good news for professionals in fields related to financial planning. The need for quality advice for retiring boomers is fast outgrowing the current supply of practitioners. However, as investment advice is often the core element of a good retirement plan, advisors need to ratchet up their knowledge of investment issues and register as Investment Advisors with the State or SEC. Doing so will meet their legal responsibility and insure that they are legally committed to placing their client’s interest first.”
Key Questions
Agents considering the transition to RIA status should evaluate the move carefully and ask themselves some important questions:
Am I willing to place the interests of my client ahead of my own?
Am I willing and able to accept an entirely new method of compensation with the result that my compensation may decrease?
And, under what legal framework do I wish to operate?
The potential answers to these questions imply an interesting set of trade-offs, opportunities and costs.
©2007 David A. Macchia. Al rights reserved.