The Ethicist: Advisors, Clients and the DOL Rule

The financial services profession can present an array of ethical quandaries and predicaments. The American College of Financial Services offers insight and perspective with regard to professional ethical dilemmas.

In this post, The American College Ethicist, Julie Ragatz, the Charles Lamont Post Chair of Ethics and the Professions, Director of the Cary M. Maguire Center for Ethics in Financial Services, and Assistant Professor of Ethics, considers a financial advisor's concerns over how the U.S. Department of Labor Conflict of Interest Rule will affect his client relationships and his practice.

The Question

A client recently asked me about how the Department of Labor’s Conflict of Interest Rule will affect his standing with me as his financial advisor. He is among my least wealthy clients, but is also one of my most long-standing; I took him on as I was just getting started in the industry. When the new DOL rule takes effect, it’s possible that the way I’m compensated will change. 

As the financial services industry reacts to the DOL rule and changes the way FAs are compensated, this client, and others like him, may no longer be able to afford my services, even if I were to provide a deep discount. 

While I anticipate this dilemma, I don’t know exactly when it will arrive because the future that this ruling will bring is still murky. If I have a feeling that a client (who can afford my services now) may not be able to afford them in the future, at what point am I ethically obligated to make him aware of this? 

The Consideration

This question raises three ethical issues. The first issue is what you owe a client in terms of disclosure about the impact of the DOL rule on his future relationship with you. The second issue is what you owe a loyal client who has become less profitable. The third issue, which is more of a general question, considers the ethical problems posed by the new fiduciary rule.

 These are all challenging issues, but I will start with the least challenging one first, which is what you should disclose regarding your speculations about what the new DOL rule will mean in terms of your relationship with this particular client. This issue is less challenging from an ethical perspective since the client asked you a direct question. In response, you owe that client an answer as candid and complete as you can provide. If you believe that the cost of doing business and the changing structure of compensation will lead to increased costs for your clients, it is imperative that you explain this to your client. You should describe your current compensation model (which should not be a surprise to your client) and how this compensation model is likely to change. You should explain the reasons why you need to compensate by imposing other fees in order to maintain a sustainable and growing business. If it reaches the point at which you determine that your client can no longer afford your services, you should recommend that he terminate his relationship with you. Upon his request, you should be willing to create a plan to transition all or part of his business to another firm or advisor. Your client has asked you this question in order to prepare for his financial future in a proactive way, and your professional duty requires that you assist him in doing so.

Further Ramifications

The more challenging question is what to say to clients who do not ask (and my suspicion is that this is the case for the majority of clients). You owe these clients the same level of candor. A strong ethical case can be made that you should provide all your clients the same opportunity to be proactive, whether they ask or not.

In both cases, you can and should be clear that you are happy to continue working with this client and are committed to providing excellent service while he or she is under your care. Acting in this way, you have provided information to your clients to enable them to make a decision in their best interest. They may choose to stay with you for a time, even if that is not in their best interest financially, because they trust you and are willing to pay to maintain that relationship. People, as we know, do not always base their decision-making on their narrow material self-interest; trust and familiarity are goods for which people are often willing to pay. You should continue to provide all of your clients with updates about how you are planning to change your compensation model in response to the DOL rule. You should also offer specific updates as to how these compensation changes will affect them.

However, this answer leaves open the more challenging question, which is, “What do I owe a long-standing client who has become less profitable to me in the course of developing my practice?”

As someone dedicated to thinking about the ethical issues in our field, this question is one of the toughest I am asked. Once you acknowledge, as all professionals do, that client relationships are not purely transactional and that they are governed by duties of care and loyalty on both sides, the question of when an advisor should terminate a relationship becomes more troubling.

Advisors do have a right to terminate these relationships. The reason is because advisors have additional, and in this case, competing obligations to their other clients and to the teams who support them. In terms of the other clients, to the extent that lower revenue clients are being supported by resources provided by higher revenue clients, this creates an unfair redistribution since the higher paying clients are funding a practice from which lower paying clients disproportionately benefit. Furthermore, successful financial advisors are often surrounded by people who rely on the advisor’s production to fund their salaries and thus support their families. A strong case can be made that the advisor has a responsibility to run his or her practice in the most profitable way possible.

Nonetheless, as a financial advisor, you have a duty that demands that you handle the transition in a careful and respectful manner. In particular, you need to be fully transparent with your clients about the reasons you have decided to end the relationship. It is appropriate to emphasize your concern that they receive excellent service from an advisor who can afford to work with them more closely. You then need to identify a competent and professional advisor and remain involved (within reason) until all parties feel comfortable with the transition.

Ethicial Implications of the DOL Rule

The final issue is more abstract. It concerns the ethical implications of the DOL rule in terms of the industry’s obligation to extend the benefits provided by professional financial planning as widely as possible. As someone who leads a Center for Ethics with a mission to raise the level of ethical behavior in the financial services profession, I am very interested in that issue. Much has been written arguing both sides of the case, with one contingent arguing that this rule will make it more difficult to offer quality financial planning services to the segment of the population (the middle market) arguably most in need of this advice. Others argue that the DOL rule will protect those same consumers from unscrupulous individuals, as well as from the defects of current compensation systems that allow advisors to inappropriately benefit at the expense of their clients.

As is the case with every regulatory change, time will determine the impact of the rule on the ability of firms and practitioners to fulfill the social mission of the profession. The important thing is to keep this mission to increase the financial security of every person uppermost in our minds at all times.

Have a question for The Ethicist? Send it to ethicist@theamericancollege.edu. Your name and identifying information will remain confidential. Questions submitted are subject to editing for grammar, length and style.

Julie Ragatz holds the Charles Lamont Post Chair of Ethics and the Professions and is the director of The American College Cary M. Maguire Center for Ethics in Financial Services. Professor Ragatz teaches in the MSM, MSFS, and PhD programs at The College, and is currently a PhD candidate in Philosophy at Temple University.