Fiduciary duty costly for dealers, advisors

The most significant impact for advisors, Di Paolo said, would be a diminished ability to defend themselves against liability in cases where clients have suffered investment losses.

“With a statutory fiduciary standard, you will lose many of the defenses available to you to defend broker liability lawsuits, and the scale of damages will be much, much higher if you’re found liable,” he said.

For example, one common defense available to advisors dealing with client losses under the existing regulations is suitability – proving that the investment they recommended was suitable for the client after having gathered the appropriate know your client (KYC) information. Under a fiduciary standard, this would no longer constitute a sufficient defense, Di Paolo.

“Suitability will no longer be the standard,” Di Paolo said. “Therefore, even a suitable recommendation – one consistent with the KYC – could result in liability.”

Another common defense is contributory negligence – the concept that the client bears some responsibility for his or her own decisions to invest. Under a fiduciary standard, however, that responsibility would essentially be transferred to the advisor.

“The notion of client responsibility is turned completely on its head,” Di Paolo said. “The client bears absolutely no responsibility for his or her poor choices, even though the client is the ultimate decision maker.”

Advisors would also not likely be able to defend themselves on the basis that the client understood the risks associated with an investment. The CSA’s consultation paper indicates that the vast majority of clients are assumed to have little financial knowledge, and therefore can’t be expected to comprehend the risks – even if they were appropriately disclosed and explained.

Furthermore, the damages that advisors would face if found liable would potentially be much greater under a fiduciary standard. Di Paolo said advisors who are fiduciaries would be likely forced to disgorge any commissions they earned in cases where they’re found liable.

In addition, the new standard would open the door for courts to award more punitive damages designed to punish advisors for conduct that is inappropriate, as well as ‘loss of opportunity’ damages to replace the returns that clients who suffered losses could theoretically have earned, had they not followed the recommendations of the advisor.

“The scale of damages would be much higher than it is under the existing duty,” Di Paolo said.

Dealers would be challenged by rising costs

Overall, Di Paolo said the costs to the industry of a fiduciary standard could be huge. “It has the potential to significantly increase the cost of doing business for all industry participants,” he said.

With margins already very thin in the mutual fund distribution business, Di Paolo said dealers – and particularly small dealers – will feel the impact considerably.

“The impact that this could have on mutual fund dealers – particularly the smaller ones – is absolutely profound,” he said. “This could put them over the edge.”

Di Paolo said the adoption of the best interest standard also threatens to drive some advisors out of the business. Many will likely gravitate towards the insurance business, he said, where there is not currently a proposal for advisors to face a fiduciary standard.

He noted that there has already been an exodus of advisors from the mutual fund business to the insurance business, as they opt to sell segregated funds rather than mutual funds due to the growing regulatory burden in the mutual fund space.

“The exodus may very well turn into a flood,” Di Paolo said.

However, if a fiduciary standard is adopted in the mutual fund space and the securities space, he suspects that insurance advisors could eventually face the same standard.

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