When you think about it, there are plenty of good reasons why pharmaceutical sales representatives are not allowed to sell drugs directly to patients. Besides the obvious lack of medical training necessary to prescribe them safely, these representatives would clearly be subject to a significant conflict of interest with their own customers.

The conflict would arise from their strong financial incentive to sell as many drugs as possible to as many customers as possible, regardless of whether that was truly in the best interest of their customer’s health. Fortunately, only medical doctors can prescribe drugs and their compensation levels are not determined by the amount of medicine they ‘sell’ to their patients. This reduces the chance of a conflict and allows doctors to focus their efforts on preserving and protecting a patient’s overall health.

Now imagine we inhabit a world in which pharmaceutical sales representatives can sell drugs directly to patients, and are also not even required to disclose the inherent conflict of interest to their customers. Incredibly, in the financial services industry, an analogous situation has been allowed to exist at least since the creation of the modern broker-dealer structure by the Securities Exchange Act of 1934.

This is because when dispensing financial advice, broker-dealers are subject to a legal standard of care called the “Suitability” standard. In a nutshell, the suitability standard requires only that a recommended financial product be deemed “suitable” for their client (including the possibility of being the least suitable among a list of suitable products). A broker (or advisor) operating under this standard has no duty to place the client’s interests above their own (or their firm’s) interests, nor do they need to disclose any conflicts of interest they may have with their own clients!

The Suitability standard contrasts starkly with the more rigorous “Fiduciary” standard, which requires (among other things):

• The duty to disclose all conflicts of interest (actual or potential), and to minimize or eliminate them wherever possible
• The requirement to place the interests of the client above those of the advisor
• The need to act prudently with the skill and judgment of a professional

The different legal standards give rise to differences in compensation structures, with most broker-dealers earning a commission for the sale of financial products (and/or the trading thereof), whereas Registered Investment Advisors, operating under the Fiduciary standard of care, typically charge a flat fee for financial planning services or earn a fixed percentage based on the level of assets managed.

In this sense, Fiduciary advisors and clients are on the same side of the table, since both stand to benefit when a client’s asset levels grow.

However, after many decades, the Suitability standard may be on its last legs. The Department of Labor is set to issue a new ruling as soon as April of this year mandating that all advice relating to the investment of retirement assets adhere to the higher Fiduciary standard.

After the rule is finalized, there would be an eight-month grace period for all advisors to reach compliance. Predictably, there is an organized backlash among broker-dealers opposed to the rule change, but as of now this appears to have an excellent chance of becoming law later this year. If so, retirement savers would have reason to celebrate the rule change as it should lead to an overall improvement in the quality of financial advice and a reduction in investment-related expenses.