Posted by Bennett Aikin on May 13, 2015
If you’re like me, you’re probably guilty of using the terms interchangeably at least on occasion. So what is the difference between “sole” interest and “best” interest? And why does it matter?
In his most recent Fiduciary Corner column for InvestmentNews, fi360 CEO Blaine Aikin looks at this distinction and asks whether some conflicts are what’s “best” for investors.
The sole interest standard is the more rigid standard, requiring that conflicts of interest in a fiduciary relationship be avoided entirely. Strictly speaking, a sole interest standard forbids even mutually beneficial transactions or compensation for the advisor. Just the opportunity for impropriety is enough to violate this standard, even if no actual harm occurs. Because of the strict interpretation of a sole interest standard, prohibited transaction exemptions are put into effect to allow for even a minimum of commerce to occur within the confines of the client-advisor relationship.
A sole interest standard exists because of the highly vulnerable position investors and beneficiaries are put into when someone else has control of their assets. It is deeply embedded in trust law, which is the foundation upon which ERISA is built.
A best interest standard is the more flexible standard. It allows for the fact that sometimes beneficiaries stand to gain the greatest benefit when the fiduciary can also benefit. The most obvious example of this is compensation. If compensation for advisors didn’t exist, professional advice would not exist either and disinterested, expert advice would be exceedingly difficult to come by.
The upside of a best interest standard vs. a sole interest standard is that it incentivizes quality of services and allows for such benefits as economy of scale. The downside is that it is more open to interpretation and ripe for abuse if not carefully monitored.
Why does it matter?
With its conflicts of interest rule proposal, the DOL has demonstrated a shift in its thinking, introducing a best interest standard when it had previously been reluctant to depart from the sole interest standard. This effectively puts more control in the hands of practitioners to determine their own business practices, as long as they can justify that their decisions were of ultimate benefit to the beneficiary.
By its nature, the best interest standard is more closely aligned with principles-based regulation than rules-based. If the DOL rule proposal is the signal of a trend, advisors and service providers in a fiduciary capacity may have less to worry about in terms of compliance, in exchange for the expectation that they be ready to demonstrate to the DOL and the courts the processes by which decisions are made on behalf of their clients.
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Editor’s note: The premise for Blaine’s Fiduciary Corner column comes from a 2005 article published in the Yale Law Journal entitled “Questioning the Trust Law Duty of Loyalty: Sole Interest or Best Interest” by John Langbein, who was the principal drafter of the Uniform Prudent Investor Act. This article was recommended to us by Eugene Maloney, Executive Vice President and Corporate Counsel of Federated Investors, himself a towering figure in the field of fiduciary law and regulation. It’s well worth the read.
For more information about a prudent investment process, we recommend you check out our Prudent Practices. For more information about the DOL fiduciary rule proposal, a recording of our most recent webinar on the topic is available in our Resources library.