If you are an investor, you may have heard that there is a huge debate raging across the country. The issue? Should the Investment Adviser’s fiduciary standard extend to broker-dealers? The pro argument holds that this could save investors billions of dollars a year in unnecessary fees. The con argument holds that this could deprive everyday mom-and-dad investors of the financial advice they need.
You may not be aware that there are currently two standards that apply to financial professionals. One is the fiduciary standard set forth in the Investment Advisers Act of 1940. This standard applies to all Registered Investment Advisers. The other is the suitability standard that applies to brokers, financial advisors, financial consultants, etc. To highlight one underlying source of investor confusion, note the difference in spelling. The fiduciary standard applies to “advisers” with an “e,” while the suitability standard applies to “advisors” with an “o.”
To make matters even more complicated, the Department of Labor issued a new rule in 2015 that came up with a third standard, basically a watered-down version of the fiduciary standard applicable only to advisers dealing in tax-advantaged retirement accounts such as IRAs and 401(k)s. Thanks to a lawsuit against the DoL brought by the U.S. Chamber of Commerce and a broker-dealer industry body, the Fifth Circuit struck down the DoL’s rule last June, holding that the DoL had not only overstepped its authority but also that its rule would harm consumers.
New proposals abound, but so does the prospect of additional lawsuits being brought no matter which, if any, proposal succeeds. So what is an investor to do? The answer consists of the following three-step homework assignment:
- Understand the two standards and to whom they apply
- Determine which kind of financial adviser/advisor you currently have or intend to hire in the future
- Determine if that adviser/advisor meets your investment needs
Suitability Standard vs. Fiduciary Standard
The suitability standard calls for your financial professional to do the following four things:
- Execute your buy/sell orders promptly and under the most favorable available terms
- Disclose all material information to you
- Charge you fees reasonably related to those of the prevailing market
- Fully disclose to you any conflicts of interest (s)he has
Financial professionals operating under this standard usually charge a commission on the products they sell, but they may charge fees as well. Since this person’s income is commission-based, (s)he can and may well steer you to high-commission investments without running afoul of the suitability standard. The only requirement is that any investment (s)he steers you to must be “suitable” for you.
The fiduciary standard is considerably higher. Not only must a financial professional operating under it do the above four things, but (s)he must also do the following five things:
- Act with undivided loyalty to you, and with the utmost of good faith
- Give you full and fair disclosure of all material facts that you, as a reasonable investor, would consider important
- Not mislead you
- Avoid conflicts of interest rather than merely disclosing them
- Not use your assets for his or her own benefit or for the benefit of other clients
How to Tell Advisers from Advisors
How can you tell when an adviser is a fiduciary? Ask him or her! Ask such questions as these:
- Are you a Registered Investment Adviser?
- Are you dual registered as an investment adviser and a broker-dealer?
- Do you get compensation above what I’m paying you?
- Have you ever received disciplinary action from a professional or regulatory organization?
If (s)he holds himself or herself out to you as a fiduciary, ask him or her to put that in writing. Remember, a fiduciary is someone who acts on your behalf. As such, (s)he has a duty of care to you that includes monitoring your investments and your financial situation and adhering to the best practices of conduct as long as (s)he is in your employ.
Note: this post contains contributed content.