Who is a Fiduciary?

Fiduciary vs. Suitability – Which standard is best?

By FPA member, Tim Sobolewski, CFP®

Last Updated: September 25, 2012

The debate as to which standard should prevail for financial advisors has raged for years now, although it’s very far under the radar as far as the general public is concerned. What is this about, and why is it important? First, some definitions:

The suitability standard says only that an advisor must do what is suitable for an investor, based on that investor’s particular circumstances. Here is how the SEC defines it:

When your broker recommends that you buy or sell a particular security, your broker must have a reasonable basis for believing that the recommendation is suitable for you. In making this assessment, your broker must consider your income and net worth, investment objectives, risk tolerance, and other security holdings.

In other words, a bond portfolio might be suitable for an older investor seeking income; a portfolio of penny stocks would not. The same bond portfolio would be unsuitable, however, for a young and aggressive investor looking for growth.

Note that the above definition does not demand that your broker do what is best for you – only that it be “suitable.” It also does not preclude conflicts of interest. Unfortunately, what is best for you may not be best for the financial advisor: there might be two investments that would qualify as suitable for you, but one would pay your advisor a 1% commission or fee, and the other a 7% commission. Which do you think he might recommend?

The fiduciary standard of care is what the Investment Advisers Act of 1940 demands of registered investment advisers (RIAs) and their representatives: the adviser must place the client’s best interests above his own. The Certified Financial Planner Board of Standards also demands that every CFP® professional act as a fiduciary, defined as “one who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client.” Even SIFMA (the Securities Industry and Financial Markets Association) agrees that:

A fiduciary relationship is generally viewed as the highest standard of customer care available under law. Fiduciary duty includes both a duty of care and a duty of loyalty. Collectively, and generally speaking, these duties require a fiduciary to act in the best interest of the customer, and to provide full and fair disclosure of material facts and conflicts of interest.

The 2010 Dodd-Frank bill authorized the SEC to mandate that brokers adopt the same fiduciary standard of care that applies to investment advisers. The SEC has still not done this, due partly to the high level of disagreement about this within the financial industry, and their consequent lobbying.

Insurance brokers, for example, are usually only Series 6 licensed; the only investments they can sell are mutual funds and variable annuities, which may not be the best choices for all investors. So we hear from NAIFA (National Association of Insurance and Financial Advisors) President Terry K. Headley:

The Consumer Federation of America’s claim that the fiduciary standard of care provides better protection for consumers is a myth… The suitability standard is robust and heavily enforced. A suitability standard is rules based, objective and prospective in nature, as opposed to fiduciary, which is process-oriented, subjective and retrospective. There is no evidence to support the claim that the fiduciary standard has provided consumers superior protection in comparison to the protection provided by the suitability standard. NAIFA believes that all Americans should have freedom of choice on how they access and pay for financial products and services.

The enormous resistance from the brokerage industry to adopt a fiduciary standard is summed up in Financial Planning:

You first have to change the culture of the brokerage industry. Before a fiduciary standard can be put in place, there has to be a fundamental shift in the behavior of regulators and broker-dealer senior management. They must move from a rules-based framework, which requires little standard of care, to a principles-based framework, which requires a high standard of care.

Most investors mistakenly think that their brokers are already governed by a fiduciary standard. According to a study by Cerulli Associates:

63% of investors working with wirehouse or regional B/Ds believe their advisors are governed solely by the fiduciary standard, but advisors in this channel report that only 13% of their clients had fiduciary-only relationships.

It appears likely that the fiduciary standard will prevail, but not before 2013 at the earliest. In the meantime, it is important for you to ask your financial advisor which standard they adhere to – just as you should ask them how they are paid. Make sure to do your due diligence, and choose your advisor carefully.

FPA member Tim Sobolewski, CFP®, is President of The Financial Planning Center, Amherst, N.Y.

The Critical Difference between a Stockbroker
and Registered Investment Advisor

By W. Scott Simon Copyright @ 2005 by W. Scott Simon.


Maybe you’ve heard the word “fiduciary” mentioned a lot in the media over the past few years. A “fiduciary” is someone that manages money for the benefit of another called a “beneficiary.” A fiduciary is bound by law to place the interests of its beneficiary first – before the fiduciary’s own interests.

You would think that anyone offering financial advice to their clients is a fiduciary. If you think that, you’d be wrong. Stockbrokers (also called “Registered Representatives,” “Account Executives,” “Financial Advisors” or “Wealth Managers”) are not fiduciaries, even though they have engaged in high-visibility advertising to portray themselves as full-service investment advisors. (Ask your stockbroker/registered representative/ account executive/financial advisor/wealth manager if he or she holds a series 7 securities license. If he or she does, then it’s probable that they aren’t a fiduciary.)

A “Registered Investment Advisor,” subject to the Investment Advisers Act of 1940, is a fiduciary.

The legal investment advising standards that govern a non-fiduciary stockbroker and a fiduciary Registered Investment Advisor are very different.

A non-fiduciary stockbroker follows only the “suitably/’ standard, which doesn’t require a stockbroker to place the interests of its clients ahead of its own. Under the non-fiduciary suitability standard a stockbroker need provide only “suitable advice” to its clients – even if the stockbroker knows that the advice is not the best advice.

A Registered Investment Advisor must follow the “trust” standard – the highest known in law – which requires it to place the interests of its clients ahead of its own and fulfill critical fiduciary duties of trust and confidence. Under the fiduciary trust standard, a Registered Investment Advisor must provide its “best advice” to a client.

Even if a non-fiduciary stockbroker wanted to follow the trust standard of law and become a fiduciary to its clients, it cannot do so because of the contract it has with its broker-dealer. Such contracts require the stockbroker to place the interests of the broker-dealer before the interests of the stockbroker’s clients.

A stockbroker, then, owes fiduciary duties only to its broker-dealer – not to its investment clients. A Registered Investment Advisor owes fiduciary, duties only to its investment clients because it doesn’t have a broker-dealer. Stockbrokers, subject to the Securities Exchange Act of 7934, maintains that they are regulated heavily by the Securities and Exchange Commission (“SEC’), the National Association of Securities Dealers and/or the various agencies in the states in which they do business. None of this less strict regulation concerning the “suitability” standard though, registers stockbrokers with the SEC as investment advisors under the more strict regulation concerning the “fiduciary” standard of the Investment Advisers Act of 1940.

The critical difference between a stockbroker and a Registered Investment Advisor is that the Registered Investment Advisor is subject to the high fiduciary legal standard when providing investment advising services while the stockbroker is not. This difference could have a major impact on your investment portfolio and hence your retirement lifestyle.


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